In a victory for banks, global financial regulators revisedrules governing how much money must be set aside to cover losses byswaps traders, backing away from guidelines that firms warned woulddestabilize the $693 trillion derivatives market.

The Basel Committee on Banking Supervision's final rule,released today, would require swaps dealers to hold less cash toprotect against defaults than did a proposal published last year.The plan now applies a minimum 20 percent risk weighting to moneydeposited at clearinghouses, which are third parties that guaranteethe transactions, down from 1,250 percent in the original proposal.The change takes effect on Jan. 1, 2017.

The interim plan had threatened to boost costs as much as 92times, according to calculations by three banks shared withBloomberg News. The risk from that original rule, which was lastrevised in 2013, was the higher costs could have caused marketparticipants to flee rather than take advantage of theclearinghouses, making it more difficult for the third parties tosafeguard the swaps market.

“They really had people spending a year thinking about it, andthey reversed it. The banks should be very happy,” said ChrisCononico, president of GCSA LLC, a New York-based underwriterthat's seeking to insure derivatives clearinghouses. The proposedrule “seems to have evaporated,” he said.

International regulators are trying to safeguard trades andbring more openness to a market whose secrecy and sheer sizeoverwhelmed regulators in 2008. Where swaps had been one-on-onedeals before, now they would be backstopped by third parties inclearinghouses that ensure everyone can pay, with the aim ofavoiding emergency bailouts and panic. Basel is made up ofregulators from 27 of the world's largest economies and setsinternational bank supervisory guidelines.

Swaps are what investors use to help guard against risk. They'rebought by pension plans and retirement funds to protect againstfluctuations in interest rates, meaning they affect most people whoown annuities. They're used by the U.S. government to limitexposure in the mortgage market and cut home-loan costs. Investorscan also hedge an investment in a company by buying a swap thatwill pay them if a borrower stops paying its debts.

They're called swaps because investors and banks exchange, orswap, payments over time based on how interest rates move or howthe creditworthiness of companies changes. They trade on swapexecution facilities, including one run by Bloomberg LP, the parentof Bloomberg News. Other SEF owners include ICAP Plc and TullettPrebon Plc.

Fine Line

The Basel committee had a fine line to walk. The lack of capitalto back up losses in the private swaps market was the main reasonwhy the U.S. bailed out American International Group Inc. in 2008,Michael Barr, a law professor at the University of Michigan, saidbefore today's revision. Barr helped write the Dodd-Frank law,which aimed to make the U.S. financial system more transparent andresilient, when he served as an assistant Treasury secretary from2009 to 2010. Taxpayers ultimately provided $182.3 billion inbailout funds to AIG, since repaid.

Clearinghouses can make trading safer by “clearing” trades —collecting cash or collateral to ensure participants are able topay their obligations. Clearinghouses deal only with member firms,which act as intermediaries for their customers. To cover lossesand keep the market from being disrupted by deadbeats,clearinghouses also pool cash and securities from the memberdealers in what they call default funds.

There's about $30 billion in default funds worldwide, GCSA'sCononico said. The largest swaps clearinghouse owners areexchanges: CME Group Inc., IntercontinentalExchange Group Inc.,London Stock Exchange Group Plc and Deutsche Boerse AG.

The world's largest derivatives brokers at the end of 2013 wereowned by Goldman Sachs Group Inc., JPMorgan Chase & Co.,Newedge Group SA, Deutsche Bank AG, Morgan Stanley and the MerrillLynch division of Bank of America Corp., according to the U.S.Commodity Futures Trading Commission.

The reversal by Basel is “not just a victory for the banks, it'sa victory for the system,” said Will Rhode, director offixed-income research at New York-based Tabb Group LLC. By reducingthe cost to clear trades, more banks will be able to offerclearinghouse services to their clients such as money managers andpension funds, he said. “That means more capacity for clearing willbe there and the system won't be working at cross purposes.”

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