WASHINGTON — As regulators continue to develop rules on a Dodd-Frank requirement to force most derivatives to be centrally traded, lawmakers heard from a slew of firms on Wednesday that are jockeying for position in the marketplace.
The regulatory reform law established swap execution facilities, which will resemble the exchanges where securities are traded, with the goal of providing more transparent pricing and reducing systemic risk in derivative markets where trades were previously made over the counter.
"The goal I think we all share is to maximize competition while minimizing barriers to entry," said Sen. Jack Reed, D-R.I., who chairs the Senate Banking subcommittee on securities, insurance and investment.
According to testimony at the hearing, as many as 40 firms plan to apply to become swap execution facilities. Those firms will specialize in the execution of trades in different kinds of swaps. There will be separate platforms for trading interest rate swaps, credit default swaps, foreign exchange swaps, commodities swaps and equities swaps. Market participants expect consolidation in the marketplace within two years or less, and said they believe that the ideal number of swap execution facilities is perhaps 15 to 20, according to Kevin McPartland of the research and advisory firm TABB Group. "Winners and losers, however, will not be chosen until after regulatory mandates are in place," McPartland said in written testimony.
Details of the regulations that firms are hoping to influence include requirements about the capitalization and independence of swap execution facilities. Another crucial question involves how much lag time there will be before the pricing of specific trades is reported. Shorter reporting times could provide more competitive pricing for end users while cutting into bank profits.
Complicating the task of regulating the exchange of various kinds of swaps is the fact that jurisdiction is split between two agencies. The Securities and Exchange Commission has authority over security-based swaps, while the Commodity Futures Trading Commission has authority over other swaps. Each agency has proposed its own set of rules, which in some cases are divergent.
At Wednesday's hearing there was bipartisan support for the idea that the SEC and CFTC should coordinate and harmonize their rules. Reed said that the intent of Dodd-Frank was for the SEC and CFTC to adopt one joint set of rules. "I hope one of the results of this hearing is to be able to focus their attention on coming up with a consistent rule for both agencies," Reed said.
Industry witnesses generally echoed that sentiment.
"The difference in rules promulgated by the CFTC and the SEC will create a significant compliance cost," said Ben MacDonald of Bloomberg LP, noting that Dodd-Frank calls on the two agencies to coordinate their work. "It remains to be seen whether they will sufficiently do so."
Sens. Mike Crapo, R-Ind., and Bob Corker, R-Tenn., both voiced their concern that U.S. financial firms will lose business if federal regulations are not coordinated with those of other nations. The two Republicans were also critical of the CFTC for what they described as a more rigid approach to regulation than the principles-based approach taken by the SEC.
"If we want to find a common international framework in order to avoid regulatory arbitrage and avoid competitive disadvantage to our markets," Crapo said, "we need to provide greater coordination and harmonization to get the rules right."
