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Dodd-Frank Drives Swaps-To-Futures Migration

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Dodd-Frank Drives Swaps-To-Futures Migration Futurization: Dodd-Frank Drives Swaps-to-Futures Migration By Will Acworth In the last several months, a new trend has taken shape in the migration of the U.S. over-the-counter derivatives markets towards electronic trading and central clearing. As the regulatory regime created by the Dodd-Frank Act has taken shape, some market participants have grown alarmed by the complexity and cost of compliance and have turned instead to the futures markets in search of a simpler and more cost-effective alternative to cleared swaps. In energy, a large part of the North American natural gas and electric power market was converted from swaps to futures almost overnight in mid-October, while in the interest rate sector, two exchanges—CME Group and Eris Exchange—have begun offering futures contracts designed to replicate plain vanilla interest rate swaps. he trend is expected to widen in the The main driving force in energy, according Policymakers in Washington have taken coming months. IntercontinentalEx- to exchange officials, was a desire by market notice. The Commodity Futures Trading T change plans to offer credit index participants to avoid certain Dodd-Frank rules, Commission is planning to hold a public futures in the first quarter, and Singapore notably swap dealer registration, swap report- meeting in the coming weeks to examine the Exchange plans to list a set of commodity fu- ing requirements, and the extra-territorial im- trend and consider its implications for sev- tures that will be economically equivalent to pact of U.S. regulation. In interest rates, the eral pending rules that will affect the trading the commodity swaps that it clears through new swap futures have only just begun trading, of both swaps and futures. That meeting is its AsiaClear facility. In the case of SGX, the but it appears that significantly lower margin likely to focus on the energy markets, where exchange has made it clear that the “futur- requirements will be the biggest attraction. In the “flight to futures” effect has been most ization” of its swaps is aimed at addressing credit, ICE cites the potential for attracting new noticeable. It will also focus on the com- the needs of market participants affected by participants to the credit default swaps market plaints of inter-dealer brokers and others Dodd-Frank, a sign that the impact of the and restoring some of the volume lost since the that the new regulatory regime has unfairly trend is extending beyond the U.S. collapse of Lehman Brothers. tilted the playing field against swap market Futures Industry | January 2013 33 Futurization participants. One hot topic will be the rules might affect the success or failure of SEFs. ing and risk management needs in the for swap execution facilities, a new type of Hanging in the balance are several im- energy and commodity space, allowing venue created by Dodd-Frank. The CFTC portant rules related to trading that will af- them to operate in a highly regulated has not yet finalized its SEF rules, and a fect the choice between swaps and futures. regime that they know and understand,” number of companies are eager to register The CFTC is now considering a package of Jeff Sprecher, ICE’s chief executive offi- as SEFs and establish their trading facilities proposed Dodd-Frank rules that will de- cer, said in a Nov. 5 conference call with in competition with futures exchanges and termine how swaps are traded on swap ex- analysts and investors. the new swap futures contracts. ecution facilities and the ability of futures In the case of ICE, approximately 800 exchanges to set block trade thresholds. energy contracts that previously traded Complaints about The package also includes rules relating to as over-the-counter swaps were listed Regulatory Arbitrage the “made available for trade” provision in on ICE’s futures exchanges in London At a Congressional hearing in December, the Dodd-Frank Act as well as a proposed and New York and made available for a coalition of interdealer brokers and swap amendment to Core Principle 9 that would trading on Oct. 15. The existing open trading venues complained that the unequal affect the amount of trading that futures ex- interest was converted into futures over playing field created by the CFTC’s Dodd- changes can conduct through off-exchange the weekend of Oct. 13-14, and ICE’s Frank rules is “threatening to strangle” the mechanisms such as block trades and ex- customers are now trading these prod- U.S. swap market in favor of the futures change-for-swaps. ucts as futures. After nearly two and a half years of rulemaking, the CFTC’s cumulative approach to swaps regulation has imposed such high costs on the industry that the U.S. swaps market is on the verge of becoming too costly and too regulated—particularly as compared with futures—to be a viable means for end-users to hedge and manage their financing risk. EXCERPT FROM A STATEMENT BY A COALITION OF INTERDEALER BROKERS AND SWAP TRADING VENUES market. The hearing was organized by Rep- Measuring the scale of the transition resentative Scott Garrett (R-N.J.), the chair- CME and ICE is difficult because ICE does not disclose man of the capital markets subcommittee of Futurize Energy Swaps the volume of trading in its OTC mar- the House Financial Services Committee. The starting gun for the futurization kets. The statistics for its futures markets “After nearly two and a half years of rule- trend came in mid-October, when CME show, however, that a significant amount making, the CFTC’s cumulative approach and ICE, the two leading markets for en- of trading has taken place in the new swap to swaps regulation has imposed such high ergy swaps in North America, changed the futures since the conversion. From mid- costs on the industry that the U.S. swaps way their markets operate just ahead of a October to the end of December, the ex- market is on the verge of becoming too key regulatory deadline. According to offi- change recorded volume of 59.6 million costly and too regulated—particularly as cials at both exchanges, many participants natural gas futures and options and 29.2 compared with futures—to be a viable in the energy swaps market, especially com- million power futures and options—all of means for end-users to hedge and man- mercial participants, were worried about which had been traded as OTC swaps and age their financing risk,” said the coalition, the impact of new rules that were set to take options prior to Oct. 15. which includes firms such as Bloomberg, effect on Oct. 12. In particular, they did not In the case of CME, the change mainly GFI Group, ICAP, Parity Energy, Thomson want to be classified as swap dealers, which affected the method of trading, with a large Reuters, Tradeweb and Tradition. would require them to comply with a host percentage of its Clearport volume executed At the request of CFTC Commissioner of regulatory requirements that go with via block trade rather than traded off-ex- Scott O’Malia, the CFTC is planning to swap dealer status. The exchanges also com- change and then submitted for clearing via hold a staff roundtable discussion in late mented that a number of non-U.S. market the exchange-for-swaps mechanism. Ap- January or early February on the futurization participants were worried about the extra- proximately 500 contracts were relisted as trend. O’Malia, a Republican who worked in territorial effect of the new swaps rules, and futures and made available for trading on the energy sector before joining the agency, preferred the familiarity of the futures regu- CME’s Globex platform. No conversion of said in a November speech that such a dis- latory environment. open interest was necessary because Clear- cussion would help in understanding why “Given the complexity of the new port transactions have been converted into firms opted to move out of the energy swaps swaps regulation regime in the United futures via the clearing process since the fa- market in October. He also said a roundtable States, customers uniformly agreed that cility was launched 12 years ago. would help the agency examine how its rules futures markets best served their hedg- Initially CME’s volume was affected by 34 Futures Industry | www.futuresindustry.com confusion about the regulatory status of its Citi, Credit Suisse, Goldman Sachs and Mor- open interest had risen to 6,275 contracts. contracts. CME Executive Chairman Terry gan Stanley all agreed to act as liquidity pro- Volume slowed over the end-of-year holi- Duffy commented on Oct. 25 that Clearport viders, and more than a dozen banks signed days, but interest is expected to pick up as volume dropped off in the two weeks after up to provide execution for block trades. market participants become more familiar Oct. 12, falling from 400,000 to 250,000 At expiration, the contracts settle with with the new contracts and consider their contracts per day. He noted, however, that physical delivery of the underlying swap. merits relative to cleared OTC swaps. volumes began coming back as market par- In effect, the CME contract is the equiva- ticipants adjusted to the change and in re- lent of a forward-starting swap that initially Morgan Stanley sponse to regulatory relief provided by the trades as a future but can be converted into Backs Eris Swap Futures CFTC that gave brokers and traders more a cleared swap at expiration. The contracts While CME’s launch attracted consider- time to comply with the new regulations.
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