Market participants have expressed support for a petition being gathered by Intercontinental Exchange (ICE) CEO Peter Barsoom, which demands that US regulator the Securities and Exchange Commission (SEC) should allow buy-side firms to use a single account to cross-margin between single name and index derivatives.
From a regulatory perspective, single name derivatives are overseen by the SEC, while the Commodity Futures Trading Commission (CFTC) handles index derivatives. But since the Dodd-Frank act also mandates standardisation and central clearing for the majority of OTC contracts, asset managers will have to post margin for single name and index derivatives on separate SEC and CFTC accounts. Barsoom is concerned that the rules create unnecessary duplication and cost for asset managers.
"Cleared derivatives must be at least as competitive as OTC derivatives,” he told theTRADEnews.com. “It would be a bizarre outcome if trading and clearing a swap was disadvantageous relative to keeping it as a bilateral OTC contract. The same margin methodology needs to apply to all customers, and the buy-side needs to be able to hold single name and index derivatives in the same account for margining efficiencies."
Other market participants have also expressed concerns that the costs of margin and collateral requirements of clearing trades at central counterparties (CCPs) could be too high for buy-side firms, particularly if they are unable to net single name and index derivatives against each other to save on margin. Alex McDonald, CEO at the Wholesale Market Brokers’ Association (WMBA), warned that the current divide in jurisdiction between the SEC and CFTC means that smaller buy-side firms are being disadvantaged.
“It would make more sense to enable netting of single name and index derivatives,” he said. “There’s a huge squeeze on collateral everywhere, and buy-side firms need to save on margin. Being efficient with collateral is starting to occupy a lot of people’s time – we would definitely support the ICE position on that.”
In October, ICE asked the SEC to allow single name and index credit swap trades to be held in one account, to allow offsetting trades to be netted against each other.
"Portfolio margining was envisioned and permitted by Congress,” said Barsoom. “Both the SEC and CFTC have approved it already for clearing members. It works, so why not allowed for end-users?"
Central clearing is intended to help reduce systemic risk in OTC derivatives markets. Regulators hope that, by requiring market participants to post margin and collateral at a CCP, they can prevent a default by one large counterparty from having serious knock-on effects on financial markets. But Gert Raeves, research director, capital markets at financial research firm TowerGroup, points out that the burden still rests with individual firms to reduce their own risk.
“The individual firm is not necessarily any better protected,” he said. “Margin and collateral requirements are providing a real headache for many asset managers, and I am concerned that some firms, in the rush to meet their compliance goal, are sacrificing some of the business advantages that would come from best-of-breed technology investment.”
The deadline for implementation of the new rules on OTC derivatives is the end of this year, in line with the G20 nations’ commitment on reducing systemic risk in financial markets. But the lack of time remaining for the rules to be finalised has been a cause of concern for market participants both in the US and in Europe, where the European market infrastructure regulation (EMIR) is currently being decided by the European Securities and Markets Authority via some 30 technical standards. For the WMBA’s McDonald, disputes over the final rules are inevitable – but he also believes they represent a constructive part of the legislative process.
“When you get the buy- and sell-side commenting on the same issues, that suggests the rules are not quite written correctly,” he said. “That is unsurprising, given the deadline for implementation. The regulators will have to process an enormous amount of comment before the deadline expires at the end of the year – but in the case of cross-margining, it should not be that hard for the CFTC and SEC to come to an agreement.”
In the past few months, the CFTC and other US regulatory agencies have made significant progress on Dodd-Frank implementation but they are still far behind schedule on the vast majority of the act. According to law firm Davis Polk, as of 1 May, a total of 221 Dodd-Frank rule-making requirement deadlines had passed – some 55.5% of the 398 total rule-making requirements. Of these 221 passed deadlines, 148 (67%) have been missed and 73 (33%) have been met with finalised rules. Davis Polk says regulators have not yet released proposals for 21 of the 148 missed rules.