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Landmark reforms of the derivatives market are being threatened by a battle over the extent of US oversight, according to bankers, investors and officials. US regulators had hoped to begin shifting the opaque derivatives market on to electronic exchanges from October 2. The switch to so-called “swap execution facilities”, which is designed to improve financial stability and transparency, is a key part of the regulatory response to the financial crisis.
There is a danger that the rules could have the opposite effect to that intended and reduce transparency by pushing trading activity away from electronic platforms and back on to the telephone, market participants argue. “Lit markets with a screen will turn dark due to the confusion”, said one interdealer broker. Robert Pickel, chief executive of the International Swaps and Derivatives Association, said: “People may fall back to trade on a bilateral basis. That’s one of the options still available".
The dispute, which was prompted by an obscure provision in the US trading platform rules known as “footnote 88”, also threatens to unpick a US-EU deal struck this summer that sought to divvy up responsibilities for policing the $633 trillion derivatives market. Any platform that allows more than one participant to trade swaps with two or more participants must register as an SEF, according to the footnote, which is scheduled to go into effect on 2 October.
The battle pits CFTC chairman Gary Gensler against a host of European and Asian finance ministers, as well as brokers, investors and banks on both sides of the Atlantic and even fellow US officials.
Europe is moving to introduce broadly equivalent derivatives rules as the US but is lagging in implementing some transparency rules for trading. Without more flexibility from the CFTC, banks and regulators fear that roughly half of London’s derivatives market will be forced to operate under Washington’s rules and supervision. European officials fear the registration requirements will split liquidity in Europe into US and locally supervised markets – a shift of regulatory control that will be almost impossible to unwind.
"During the week Commissioner Barnier was in Washington to sign the agreement on EMIR, both sides promised to do everything to avoid these kinds of situations in future – but we didn't take note of the famous footnote 88 at that stage of the discussions", said Ferber.
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