Opinion: Two early for reform celebration
The one-year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act passing into law rolled quietly by last month. By Bernard Kellerman, AB+F Managing Editor.
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Bernard Kellerman, AB+F
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For the American derivatives market, the ramifications of the Dodd-Frank reforms, if final versions ever see the light of day, are enormous. Users of the US$600 trillion overthe-counter derivatives market face sweeping new trading, clearing, margin, capital, reporting and business conduct regulations – and that is before the international implications are considered.
The intent of the new law is to reduce systemic risk by promoting better transparency, efficiency and risk management around the use of derivatives in the wake of the global financial crisis. The big question, one that is yet to be answered a year on, is what is the effective date for compliance?
Much work has been done to date, but many of the rules remain in draft format. Others seem doomed to remain in limbo indefinitely. For example, regulatory agencies are yet to define a swap, one of the building blocks of the derivatives industry. The latest roiling of the equities and bond markets following sovereign debt crises on both sides of the North Atlantic has proven how important it is to have a united regulatory front, rather than let American banks do things differently to the rest of the world, again.
“It’s not about economies, it’s about regulation and banks are good at finding regulatory arbitrage,” observed Jiro Okochi, the New York-based chief executive and co-founder of corporate financial risk management software firm, Reval, when in Australia recently. Okochi has been representing corporate hedgers in Washington since financial reform got underway and is on the United States Commodity Futures Trading Commission’s global markets advisory committee in this capacity.
Separation gets boring
In a recent discussion with me about the derivatives market, he observed that, of the rules he sees coming from over the horizon, the biggest change for foreign banks operating in America is that they may have to separate their swap businesses from their main commercial banking business.
“Part of Dodd-Frank is to make banks more boring and less aggressive,” Okochi said. “If it’s a derivative that’s related to your everyday business – interest rate swaps because you’re selling loans or foreign exchange transactions for your clients – keep those in-house.
“Gold, silver and oil [swaps] – old-time banking commodities – keep those, but everything else has to be pushed out: metals desks and soft commodities desks.”
The net result is that, anecdotally, many of the foreign banks operating in America – and that includes Australian banks, which are well versed in commodities – are even questioning whether they will need to keep their plain vanilla swaps businesses.
Not only will pending regulations directly affect end-users, but they will also indirectly affect these market participants as swap dealers – who are the end-users’ counterparties – also face more stringent requirements.
While industry heavyweights such as Okochi are hopeful of further resolutions sooner rather than later, the danger is that the original G-20 timeframe of “by the end of 2012” may come under pressure to be pushed back, if not dropped entirely by a fearful legislature and bureaucracy, spooked by the spectre of a double-dip recession.
Database breakthrough
Progress appears to be glacial, but Okochi pointed out that “it’s only been a year” since the Dodd-Frank bill became law, and the change does involve putting swaps with a notional value of US$500 trillion onto a database and regulating 200 banks.
“If this was a triathlon, they’ve just got done with the swim portion,” he told me. “They know pretty well how to ride a bike and run. The final leg will be the move to clearing and margins.”
Soon after his return to New York, the pace did indeed step up a notch, with the United States Commodity Futures Trading Commission completing the first set of Dodd- Frank rules for the swaps market, regulating information databases.
According to news reports, this means all transactions will be reported to swap data repositories and information on trading volumes and prices is to be made available to financial regulators. Commission chairman Gary Gensler said – amazingly – that this is the first time regulators will have specific information on the market’s scale and risk.
Whistleblower rewards
One area of progress has been on a very personal level, with the commissioners voting four to one to let whistleblowers collect as much as 30 per cent of penalties when they report financial wrongdoings to the agency.
Whistleblowers would be eligible if information they provide leads to a successful enforcement action that results in sanctions (read “fines”) of at least US$1 million.
While, unsurprisingly, the United States Futures Industry Association and their counterparts at the United States Securities Industry and Financial Markets Association were quick to criticise the proposed rules, news reports said there are fewer than 50 enforcement actions a year that produce sanctions of at least that value.
Further, the United States Commodity Futures Trading Commission said it would set up a panel to determine the amount of the award. This could range from 10 per cent to 30 per cent of the sanctions. The panel is to include representatives from three of the commission’s divisions.
Closer to home
In a positive move, Australian authorities have issued a discussion paper Central Clearing of Over-the-Counter Derivatives as part of their consideration of Australia’s response to the international reform efforts underway in global derivatives markets.
The paper was released by the Council of Financial Regulators, which comprises the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission and the Federal Treasury, and is chaired by the Reserve Bank of Australia.
It discusses the evolving global landscape for over-the-counter derivatives and central clearing, the Australian market for these derivatives and a range of considerations that need to be weighed if central clearing in the domestic market is to be established.
Submissions close on 1 September. The views of the local industry will be covered in a later column.
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- Capital Markets
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- Author:
- Bernard Kellerman, AB+F Managing Editor, bkellerman@financialpublications.com.au
- Article Posted:
- August 15, 2011
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