Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler in addressing attendees of the Futures Industry Association’s (FIA) Expo in Chicago in October urged everyone to remember why it was necessary to have a financial regulatory overhaul. You know, the financial crisis. The reminder was necessary as industry participants are increasingly frustrated with the process and resistant to new rules as Dodd-Frank appears to be missing its target.
An undercurrent to the muddle of Dodd-Frank is that with an election year coming, efforts to finalize rules will become that much more difficult. But the problem is not just the confusion over scores of new regulations covering a myriad of markets and products, it is a growing discontent based on the overhaul having a greater impact on the regulated market that did not have a problem. This, along with some errant proposals, seems to be pushing products toward the opaque swaps world and away from the daylight of centrally cleared futures, counter to goals of the law. There is also push-back from the industry and a divided Commission.
For example, margin on swaps will be based on a five-day liquidation as opposed to one- or two-day liquidation in futures. "If it was [margined] at one or two days as a future, you instantly made it more expensive," says CFTC Commissioner Scott O’Malia. "If they are swaps that are equivalent to futures in their terms, why do we have a different margining regime?"
The obscure 85/15 rule, according to many insiders, would force a large number of products on CME Group’s Clearport platform that do not execute 85% of its orders on a central limit order book to be delisted. "They would become endangered species [as] exchange-traded futures," O’Malia says.
The issue for O’Malia and others is not the number, but the fact that there is a number. When asked why the Commission was even dictating where execution occurs and margin requirements, O’Malia joked because "we can," while adding that the Commission should go back to the principle based approach.
Philip McBride Johnson, a former CFTC chairman and industry veteran says that Dodd-Frank effectively moves commodity options into the swap regime. "If [options] are traded like swaps, if I am a commercial hedger, I can trade my little heart out opposite [anyone]," Johnson says. "I don’t have to put the order on the exchange. I don’t have to clear it and I can sit down and decide along with [my counterparty] what collateral arrangement I need. That stuff can be off-exchange and stay off-exchange as far as I can tell."
Johnson says it all comes down to the definition of a swap. "People can write it up as a swap and then they fall into the swap regime; if they are commercial hedgers, they are out of the exchange clearing environment entirely. The more the definition confuses distinctions between futures and swaps, futures might [become] a quaint old thing like whale oil lanterns."
Gensler has heard those concerns and stated, "We are focused on not undercutting the futures model that has worked very well over many years. [It is important in] finalizing rules on swap execution facilities and trading of swaps that we not somehow undermine the trading of futures because that model, the futures model, has been very transparent where the public has been able to see all of the transactions, and the swaps market has been dark."
However, some rules appear to allow products to move, or force them, into the swaps world.
Johnson recommended defining swaps as futures. "Why are we going through this enormous [process] saying that we are going to treat swaps one way, futures a different way, when we could say they are all futures and options and let’s live within the existing structure but make exceptions where we think it is appropriate to do so."
The industry is worried they are facing more changes than the products the law was aimed at. "When the smoke clears and everybody claims the exemption that they are entitled to under the statute, a lot of people are going to be surprised at how little impact this is having," Johnson says.