A revision of the swap dealer rule suggested by Commodity Futures Trading Commission (CFTC) commissioner Scott O’Malia could avoid a reduction in buy-side counterparties due to a lower threshold requirement, according to Sean Owens, director of fixed income for consultancy Woodbine Associates.
On Monday, O’Malia called for changes to CFTC swaps regulation including the swap dealer rule, to benefit end-users.
He said the rule should be crafted around the characteristics of participants rather than their activity, and specifically cited the lowering of the threshold defining swap dealers when engaging with special entities – firms such as municipal utility companies.
The CFTC lowered the US$8 billion threshold defining swap dealers to US$25 million for those engaging with special entities, resulting in smaller swap dealers scaling back activity to avoid more burdensome regulation. This threshold was then raised to US$800 million to entice such participants back to the market, a “quick fix” O’Malia said hadn’t worked.
“These municipal energy firms are large and savvy market participants and should be treated like any other commercial entity. The Commission must fix the paradoxical result of this rule so that commercial counterparties will come back to the market to do business with special entities,” O’Malia said.
But, the buy-side too could be affected alongside special entities if less counterparties are willing to engage with them to avoid the lower threshold, said Woodbine’s Sean Owens.
“The rule does not directly affect asset managers, but if counterparties scale back swaps activity to avoid this lower $800 million threshold, then asset managers could be disadvantaged due to a reduction in counterparties active in the market,” Owens said.
O’Malia, who has openly criticised the CFTC rule-making process recently, added that centrally cleared swaps should be excluded from the swap dealer threshold.
“The swap dealer definition was meant to capture entities engaging in dealing activities that could become systemic to their counterparties,” he said, speaking at a Commodity Markets Council event on Monday. “To the extent that end-users utilise clearing, they should never have been caught up in the de minimis calculation.”
Owens believes O’Malia’s comments reflect a desire to move away from short-term, rule-making as participants adapt to post-crisis OTC derivatives reforms.
“O’Malia is advocating a greater reliance on evidence to tweak the rules to create a long-term framework, instead of the reliance on short-term regulatory tools like no-action letters, which we’ve seen used extensively in Dodd-Frank implementation,” he said.