CFTC Commissioner Christopher Giancarlo has proposed a sweeping overhaul to controversial trading rules governing the execution of over-the-counter swaps.
The rules are aimed at increasing pre-trade transparency in OTC markets as a part of the Dodd-Frank law. The new trading framework came into full affect in February of last year but has been marred by fits and starts.
“There is a fundamental mismatch between the CFTC’s swaps trading regulatory framework and the distinct liquidity, trading and market structure characteristics of the global swaps markets,” wrote Giancarlo in a white paper released today.
“This misalignment was caused by inappropriately applying to global swaps trading a US-centric futures regulatory model that supplants human discretion with overly complex and highly prescriptive rules in contravention of congressional intent.”
The rules, which the CFTC has implemented over the last three years, have been criticised by market participants who believe the framework is overly prescriptive and burdensome.
Giancarlo, a former executive at inter-dealer swaps broker GFI Group, believes brokers should be subject to stricter examinations by regulators to ensure participants are qualified to match buyers and sellers in OTC instruments.
Further, the recently installed Republican Commissioner says his agency should increase flexibility for platforms offering swaps, known as swap execution facilities (SEFs).
SEFs, he believes, should be allowed to offer execution “by any means of interstate commerce,” including by matching of counterparties over phone.
Currently, CFTC rules proscribe that participants request quotes from a minimum number of counterparties and execute for the most part electronically, though phone-based matching is allowed as part of hybrid execution models.
Giancarlo believes swaps are ill-suited for mandated execution parameters.
“Prudent regulatory oversight should allow methods of swaps execution to evolve organically based on technological innovation, customer demand and quality of service,” wrote Giancarlo in the white paper.
“SEFs, not regulators, should decide what methods of swaps execution are most suitable for the instruments they seek to execute.”
The conservative perspective on Dodd-Frank implementation has its detractors. Former agency Chairman Gary Gensler believed that Dodd-Frank intended for swaps to execute electronically and between all participants, similar to an equity exchange.
Detractors of Giancarlo’s reform efforts say that a loose regulatory edict allows entrenched market participants, such as inter-dealer brokers, to preserve an exclusive market framework where dealers retain information advantages.
The reform perspective dovetails with industry complaints regarding the framework. Industry groups such as ISDA maintain that the structure has fragmented a formerly global swaps market across jurisdictional borders.
The group says the CFTC framework has scared off non-US market participants from transacting with US counterparties.
Flexible execution
Giancarlo says his reform package needs to be treated as just that – a package – if it is to work.
“My whole proposal is a package, it doesn’t work if we don’t adopt flexible execution,” he told IFR on the sidelines of the TABB Fixed Income Event in New York on Thursday.
Flexible means of execution, he says, would promote trading on a group of platforms that to-date have been treated as black sheep by swaps users.
“Dodd-Frank had two goals – to increase trading on-SEF, and to increase price transparency,” he said at the conference.
“The first rule framework focused too much on price transparency, to the detriment of attracting volumes onto SEFs. Now we have no trading on-SEF and no price transparency. My proposal focuses first on promoting trading on-SEF, and let the market choose the structure – and then price transparency will follow.”
The release of the white paper Thursday follows on from a speech on Monday in which the Commissioner criticised the CFTC’s commodity derivative regulations.
The Commissioner believes commodities rule are unduly affecting end-users of derivative contracts, rather than the financial firms Dodd-Frank intended to ensnare.
“The stated purpose of the Dodd-Frank Act was to reform ‘Wall Street’…instead, we are burdening ‘Main Street’ by adding new compliance costs onto our farmers, grain elevators, and small futures commission merchants,” he said in prepared remarks before the Commodity Markets Council on Monday.
