Second, the swaps market has been transformed to a market with mandated central clearing for financial entities as well as dealers.
Central clearing 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 crisis.
Reforms have taken us from only 21 percent of the interest rate swaps market being cleared in 2008 to approximately 70 percent of the market this fall. More than 60 percent of new credit index swaps are 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 a key benefit 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 swap trades intended to be cleared.
Thus, breakage agreements – agreements that dealers had requested 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 DCM.
Third, the market has been transformed for swap dealers.
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.
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 2008.
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.
We also have been asked by a number of foreign-based swaps dealers if Dodd-Frank applies to them when they are arranging, executing or negotiating swaps in the United States. We thought the answer was pretty clear, but we put out an advisory reminding people that the answer is yes.
A U.S. swap dealer on one floor of a New York building and a foreign-based swap dealer along the same elevator bank are required to follow the same rules when arranging, negotiating or executing a swap.
Market events of the last two years also highlighted the need to further ensure the protection of customer funds.
Segregation of customer funds is the core foundation of the commodity futures and swaps markets.
Segregation must be maintained every moment of every day.
The CFTC went through a two-year process with market participants, including the CME, to ensure that customers have confidence that their funds are segregated and protected. Last month, the Commission finalized the sixth set of customer protection rules.