Some Swaps Rules Need Work

Reforms to swaps market are reducing risk, but ISDA’s O’Connor cites 'serious concern' about some policies.

Reforms to the $708 trillion private derivatives market are reducing systemic risk while some rules need more work before being implemented, said Stephen O’Connor, chairman of the International Swaps and Derivatives Association.

“There is today serious concern about some of the other policies underway” related to the Dodd-Frank Act that toughens oversight of the market, O’Conner, Morgan Stanley’s global head of over-the-counter client clearing, said at ISDA’s annual meeting today in Chicago. He cited differences between new swaps rules in Europe and the U.S., known as extraterritoriality, and mandated electronic execution for swaps as issues the industry wants to address.

Banks, hedge funds and asset managers active in the over-the-counter derivatives market are adapting to changes mandated by the Dodd Frank Act passed by Congress in 2010, including a requirement to process most swaps with a clearinghouse to cut counterparty risk. While embracing measures to adopt clearing, the industry group has opposed requirements that any cleared swap be traded on exchanges or similar electronic systems.

“There’s little to suggest it will benefit users,” O’Connor said, referring to ISDA research that found that requiring electronic trading would reduce trading and increase the gap in prices to buy and sell swaps.

A proposal by the Commodity Futures Trading Commission that traders get a minimum of five price quotes before a transaction “needs further consideration,” O’Connor said. Many bank swaps customers “are opposed to this since excessive inquiry might itself stimulate an adverse price move,” he said.


Profit Center

The reforms are aimed at one of Wall Street’s largest profit centers. The largest dealers make a collective $30 billion a year by executing fixed-income swaps, such as for interest rate and credit risk, with their customers, compared with $3 billion to $5 billion a year from trading fixed-income futures, according to consulting firm Oliver Wyman.

The CFTC has completed 100 rules out of a total 400 to cut risks in the market, O’Connor said. The industry lowered systemic risk by adopting clearing ahead of regulations and through collateral agreements that protect against counterparty losses, O’Connor said.

“ISDA strongly supports clearing requirements but wants to make sure the implementation is done right,” he said in opening remarks at the conference. “We don’t want to see a race to the bottom on margin terms,” or fragmentation of clearinghouses that will make the market less stable, he said.

Non-cleared interest-rate swaps trades have decreased to 28 percent of the market, he said. O’Connor was appointed as ISDA chairman a year ago, “a time of significant change in our markets and our firms,” he said. “Life as we know it will change.”

ISDA, the lobbying and industry group for swaps users, has more than 800 members in 58 countries, O’Connor said.



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