US regulators to monitor London over-the-counter swaps

Part of London’s lucrative over-the-counter swaps market is set to come under direct US regulatory oversight as dealers in the UK capital wrestle with meeting tighter rules for overseas swaps dealers accessing US markets.

ICAP, the world’s largest interdealer broker, will next month begin trading US dollar-denominated swaps from its London home on a new US-regulated electronic marketplace.

Its favoured approach eschews an alternative that would have meant its US dollar-denominated trades being overseen by the UK’s Financial Conduct Authority.

The move may last for several years until new European rules, in line with US standards, come into effect.

The decision is set to give US regulators, in the form of the Commodity Futures Trading Commission, more responsibility in part-monitoring one of London’s largest financial services.

Over-the-counter derivatives markets and swaps trades are one of the pillars of London strength as a financial centre, with nearly half of the global daily turnover worth $1.4tn taking place in the UK.

Since the financial crisis, US authorities have also been keen to clamp down on what they perceive as a “London loophole” for global regulation.

To underpin the market against systemic risk, US authorities mandated that more of the opaque, clubby, over-the-phone swaps market be traded on new electronic venues known as swap execution facilities (Sefs). Many interdealer brokers, including ICAP, already have US-based Sefs.

As Sefs came into existence in February, US and Europe agreed a reprieve that will allow European dealers to be regulated by their national authorities. However, the final details have also been delayed, giving swaps dealers little chance to meet the CFTC’s May 14 deadline.

ICAP has begun connecting customers to its platform and will go live on May 12. It is the most high-profile interdealer broker to take such an action but others are considering the same route.

Companies such as Tullett Prebon, GFI Group, Tradition and BGC Partners act as middlemen to help brokers trade illiquid and often bespoke assets such as interest rate swaps.

Market participants have warned the uncertainty created by the piecemeal introduction of Sefs and uneven pace of global rulemaking is splitting the $700tn global OTC derivatives market.

“The core of US liquidity is US-based and the popular feedback [from customers] we had is that it ought to be on a Sef,” said Peter Best, chief operating officer of ICAP’s London-based Sef. “They didn’t want two liquidity pools. Given that it was a US-centric market, we decided to go with the Sef.”

Recent research by the International Swaps and Derivatives Association has found evidence that the venues are increasingly US-centric, with fewer trades, and of lower value, in non-dollar denominated currencies.

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