The financial reform bill that passed the Senate in late May will open the door to an even longer rule-making process that will impact traders and the futures industry. On May 20, the Senate passed the Restoring American Financial Stability Act of 2010, which includes broad clearing requirements for over-the-counter (OTC) derivatives, margin and execution requirements, requirements that swap dealers and major participants be registered and gives the Commodity Futures Trading Commission (CFTC) authority to impose position limits across commodity markets. In June, the Senate bill was being reconciled with similar legislation passed last December in the House. Congress aims to pass a final bill into law by July 4.
Kevin McPartland, senior analyst at Tabb Group, says the reconciliation would likely happen by the end of August. He expects some required clearing, some required trading on electronic platforms, reporting of all OTC transactions and more registration of market participants to all make it into the final legislation.
Two major differences between the House and Senate versions were still pending at press time. The provision introduced by Senate Agriculture Committee Chairman Blanche Lincoln (D-Ark.) that would prohibit the Federal Reserve and FDIC from providing any federal funds to banks who engaged in derivatives trading, thereby requiring banks to spin off their derivatives business to retain FDIC insurance, looked unlikely to pass. Another provision up in the air is the Volcker rule, which would ban proprietary trading and investment in private equity funds by depository institutions and their affiliates.
“The swaps desk spin-off will [probably] die and the Volcker rule will go through in some capacity. They’re not going to say ‘banks can’t prop trade any more,’ but at some level, it will go in,” McPartland says.
Former FDIC chairman William Isaac (see Cover Story) supports the Volcker rule and is worried provisions of the legislation will tie the hands of the FDIC and the Fed, not allowing them to act swiftly in the next crisis.
Jon Corzine, CEO and chairman of MF Global and a former head of Goldman Sachs, disagrees. “They are in a much better position with the new arrangements to exhibit the leadership that is necessary in a timely crisis. The Fed at the end of the day has the ability to get the money into the system the fastest,” Corzine said while speaking at the Managed Funds Association conference in June.
Corzine is largely in favor of the legislation, though he has some reservations. “The bill isn’t perfect but it does some reasonable things that would be good for all of us and our industry. The need for organized systematic risk oversight of all meaningful players in the marketplace is a good thing.”
Willa Bruckner, partner, Alston & Bird, agrees that support for the swaps spin-off provision is waning. As far as what will make it into final legislation, she says, “Broad clearing requirements, margin requirements, execution requirements will be in there, the requirements that swaps dealers and major participants be registered and the capital requirements. There will be some sort of end user exemption that will make it into the legislation.”
The reform will affect the way traders do business in many ways. “Dealers or major swaps participants will have to register with the CFTC or the SEC or potentially both. That means there will be reporting requirements, compliance requirements, record-keeping requirements and additional capital. There will be an additional layer of internal controls that they’ll have to deal with,” Bruckner says.
McParland adds, “The real complications are going to be for the operations people who are going to need to redefine the entire process of how trades are confirmed and settled and cleared.”
After passage, it will be up to the CFTC and Securities and Exchange Commission (SEC) to determine final rules, which could be a long process. “We’re going to see at least 12 months of rule writing from the regulators [followed by] another six to 12 months of implementation,” McPartland says. This is a process that concerns Corzine, “There is the potential that a lot of the real regulation will be written by the regulatory authorities,” he says.