U.S. banks set to win rollback in Dodd-Frank swap-trading rules

Buyers will be required to seek fewer quotes

JPMorgan Chase & Co., Goldman Sachs Group Inc. and the world’s largest banks are set to win a rollback in final Dodd-Frank Act rules intended to transform the swaps market by increasing competition.

The Commodity Futures Trading Commission’s five members are scheduled to vote in Washington today on rules determining how buyers and sellers must trade credit-default, interest-rate and commodity swaps in a $633 trillion global market. They plan to weaken a proposal by reducing the number of price quotes buyers must seek on swap-execution facilities after banks said a five- quote requirement was onerous and would impair trading.

The vote on the rules represents “the start of a process that could eventually lead to a seismic change in trading of over-the-counterderivatives,” Richard Repetto, an analyst with Sandler O’Neill & Partners LP in New York, said in a telephone interview yesterday. “It is a switch from an opaque, bilateral market to something where there is some price transparency and a more open and automated market.”

The trading regulations are the latest step in efforts by the CFTC and Securities and Exchange Commission to curb risk and increase transparency in the swap market. Largely unregulated trades helped fuel the 2008 credit crisis that led to the collapse of Lehman Brothers Holdings Inc. and a U.S. rescue of New York-based American International Group Inc.

CFTC Chairman Gary Gensler has pushed for rules to improve competition by shifting the “information advantage” away from Wall Street banks.

‘Lower Costs’

The final rule “will lower costs to the American economy and also lower risks,” Gensler told reporters on a telephone news conference yesterday. “It lowers risk because when assets and derivatives are priced real-time in competitive marketplaces, it’s easier to know what’s happening inside your company and inside those large financial institutions.”

Five Wall Street banks dominate the U.S. swaps business with JPMorgan, Goldman Sachs, Bank of America Corp., Citigroup Inc. and Morgan Stanley controlling 95 percent of cash and derivatives trading for U.S. bank holding companies as of Dec. 31, according to the Office of the Comptroller of the Currency.

The rules may erode bank profits by reducing their current ability to trade directly with other banks or clients in the bilateral market. The trading, clearing and other rules may cost JPMorgan $1 billion to $2 billion in revenue, according to a Feb. 26 presentation by the bank.

New Platform

The rules represent the final definition of a new type of trading platform set up under Dodd-Frank that is intended to serve as an alternative to exchanges operated by CME Group Inc. and Atlanta-based Intercontinental Exchange Inc. Bloomberg LP, the parent company of Bloomberg News, has filed a lawsuit challenging a separate CFTC rule that the company said will harm its planned swap-execution facility. Tradeweb LLC, Icap Plc and GFI Group Inc. have said they plan to set up so-called SEFs.

Dodd-Frank would have most swaps traded on SEFs or exchanges that let buyers and sellers interact with multiple participants. About 80 percent of interest-rate swaps will be guaranteed at clearinghouses and traded on SEFs, Credit Suisse AG analysts Ira Jersey and Michael Chang estimated in a May 2 note.

CFTC commissioners changed the proposed quote requirement after talks faltered late last year over the plan to mandate five quotes. JPMorgan, Deutsche Bank AG and other swap dealers lobbied against the five-quote requirement, telling regulators that it is unnecessary, will increase trading costs and reduce liquidity on facilities using request-for-quote systems.


The final rules up for a vote today would let buyers request two quotes initially and then three quotes after a phase-in process, according to a CFTC official who briefed reporters yesterday. Gensler agreed to the quote compromise after failing to persuade Republican and Democratic commissioners that five were needed. The three-quote requirement would begin in around October 2014.

“It is going to be perceived as a win for the dealers, especially the two included in the RFQ,” Sunil Hirani, chief executive officer of the trueEX Group LLC swap-trading platform, said in a telephone interview yesterday. “I see it as a capitulation for those who wanted a higher number.”

The final rule would allow companies that execute trades through the telephone or any form of technology to operate as SEFs, according to a CFTC official. Brokers such as GFI and Icap, which facilitate trades between banks, lobbied the agency to permit trades conducted by voice and not require electronic- only methods.

‘Voice Broking’

“We’ve got a very strong electronic initiative so if the outcome is heavily supportive of electronic solutions we have covered that base,” ICAP Chief Executive Officer Michael Spencer said on a call with reporters as the London-based inter- dealer broker reported full-year earnings on May 14. “If on the other hand the status-quo of voice broking remains unchanged, we obviously have a big voice-broking business.”

A separate rule also scheduled for a vote today would set the threshold for when trades are large enough to be traded off the platforms in transactions known as blocks. The rules for blocks also allow for a phase-in process. rules for blocks also allow for a phase-in process.

Under the rule, a trade would be considered a block if it is larger than the 50th percentile for notional value in a given category of swaps. Starting in April, the threshold would rise to the 67th percentile. About 14 percent of interest-rate and credit swaps might be traded as blocks until the higher threshold takes effect, a CFTC official said.

“These are short-term gains for the status quo,” James Cawley, CEO of Javelin Capital Markets LLC, said in a telephone interview yesterday. “The market is moving to cheaper and more electronic trading of swaps. The argument that the products are bespoke and too complicated to be traded on a screen are unfounded.”

The commissioners are also scheduled to vote today on on interpretive guidance and policies on disruptive trading practices.


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