Tuesday, February 16, 2016

Better Markets Urges CFTC to Rein in Big Swaps Dealers

By Anne Sherry, J.D.

Better Markets is urging the CFTC to defend Dodd-Frank's derivatives reforms against the large Wall Street dealers that control over 90 percent of the swaps markets. The agency's recent position that markets should evolve naturally seems to condone large derivatives dealers' abuses, according to the think tank's new policy brief. Better Markets wants the CFTC to stop exempting dealer-banks from rule compliance, enforce impartial access rules, eliminate post-trade name disclosure on swap execution facilities (SEFs), ensure global harmonization, and shed light on de-guaranteed affiliates' derivatives activities.

Dodd-Frank authorized the creation of SEFs to provide greater pre- and post-trade transparency to the swaps market. Last month, the CFTC granted permanent registration to 18 SEFs that had been operating for two years under temporary status. But Better Markets submits that the SEFs have encountered resistance from the big dealers that control the derivatives markets and see an open swap market as a threat. End users have brought two lawsuits against these dealers recently, one of which settled for nearly $2 billion.

Cross-border evasion. The large banks have also attempted to divert business away from U.S. SEFs by removing U.S. parent guarantees from foreign affiliates to take advantage of a regulatory loophole ("de-guaranteeing") and convincing the CFTC to exempt traders working in the U.S. from Dodd-Frank rules if they booked the swaps to offshore entities. These actions increase systemic risk, harm investors, and threaten reforms, Better Markets says. The CFTC should enforce existing rules and apply substituted compliance only to foreign regulatory regimes that are in fact equivalent to Dodd-Frank's rules.

Retaliation. Other dealer tactics that Better Markets identified include denying clearing customers the credit limits needed to trade on SEFs that don't acquiesce to the dealer's demands, ceasing liquidity provision on SEFs that attempt to comply with CFTC impartial access requirements, and threatening to provide inferior off-SEF pricing to customers trading on dealer-only SEFs. Post-trade name disclosure also invites retaliation against customers trading on certain platforms. But despite acknowledging that he hadn't heard a compelling justification for name disclosure, Chairman Massad said later at a conference that the Commission would not be taking any action against it.

Necessary actions. According to Better Markets, U.S. regulators must oversee activity conducted by swaps traders in the U.S. Even if substituted compliance were appropriate for some activities, U.S. regulators should retain oversight until they ensure that the foreign rules are equivalent in fact to U.S. standards. Furthermore, the CFTC should enforce its rules on impartial access to prevent dealers from preserving dealer-only platforms. The legacy practice of post-trade name disclosure must also be prohibited.

The group also wants to see U.S. regulators work with global regulators to promote harmonization and eliminate regulatory arbitrage. Finally, due to the risks that de-guaranteed affiliates of U.S. entities may pose to the financial system, there must be full transparency around their derivatives activities.

Statement. Announcing the policy brief, Better Markets' Dennis Kelleher stressed that unregulated derivatives were a primary cause of the financial crisis. Although an entire chapter of Dodd-Frank addressed derivatives, large Wall Street dealers are evading or threatening the reforms, he warned. The CFTC must "stop derivatives reforms from being undermined, if not defeated."