Sum of Swap Rules May Hurt Trade

Proposed rules seen boosting costs; Morgan Stanley exec cites ‘multiplier effect’

Proposed rules to increase transparency in the $708 trillion private derivatives market may combine for an amplified effect that boosts costs for users, according to industry executives.

Trading in interest-rate, credit-default and other swaps may decrease if several changes are taken together, James Hill, a managing director at Morgan Stanley, said today at the annual conference of the International Swaps and Derivatives Association in Chicago.

“I’m very concerned there’s a multiplier effect to this,” Hill said during a panel discussion. “That’s something we need to look out for.” He listed increased costs associated with margin for swaps trades, for processing transactions with a clearinghouse and increased capital requirements banks will have to adopt.

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 needs to be time for market users to adapt to the changes coming under Dodd Frank and to absorb the costs, said William De Leon, global head of portfolio risk management at Newport Beach, California-based Pacific Investment Management Co.


'Knock-on Effects'

“The cold-turkey effect can be quite large,” said De Leon, who is also an ISDA board member. “As you add them up, the unknowns are quite large and the potential knock-on effects are larger than we’d hoped.”

Making prices known to the public helps improve market activity, Gary Gensler, chairman of the Commodity Futures Trading Commission, said today in remarks to the conference.

“Economists for decades have shown that transparency lowers trading costs, lowers bid-ask spreads, increases liquidity,” Gensler said.

Such a view is at odds with trading in swaps markets, Hill said.

“That’s simply not correct in these markets,” he said. “There are times increased transparency can reduce liquidity.”

De Leon said the effects of publicly reporting swaps trade prices and moving trading onto electronic systems could harm large investors.

“For the occasional user of derivatives who’s not watching the market every day who trades small size, this transparency will be a benefit to them because they’ll get more information,” he said.

For larger investors who trade in bigger size on behalf of clients, increased transparency may hurt the firm as “the bid- ask will be higher and it will ultimately hurt our investors,” De Leon said. “From that standpoint I think the market needs to be patient” and not rush implementation of the rules, he said.



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