On both sides of the Atlantic, many capital-constrained swap dealers are balking at the expense of implementing new G20-endorsed rules for the clearing and on-exchange trading of derivatives, while doubting the benefits proposed by regulators.
In Europe, the cost of establishing OTC clearing services, connecting to clearing houses and setting up new technology in the midst of the widening Eurozone crisis, are leading dealers to battle – if not derail – European OTC reform coming from the European market infrastructure regulation (EMIR), according to financial research firm TABB Group.
The report found 70% of dealers were lobbying against reforms, although they were continuing to build systems upon the presumption the regulation would go forward as planned.
Top-tier European banks are each planning to allocate a minimum US$100 million a year to their OTC derivatives reform technology budget, according to the TABB report, while mid-tier firms expected to spend in the tens of millions.
The larger borker-dealers are building out their trading and clearing operations, revamping their prime brokerage, clearing and intermediation teams to operate as new, stand-alone units that can cross-sell swaps into the hedge fund space, TABB says. However, mid-tier dealers are balking at the cost of clearing.
“Whether it be trading connectivity, reinventing prime broker systems for client clearing, implementing straight-through processing software or revamping single-dealer platforms, these dealers are dedicating valuable resources to new technology roll-outs, despite such capital constrained times,” said Will Rhode, TABB senior research analyst and author of the report, ‘European credit and rates dealers 2011: Capital, clearing and central limit order books’.
EMIR is currently being harmonised by the European Parliament and the Council of the European Union.
Across the pond, more than one year since the Dodd-Frank Act was signed into law, scepticism is growing in the swaps markets about the benefits of swap execution facility (SEF) rules, which many believe will have a negative impact on liquidity.
Dodd-Frank aims to move as large a proportion of OTC trading activity as possible onto the newly-defined SEFs.
Kevin McPartland, director of fixed income research at TABB, said although US regulators expect to begin the implementing SEF trading mandates by the third quarter of 2012, over 80% of market participants do not expect implementation until 2013.
“Although we still see little clarity as to how the swaps market will function going forward, that has not prevented the swaps industry from innovating and creating new business models and technology to ensure liquidity in the swaps market remains, despite the frustrating regulatory uncertainty.” McPartland, who has authored a report entitled ‘SEF Industry Barometer: Fall 2011’, said.
Despite concerns regarding overly prescriptive regulation, McPartland said there was no lack of interest in the sector. Over 43 firms have expressed an interest in creating a SEF.
The Dodd-Frank Act has been delayed from its original July target date, following the announcement by Commodity Futures Trading Commission chairman Gary Gensler in September that some of the key rules will not be implemented until 2012, including the final rules for SEFs. The regulation had also come under attack from Craig Donohue, head of Chicago-based derivatives exchange CME Group, on the basis that it does not take sufficient account of the costs and benefits of the proposed new rules.
By Christopher Gohlke, Global Custodian – an Asset International publication
Extra reporting, Bruce Love