Unfriendly Fire

Everyone wants to be liked.  Even banks.  That’s one reason why a recent headline — Bank-Friendly Financial Reform – caught our eye.

It’s courtesy of Taking Note, the editorial page editor’s blog of The New York Times, and it leads a post that focuses on the cross-border application of derivatives regulations.

Truth be told, the piece is not very friendly to banks.  (But you knew that.)  It largely dismisses the legitimate concerns that have been expressed about the scope and timing of the US regulatory framework by numerous policymakers around the world.  The list includes the EC Commissioner for Internal Market and Services, finance ministers in Brazil, France, Germany, Italy, Japan, Russia, South Africa, Switzerland and the UK, and regulators and central bankers in Australia, Hong Kong and Singapore.

Instead, it espouses the curious viewpoint that the administration is not resisting these concerns forcefully enough…and that it might be “saying just enough to shield the administration from charges that it has generally stood by while the banks watered down reform…”

Really?  So that’s what’s been going on?  Washington has been just going through the motions on derivatives reform?


The situation regarding the cross-border application of derivatives rules is important to understand:

• The G20 (which, of course, includes the US) initiated a global process of reform that was intended to create a level playing field among regulators and across jurisdictions.  To achieve this, it’s important for all jurisdictions to remain aligned on the substance and timing of reform.

• European rules are expected to be as stringent and comprehensive as US rules.  Within the US, the SEC is also drafting a strong ruleset.  We expect that ISDA and market participants will continue to find plenty with which to disagree (and hopefully agree) on both counts.

• For one regulator to go it alone risks a number of adverse consequences:  significant legal and operational uncertainty; duplicative or incompatible requirements that create undue costs or are impossible to implement; destabilizing markets by favoring firms/trades in some jurisdictions over others; undermining efforts to develop a long-term, stable regulatory environment that is crucial for strong markets and financial stability.

Much work remains to be done to finalize and implement the new regulatory framework in the US, Europe and other jurisdictions.   International harmonization of these rules is vitally important to achieve the goals of greater financial stability and a more robust financial system – goals that everyone likes.

Sometimes More is Less

Earlier this week, the US CFTC approved rules governing the execution of swap transactions.  Among the major issues was a proposal to require market participants to seek five price quotes on trades done on a swap execution facility.  The Commission ultimately voted to mandate two “request for quotes” (RFQs), with the requirement eventually increasing to three.

The range of headlines (and stories) following the CFTC vote was interesting:

“US in Compromise on Derivatives Trade Rules” (Financial Times)

“Regulators Strike Compromise on New Derivatives Rules” (Wall Street Journal/Dow Jones)

“Big Banks Get Break in Rules to Limit Risks” (New York Times)

“Wall Street Wins Rollback in Dodd-Frank Swap-Trade Rules” (Bloomberg)

“CFTC adopts SEF rule, including RFQ3, voice broking” (Reuters)

Hmmmm.  Was it a compromise, a rollback, a break or something else entirely?  (It clearly was an adoption of a rule, as Reuters notes.)

Another point of interest:  in at least some of the articles, there’s a presumption in favor of requiring five RFQs.

Why?  How or why is it “good” to mandate that a derivatives user request a certain number of price quotes from different dealers?  And why five?

Shouldn’t this be up to market participants to decide?  Particularly since getting a quote is easy enough, given the different ways derivatives users can get or check prices (via phone, terminals, and dealer, broker and other trading systems)?

The flawed assumption is that the client is not qualified to decide for itself whether 2, 3 or 23 quotes are optimal.  It also ignores the fact that information has value for the recipient of the quote requests and the client might not want to offer that information to any more counterparties than is appropriate to the situation.

There’s something else that’s interesting:  it’s the presumption that these trade execution rules have anything to do with reducing risks in the financial system.  Trade execution is about market structure – not systemic risk.  If the goal of financial regulatory reform is to reduce systemic risk, shouldn’t we focus on issues that affect it, like regulatory capital, clearing, margining and regulatory transparency?

Shouldn’t we also avoid mandating “more” to customers when it really means less, and just leave it to them to decide how much is enough?

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Crossing the Line

What do the EC Commissioner for Internal Market and Services, finance ministers in Brazil, France, Germany, Italy, Japan, Russia, South Africa, Switzerland and the UK, and regulators and central bankers in Australia, Hong Kong and Singapore have in common?

They have all written to the US CFTC to express their concerns about cross-border derivatives regulations.

Why are they concerned?  As the finance ministers recently wrote:

“We are already starting to see evidence of fragmentation in this vitally important financial market, as a result of lack of regulatory coordination. We are concerned that, without clear direction from global policymakers and regulators, derivatives markets will recede into localised and less efficient structures, impairing the ability of business across the globe to manage risk. This will in turn dampen liquidity, investment and growth.”

To anyone who has watched this issue unfold over the past two or three years, such concerns are no surprise.  It is, though, a bit of surprise to see how The New York Times describes the situation.  Witness this page one headline from the Wednesday, May 1 paper: “Banks Resist Strict Controls of Foreign Bets”

There are (at least) three things wrong with these seven words:

1)      There’s nary a mention of the concerns of some of the world’s leading policymakers in the headline.

2)      No one is resisting strict controls.  The issue, as the finance ministers point out, is that “We share a common commitment with respect to OTC derivatives reform, and are implementing rules across very different markets with different characteristics and different risk profiles, to support this global initiative… An approach in which jurisdictions require that their own domestic regulatory rules be applied to their firms’ derivatives transactions taking place in broadly equivalent regulatory regimes abroad is not sustainable. Market places where firms from all our respective jurisdictions can come together and do business will not be able to function under such burdensome regulatory conditions.”

3)      Bets?  Even better, foreign bets?  How and why are derivatives transactions characterized as bets?  Is capping your interest rate exposure a bet?  Is hedging your currency exposure a bet?  Is protecting your credit exposure a bet?

We’re an international organization, and especially sensitive to these sorts of things, but even so, doesn’t this seem a touch xenophobic?  If the letter mentioned above had been co-signed by a US Treasury Secretary and sent to his EC counterpart, would it have been described in the same way?

But wait, there’s more.

Further down in the article, there’s this description of the “bitter international campaign” being waged by Wall Street and the world’s top finance ministers (as if they are working in concert):

“The effort…is just one front in the battle still being waged nearly three years after Congress passed the Dodd-Frank law, which revamped financial regulations in the United States in hopes of curtailing risky trading practices blamed for the global financial crisis in 2008.”

We’re the first to admit that the financial system needed strengthening (and we have made good progress doing so), but let’s not forget what the financial crisis was all about.  It was, first and foremost, about bad real estate decisions and bad mortgages. That was true in the US just as it was true in the UK, Ireland, Portugal, Spain and other hard-hit nations.

Unfortunately, The Times’ treatment of the important issue of cross-border derivatives regulation really crosses the line.