The costly swap dealer label has been avoided by all but the largest financial players – estimated by the Commodity Futures Trading Commission (CFTC) to be around 125 firms – and the vast majority of buy-siders will avoid the branding due to a significantly raised bar and a number of extra exemptions for hedging.
New swaps regulation, including the definition of what is a swap dealer, come as part of the sweeping financial reforms that comprise the Dodd Frank Act.
Firms which must register as swap dealers will be subject to tough new oversight of derivatives trades and harsher guidelines, but during the CFTC’s rule-making process, the buy-side has successfully lobbied for a broader hedging exemption delineation and a narrower swap dealer definition.
In December 2010, the CFTC originally put the threshold for mandatory registration at US$100 million in swaps over a 12-month period, but this was decried by firms regularly using swaps for hedging – an activity which the buy-side insisted does not jeopardise the broader financial system.
Last week’s CFTC ruling bumped that line up to US$8 billion for most types of derivatives during the initial phase-in stage, dropping to US$3 billion, pending a study by regulators. And more explicit hedges were introduced as types of activities which will not count towards triggering the threshold. Such actions include reducing exposure to oil price moves or interest rate fluctuation.
But while the move is seen as a win for the buy-side, the industry has been warned to remain alert to further regulatory changes and analyse the implications of current rules.
“The swap dealer definition is just the tip of the iceberg,” said John Jay, a senior analyst at Aite Group. “The buy-side needs to keep abreast of regulatory movements at the CFTC, with management having adequate contingency plans.”
The news came in a week of a certain amount of regulatory reprieve for the investment community. Last Thursday, the Federal Reserve Board confirmed the industry would have two full years to conform to the so-called Volcker rule ban on prop trading. Unless the board further extends the conformance period, deposit-taking institutions will have until 21 July, 2014. Previously, some banks were concerned they would need to begin compliance of the yet to be fully understood rules by the beginning of the enforcement period, 21 July, 2012.
And reports are surfacing this week that the CFTC may also be looking to grant certain foreign institutions temporary exemption from new derivatives regulations which impose stricter business conduct standards, central clearing and higher capital requirements. The CFTC is believed to be presently evaluating whether US bank foreign subsidiaries trading with foreign counterparties need necessarily comply with the rules.
The CFTC has also come under fire from industry lobby groups concerned over regulatory creep. While not part of Dodd Frank, a new rule which means investment funds would need to report to the CFTC their use of leverage and exposure to counterparty risk has come under fire from the Investment Company Institute (ICI) and the US Chamber of Commerce.
The interest groups last week filed a suit charging that the rule is “arbitrary and capricious”, because such firms already must report to the Securities and Exchange Commission.
“Mutual funds are some of the most highly regulated entities in the financial industry and this rule will require scores of mutual fund advisers to register with two regulators for the same functions,” said Karrie McMillan, general counsel for ICI, which will seek expedited consideration by the US District Court for the District of Columbia. “Rather than do its statutorily obligated due diligence and cost/benefit analysis, the CFTC simply ignored key elements of the reasoning it had previously followed in lowering barriers to participation in the commodities markets. Nowhere has it attempted to demonstrate that SEC regulation is insufficient.”