Regulators inch closer to Dodd-Frank finish line

Ever since the Dodd-Frank Act came into law on 21 July 2010 the financial industry has tried to wait patiently for US regulators to issue the final versions of the Act's 398 rules. Entering into 2013, the process probably won't change, according to experts.

Ever since President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on 21 July 2010 the financial industry has tried to wait patiently for the various US regulators to issue the final versions of the Act's 398 rules. Entering into 2013, the process probably won't change, according to experts.

Industry watchers like Anshuman Jaswal, senior analyst, securities and investments at industry research firm Celent, doubt regulators will have the remaining final rules done and dusted by the end of 2013.

"The important ones are expected to be," he says. "Then it will just be a matter of tying up the loose ends."

Currently the Commodity Futures Trading Commission (CFTC) has finalised 40 of the 60 rules for which its responsible, while the Securities and Exchange Commission (SEC) has finalised 33 of the 95 rules for which it is responsible. For Title VII of the Dodd-Frank Act, which addresses the migration of over-the-counter (OTC) swaps trades to an electronically traded and centrally cleared environment, 43 of the 90 rules remain to be issued.

Yet, this year will be critical for the industry, as it already has seen much of the progress made by the regulators, according to Jaswal. "In the next few months, we will see the debut of new swap trading platforms and other important institutional changes in the capital markets and the broader financial sector. A lot of the rulemaking undertaken this year will have vital practical implications."

US regulators still need to finalise several major rules that will transform the market structure and individual firms, including mandatory trading deadlines, business conduct standards and the infamous Volcker Rule.

"Implementing the Volcker Rule may have an impact on the swaps market's pricing and liquidity as leading investment banks move their prop-trading units outside of their main businesses," says Jaswal.

Another rule also likely to rear its ugly head this year will be a re-vamped version of the CFTC's position limit rule, which was struck down by US District Court Judge Robert Wilkins just weeks before it was to go into effect on 12 October 2012, predicts Jaswal.

However, swap execution facilities (SEFs) operators, who have been chomping at the bit waiting to begin their trading operations, may see cause for a mid-year celebration as researchers at legal firm Latham & Watkins estimate that regulators will complete the mandatory trading rule in June.

"We're already working with more than 20 SEFs and other platforms to clear their trades and more than 10 are already connected to our clearing house," says Jack Callahan, executive director, OTC products at the CME Group. "We are already to go with many of these electronic platforms."

The year of clearing and futurized swaps

Although no clearing house representatives will share estimates on the expected volume growth in cleared OTC swap trades for 2013, the OTC clearing houses witnessed dramatic growth over the previous year.

LCH.Clearnet's SwapClear business ended 2012 clearing approximately US$3.8 trillion in open interest client OTC interest rate swap (IRS) trades while competitor CME Group ended the same period clearing US$642.8 billion in open interest on the same instruments, a respective approximate growth rate of 1,847% and 643% since the beginning of 2012.

"This year has been off to an aggressive start with more customers registering for clearing while existing clients clear their first trades and others, who had not cleared that much previously, increase the amount of trades they clear," adds CME Group's Callahan.

Eris Exchange CEO Neal Brady attributes much of this to firms preparing for the pending mandatory clearing of IRS as well as single-name and index credit default swaps (CDSs), which begin on 11 March for US swaps dealers and major swap participants, on 10 June for US financial entities and 9 September for end-users and other entities.

"The mandatory clearing dates have definitely sharpened the industry's focus on how to trade swap risk the most efficiently," says Brady. "Capital efficiency is the name of the game."

To further address clients' capital efficiency in the new centrally cleared market, the CME Group introduced portfolio margining capabilities for all of its customers accounts in November 2012, which has provided clients with a cumulative US$1 billion in savings in margin requirements, claims Callahan. 

Meanwhile, IntercontinentalExchange received the final approval from the CFTC to offer portfolio margining on CDS trades last week. With the SEC already having approved portfolio margining for the single-name products it governs, the exchange operator's clearing house ICE Clear Credit can similarly reduce margin payments for correlated CDS trades.   

Soon after on 3 December 2012, the CME Group also launched trading in its new family of deliverable IRS future contracts. From their first day of trading through 15 January, this new product family attained a trading volume of 37,717 across its 2-year (7,018), 5-year (10,145), 10-year (17,011) and 30-year (3,543) contracts.

A week later, the Eris Exchange began trading its Eris Standard IRS futures contract, which is a quarterly forward-starting swaps futures with a fixed coupon that are also available in the standard 2-, 5-, 10- and 30-year contract lengths.

"By trading a 'futurized' swap, we lean on a designated contract market's known regulatory framework," explains Brady.

As such, CME Clearing, which clears all Eris Exchange trades, require only a two-day initial margin requirement rather than the five-day requirement for OTC swaps since the Eris Standards contracts trade with a fixed coupon and are completely nettable, he adds.

For the rest of 2013, CME Group officials do not expect to introduce other swap futures contracts outside their respective IRS futures product lines. However, they plan to introduce IRS futures contracts in Swedish krona, Norwegian krone and the Danish krone in March and in seven other currencies beginning in June, according to Callahan.

Brady keeps his firm's 2013 plans a bit closer to his chest. "You could see us possibly entering other asset classes or licensing our intellectual property to others to be used in their own execution venue, but we have nothing to announce now," he says.