US regulator the Securities and Exchange Commission (SEC) has proposed new rules governing the stake banks are able to hold in swap trading facilities in an attempt to resolve potential conflicts of interest.
The suggestions – known as Proposed Regulation MC – come as the Dodd-Frank financial reform bill seeks to shift a portion of over-the-counter (OTC) derivatives trading to public exchanges as well as mandating central counterparty clearing for these instruments.
Under the first proposal by the SEC, individual clearing house members will not be able to own more than 20% of any voting interest in a security-based swap clearing agency, rising to 40% if done in conjunction with any other clearing house members. In addition, 35% of the board of directors of any committee relating to the ownership of a clearing house must be independent.
The second proposal restricts an individual clearing house member from owning or having voting rights of more than 5% in any security-based swap clearing agency, with a majority directors appointed on a corresponding board required to be independent.
According to the SEC, conflicts of interest in the ownership of clearing houses could cause banks to restrict access to swap clearing facilities for some participants, in order to gain a competitive advantage.
In addition, the regulator believes bank ownership of clearing houses could lead to a reduction in the scope of products eligible for clearing if it is considered to be economically advantageous for the banks to keep some products traded OTC. Bank ownership also has the potential to lower risk management controls at the swap houses, as firms that hold stakes seek to reduce their collateral requirements, according to the SEC.
“The concern about conflicts of interest stems from the fact that the over-the-counter derivatives markets have a relatively high concentration of market activity through a limited number of dealers who earn significant revenues from their transactions,” said SEC chairman Mary Schapiro. “By creating a structure that would promote more independent voices within clearing organisations and trading venues, this proposed rule is intended to make these entities less susceptible to promoting the interests of a few participants.”
The SEC cites that five large commercial banks currently represent 97% of the total US banking industry notional amounts of derivatives outstanding, according to data from bank regulator the Office of the Comptroller of the Currency. The regulator will now seek public comment for 30 days before publishing the rules in the Federal Register.