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Daniel L. Doctoroff Headshot

Out of the Shadows and Into the Light

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When President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law in the summer of 2010, he proclaimed to the American people that it would finally "bring the shadowy deals that caused [the financial] crisis into the light of day."

Today the shadow grows darker.

The unfortunate truth is that a Commodity Futures Trading Commission (CFTC) rule related to swaps and futures products is threatening the president's vision for financial reform generally and, more specifically, reform of the $700 trillion swaps market. In response to the CFTC's rule, market participants can, without repercussion, evade Title VII of Dodd-Frank and its regulations dealing with derivatives. This will not only dismantle all of the well-intentioned policy goals that the drafters of Title VII labored to achieve, but undermine one of the central pillars of Dodd-Frank, which was to bring transparency to the opaque swaps market. To prevent this flawed regulation from further sabotaging swap market reform, Bloomberg filed a lawsuit yesterday against the CFTC.

At issue is the CFTC's disparate approach to initial margin requirements for cleared swaps and cleared futures. Specifically, the CFTC rule determines how much margin, or upfront cost, is required to trade a financial product based on how it is labeled, rather than the risk it presents. Margin is set based on estimates of how much value an instrument could lose over the time it takes to "liquidate" the position of a trade participant if the trade participant defaults. Under the CFTC rule, financial swaps, such as credit default swaps and interest rate swaps, are saddled with margin that is calculated based on an assumed five-day "liquidation time." Financial futures, with the same risk profile as financial swaps, are treated differently and are blessed with substantially lower margin based on an assumed one-day liquidation time.

In response to the CFTC's rule, a market phenomenon called "forced futurization" has taken place, whereby market participants are simply re-labeling a swap as a future. This in turn has led to less transparency, less ability for market participants to access data, and more risk to retail investors.

Let's start with the detrimental effects the margin rules have on transparency and the ability of market participants to access data. Congress mandated that swap transactions be reported to a "Swap Data Repository" that regulators can monitor to conduct real-time market surveillance and that the public can access immediately and for free. Nothing comparable exists in the futures market. There is no "Futures Data Repository," and no real-time public reporting of futures data, which means that the public will no longer have the access to market data that it was supposed to have under Title VII.

Forced futurization is also producing market anomalies that are transferring risk to retail investors. Consumer groups fought hard to provide investor protections for "special entities" such as pension funds, schools, and municipalities who purchase swaps. No comparable protection exists in the futures market. The CFTC's rule will expose consumers to exotic financial products, such as credit default swap index futures, which if they were swaps, only sophisticated investors would be allowed to trade them. Main Street investors, who cannot trade credit default swaps, should not be tempted to trade an instrument with the same risk profile simply because it has been given a different name.

The protections that President Obama, Congress and a number of consumer groups fought so hard to apply to the regulated swaps market do not apply to the futures market. Transparency and investor protection in the futures markets, while far greater than in the pre-Dodd-Frank over-the-counter swaps market, falls significantly short of the transparency Congress mandated for cleared swaps. In the post-Dodd-Frank world, transparency should not be thwarted, access to immediately free market data should not be reduced, and retail investors should not have less protections. The CFTC's rule must not be implemented.

Dan Doctoroff is Chief Executive Officer and President of Bloomberg LP.