Chicago hosted two important events last week and it highlighted a growing disconnect between the foot soldiers of the futures industry and the regulators charged with policing the futures markets.
A focus of both was swaps regulation and the expert panel on swaps (Swaps: What are they? Who has to Register?) at the NIBA event attempted to address items of concern in more detail.
The panel moderated by Michael D. Sefton, of Henderson & Lyman with Ryan Ahlfeld of the National Futures Association and Tim McDermott of the North American Derivatives Exchange (Nadex) was informative but created more questions than answers.
What was clear is that more than three years after the Dodd-Frank Act was passed and with many deadlines missed and more deadlines on the horizon there is a massive amount of confusion regarding how these products are to be regulated, who comes under this regulation and what end users must do to comply, even by those who spend their time studying it. This is a failure of regulation.
Nadex recently learned that their binary option products would fall under the definition of swaps and they would need to become compliant. I am not sure what specific aspect of binary options fall under the swaps definition but given the fact that these are fully margined products (there is no leverage involved) aimed more at the retail trader you would think they might garner some exemptive relief.
There appears to be some confusion of what foreign exchange products may come under the swaps definition particularly regarding rolling spot forex (FX) transactions.
At a later panel several over-the-counter voice brokers complained that they needed to register as Introducing Brokers (IB) even though they do not introduce account to futures commission merchants and many of the provisions don’t apply to their business.
The Commodity Futures Trading Commission’s Rule 1.35 is causing consternation in the IB world as it broadly requires recording conversations between brokers and clients and may run afoul of many state laws regarding recording of conversations. Now to mention the CFTC's margin rule interpretation that could force FCMs to sharply increase the margin it holds at exchange clearinghouses.
Too often regulatory arguments are put in black and white good and bad terms but regulation, when done right, enhances the markets they are regulating by providing end users comfort that there is an even playing field.
When it breaks down into an exercise in trying to get as many entities under your purview it becomes less effective and efficient. In the end the most powerful entities will manage to get themselves exemptions and other entities that did not create the problem in the first place face proscriptive rules and fewer people and perhaps the more vulnerable will be unable to manage their risk.
In the credit crisis that caused our great recession and led us to rethink our approach to regulation, it was the largest investment banks that were creating dubious products, which created risk that was not appropriately measured or accounted for. Conflicted ratings agencies mislabeled these products creating times bombs of over-leveraged risk being passed around institutions. Little of that had to do with the folks meeting in Chicago last week but they may be impacted by some of these fixes more than those who created the problem.
The NFA's Ahlfeld reported that 889 entities have become registered for swaps: 39 FCMs, 143 IBs, 394 Commodity Pool Operators, 261 Commodity Trading Advisors (CTA)/CPOs and 52 CTAs.
In the end, if Dodd-Frank has a greater impact on the regulated markets (and market users) that initially served as a model for regulatory reform than the large institutions that created and marketed the “financial weapons of mass destruction” that led to our credit crisis, it will be a massive failure as it will harm markets that worked and not fully address what created the mess in the first place.