The main US derivatives regulator has finalised rules aimed at reducing the risk of trading privately negotiated deals, but it softened early draft proposals in a move that is likely to be welcomed by Wall Street.
The Commodity Futures Trading Commission introduced a requirement to collect collateral, or “initial margin”, that can be used to cover losses from a default on a derivatives contract that is not centrally cleared.
Roughly 80 per cent of interest rate contracts, which make up $435tn of the $553tn over the counter derivatives market, are now centrally cleared, according to the Bank for International Settlements and the International Swaps and Derivatives Association.
The CFTC rolled back on its proposed rules and exempted trades between affiliates, in contrast with similar requirements released by the Federal Deposit Insurance Corporation in October. The rule passed with a majority of two to one, with Commissioner Sharon Bowen voting against it.
“This action today seems to be a return to blindly trusting in large financial institutions’ ability and willpower to manage their risks adequately,” she said. “And we’ve already seen where that leads.”
Commissioner Bowen said that half of the uncleared market represents banks trading with their own affiliates.
Broadly speaking, the FDIC is responsible for oversight of banks and the CFTC regulates non-bank entities. Big, sprawling global banks say they trade between different legal entities in a bid to centralise risk, or offset positions that arise in different parts of the bank.
The FDIC’s rule requires banks to collect margin from their non-bank affiliates but not post margin, a step back from their earlier proposal that required collection by both entities. The CFTC’s rule goes one step further, with no requirement to collect initial margin, apart from some special circumstances.
Despite the FDIC’s concessions banks reacted strongly saying that the rule would consume capital that could be better put to work in the market. One large US dealer said the rule would double its cost of funding transactions.
“Inter-affiliate swaps transactions do not involve transactions between distinct financial institutions that was at issue in the 2008 financial crisis and do not pose the systemic risk that the Dodd-Frank Act was ostensibly designed to address,” said Commissioner Christopher Giancarlo. “Congress expressed no particular intention to subject inter-affiliate transactions to clearing or inter-affiliate margin.”
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