The U.S. regulator overseeing the derivatives market is set to retreat from an ambitious proposal that would have increased competition in the swaps market, handing victory to large banks including JPMorgan Chase and Goldman Sachs.
The Commodity Futures Trading Commission will vote Thursday on final rules that will govern a large portion of transactions in the $633 trillion swaps market. Some derivatives are known as swaps because they “swap” risk from one party to another.
The impending regulations will determine how many prices buyers of swaps must solicit when trying to enter into a derivatives contract, the minimum size of large transactions that can be traded outside transparent trading platforms, and how trades can occur on derivatives marketplaces known as “swap execution facilities,” according to officials and agency documents.
Roughly five years after previously unregulated derivatives helped fuel the downfall of large financial institutions and led to a global financial crisis, the rules to be voted on by the five-member commission, led by Gary Gensler, Democratic chairman, represent a big portion of the government's response to rein in risky activities under the Dodd-Frank overhaul of U.S. financial regulation, while also helping to determine the profitability of swaps trading for dealers such as Citigroup and Bank of America.
After failing to persuade a majority of his commission, Gensler conceded on the price solicitation proposal, known as “requests for quote,” or RFQ, officials said. Gensler had originally proposed that buyers of swaps such as institutional investors solicit a minimum of five quotes before entering into a swap.
But the largest global banks, including Deutsche Bank, Barclays and Morgan Stanley, fiercely objected to the five-quote minimum, according to comment letters filed with the agency. The proposal was intended to increase price transparency and encourage wider participation beyond the small number of dominant dealers in a bid to diffuse risk and lower prices for institutional investors and companies that purchase swaps to offset risk.
Tens of billions of dollars in annual revenues at the world’s largest banks are at stake, analysts have estimated. Some of the world’s biggest asset managers also objected to Gensler’s proposal, and argued for flexibility.
Opposition from the two Republican commissioners -- Scott O’Malia and Jill Sommers -- and Mark Wetjen, Democratic commissioner, led Gensler to compromise on the final RFQ rule, according to people familiar with the matter. The three commissioners had settled on a two-RFQ minimum, these people said.
The agency internally considered a number of compromises, including one that would have determined the RFQ minimums based on how often certain types of swaps were traded. Traders of illiquid swaps were thought to suffer in a regime in which buyers had to solicit five quotes, based on the theory that the market would turn against them once it became known that they were looking to make a transaction. A compromise that called for a lower RFQ minimum for illiquid instruments was thought to have a chance.
In the final rule, swaps buyers will be able to solicit only two prices through swap execution facilities trading platforms for the first year after the rule is in effect, with the minimum requirement increasing to three quotes thereafter, officials said.
Gensler’s term expires this December. A future chairman could keep the RFQ minimum at two solicitations before the three-RFQ rule goes into effect.
The agency will allow voice brokers -- middlemen that facilitate trades between buyers and sellers over the phone -- to operate swap execution facilities. The voice brokerage business was once thought to be among the bigger losers of the government’s overhaul of the swaps market, as officials emphasized electronic trading.
The CFTC also is poised to vote on a rule that will finalize proposals governing so-called “block trades,” or large transactions that allow market participants to strike deals in private and report details after a delay.
Agency officials led by Gensler have pushed for a high threshold, in hopes of pushing more transactions onto transparent trading platforms.