Regulating Derivatives

Yesterday, the House Financial Services Committee approved a series of bills attempting to steer CFTC efforts to regulate derivatives trading under the Dodd-Frank Act. Committee Chairman Spencer Bachus (R-AL) said the legislation will “bring much needed certainty” to the derivatives market and ensure that “end-users are able to efficiently hedge their risks.” Ranking Democrat Barney Frank (D-MA) accused Republicans of “finding the weakest links” in an effort to undermine enforcement of Dodd-Frank.

According to the Committee description, the bills would:

  • Require the CFTC to promulgate rules for swap execution facilities (SEFs) that remove regulatory obstacles requiring SEFs to have a miniumum number of participants receiving bids or offers; ensure that trading platforms executing swap transactions include voice-based and hybrid trading models; allow market participants to receive and respond to a single quote; and require immediate execution of matched trades.
  • Reconfirm the end-user exemption from margin and capital requirements.
  • Exempt inter-affiliate swaps from the margin, clearing and reporting requirements of Dodd-Frank.

Frank said the changes would reduce transparency in derivatives trading because under the legislation some transactions would not be listed until “after [the trade] had been consummated.”  Yet fellow Democrat Congressman Jim Himes (D-CT) said there are specific occasions, such as for illiquid securities, “where one trade will move the market very substantially, where good execution would actually mean something much more strategic” than full pre-trade transparency:

“If you are going to buy a Ford Focus, you go online, you look at 20 dealers around and – boom – you hit the best price.  If you are going to buy a 1950 Aston Martin, and there are two in the world, it’s a very different dance…The CFTC in pursuit of a good goal, which is creating more pricing transparency, has recommended a lot of protocols that would be good for buying a Ford Focus” but not the Aston Martin.

Now the bills will move to the House floor for a vote by the full House. Meanwhile, most observers expect the bills to get little traction in the Senate.