Second, the swaps market has been transformed to a market with mandated central clearing for financial entities as well as dealers.
Customers now gain the benefit that until recently only dealers had. Central clearing of swaps lowers risk and allows customers more ready access to the market.
Clearinghouses have operated successfully at the center of the futures market for over 100 years – through two world wars, the Great Depression and the 2008 financial crisis.
Reforms have taken us from only 21 percent of the interest rate swaps market being cleared in 2008 to 80 percent during the week ending October 25, 2013.
That same week, we saw 62 percent of new credit index swaps being cleared.
Further, we no longer have the significant time delays that were once associated with swaps clearing.
Five years ago, swaps clearing happened either at the end of the day or even just once a week. This left a significant period of bilateral credit risk in the market, undermining one of the key benefits of central clearing.
Now reforms require pre-trade credit checks and straight-through processing for swaps trades intended for clearing.
As a result, 99 percent of swaps clearing occurs within 10 seconds, with 93 percent actually doing so within three seconds. No longer do market participants have to worry about credit risk when entering into swaps trades intended to be cleared.
Thus, breakage agreements – agreements that had been requested by dealers in the event a swap wasn’t accepted for clearing – are not needed and should not be required for access to trading on a SEF or designated contract market.
Taken as a whole, these reforms have completely transformed the swaps market to a new marketplace.
Third, the market has been transformed for swap dealer.
In 2008, swap dealers had no specific requirements with regard to their swap dealing activity.
Today, with 90 swap dealers registered, all of the world’s largest financial institutions in the global swaps market are coming under reforms.
These reforms include new business conduct standards for risk management, documentation of swap transactions, confirmations, sales practices, recordkeeping and reporting.
Just to note how significant this is – this past summer, swap dealers and their over 10,000 counterparties around the globe changed their swap documentation, lowering risk by cleaning up the back office.
These documentation reforms build on what the Federal Reserve Bank of New York had tried to achieve with dealers voluntarily.
I would note from my own experience in the financial community, those back office documents really matter in a bankruptcy or other crisis.
International Coordination on Swap Market Reform
Further, the transformed marketplace covers the far-flung operations of U.S. enterprises.
Congress was clear in the Dodd-Frank Act that we had to learn the lessons of the 2008 crisis.
AIG nearly brought down the U.S. economy through its guaranteed affiliate operating under a French bank license in London.
Lehman Brothers had 3,300 legal entities when it failed. Its main overseas affiliate was guaranteed here in the U.S., and it had 130,000 outstanding swap transactions.
A decade earlier, Long-Term Capital Management was operating out of Connecticut but actually booked their $1.2 trillion derivatives book in the Cayman Islands.
Based upon CFTC guidance, swaps market reform covers transactions between non-U.S. swap dealers and guaranteed affiliates of U.S. persons, as well as swaps between two guaranteed affiliates.
As of last month, offshore branches and guaranteed affiliates, as well as hedge funds, like Long-Term Capital Management, all had to come into central clearing and the other Dodd-Frank reforms.