UPDATE: CFTC Backs $50Mln Minimum For Clearinghouse Membership
October 18 2011 - 12:01PM
Dow Jones News
U.S. derivatives regulators on Tuesday backed a lower entry fee
for financial institutions to gain entry into the business of
processing privately negotiated derivatives, or swaps--a sector
dominated by the biggest Wall Street banks.
The move is designed to loosen the grip that dealer banks have
had on the business of swaps clearing, which is seen to be a
lucrative new niche in light of a pending regulatory overhaul.
Regulators hope that increasing competition for clearing services
would reduce position concentration and transaction costs among
swaps users, reducing risks to the financial system.
The Commodity Futures Trading Commission reiterated its proposal
for a $50 million minimum net capital requirement for firms to
become members of clearinghouses set up to guarantee obligations on
credit, interest-rate and other financial instruments.
The agency is expected to finalize the rule at a hearing Tuesday
in Washington, subject to a vote. "I think this is one of the more
significant rulemakings to help lower risk in the financial
system," said CFTC Chairman Gary Gensler at the hearing.
One of the CFTC's five commissioners signalled he would vote
against the $50 million capital test, however. Commissioner Scott
O'Malia said the rule would leave derivatives clearing
organizations with "insufficient discretion ... to manage the risks
they confront."
O'Malia added that the number "makes a great headline" but may
prohibit clearinghouses from taking legitimate steps to reduce
risks to their guarantee funds.
Regulators in Europe and Asia are working to craft their own
rules aimed at tightening industry practices for the $601 trillion
global swaps market, which was blamed for deepening the most recent
financial crisis. The CFTC estimates the U.S. swaps market to be
around $300 trillion.
Clearing, which involves posting collateral to a central
repository in order to reduce the fallout if a member of the
clearinghouse fails, will be mandated for standardized, actively
traded swaps under the new rules. Annual revenues on swap clearing
post-reform are estimated to be worth several billion dollars,
according to research by Booz & Co.
The $50 million barrier to entry was first proposed by the CFTC
last December and has been the focus of intense debate among banks
and brokers angling for a share of the clearing business. That is
partly because it comes in far lower than previously set standards
at clearinghouses run by IntercontinentalExchange Inc. (ICE) and
CME Group Inc. (CME), which had ranged as high as $5 billion.
In July, ICE lowered its minimum net capital threshold for
members of its credit default swaps clearinghouse to $100 million
from $5 billion in tangible net equity. Shortly afterwards, ICE
chief executive Jeffrey Sprecher told analysts he knew the net
threshold was still above the CFTC proposed level, but that it was
a "good landing point" to start with. Others also believed the
CFTC's $50 million proposal was a placeholder, and subject to
change.
ICE's new test will apply to clearing agents for customer swaps,
now referred to as futures commission merchants (FCMs) after their
parallel role in the exchange-traded derivatives business. The $5
billion test will still apply for some broker dealers and agents
that were members before ICE changed its membership requirements,
however.
But would-be new entrants to swaps clearing say the lower
barrier to entry will still keep them out, and that this is not in
the spirit of open-access rules in the U.S. Dodd-Frank financial
overhaul law of 2010, which sought to have a big chunk of the swaps
market cleared.
At the same time as cutting the capital requirement, ICE
introduced a new rule asking members to keep excess net capital
totaling at least 5% in customer funds--regardless of whether that
capital was supporting swaps intended for clearing, or futures and
options.
For at least two firms looking to get into swaps clearing--MF
Global Holdings Ltd. (MF) and Newedge USA LLC--that 5% margin
requirement would mean not just the entry fee to the clearinghouse,
but hundreds of millions in extra capital set aside. The net
result, these firms say, is that the big dealers that have hitherto
controlled the business could continue to do so.
Moreover, the would-be new entrants say the 5% test will
penalize them for being more conservative on the margin they demand
from customers during choppy market conditions. The more customer
funds they have to cushion them in volatile times, the more money
the 5% excess capital test will force them to set aside.
On top of the dollar capital requirements, ICE says clearing
members have to have sufficient operational capabilities to price
and manage a book of credit default swaps so that they can be
relied upon in case another clearing member defaults and they have
to take over the defaulting member's positions.
Banks say the business of managing risk is complicated and
players looking to become members need to be sophisticated enough
to manage defaults if a clearinghouse should fail.
The CFTC is proposing that clearinghouses be allowed to have
more risk in the clearinghouse if they have more capital, thereby
scaling participation in accordance with size. That may not be
enough to appease those who say the access rules need to be
broader.
"We like the idea that if there's a default, there's a wider
group to help pick up the pieces," said Gary DeWaal, general
counsel for derivatives brokerage Newedge.
-By Katy Burne and Jacob Bunge, Dow Jones Newswires;
212-416-3084; katy.burne@dowjones.com
--Jamila Trindle in Washington contributed to this article.
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