Swap rules’ impact on commercial end-users dominated CFTC Commissioner Christopher Giancarlo’s recent testimony before a Congressional committee overseeing the regulator.
Among the most critical for multinational corporations (MNCs) is the failure thus far of the CFTC to persuade the European Commission to recognize US central counterparties (CCPs) as equivalent under the European Market Infrastructure Regulation (EMIR), as it has for CCPs in Japan, Hong Kong, Australia and Singapore.
Fellow Commissioner Mark Wetjen, also testifying April 14 to the US House Committee on Agriculture’s Subcommittee on Commodity Exchanges, Energy and Credit, said that CFTC Chairman Tim Massad and commission staff are continuing to consult with their European counterparts. He added that “considerable progress has been made, and an equivalency decision should be made soon by the European Commission.”
If no decision arrives by June 15, 2015, however, US CCPs will not be classified as “qualifying” for purposes of Basel III risk weighting for banking institutions. In turn, Commissioner Giancarlo said, it will become cost prohibitive for European Union (EU) banks to clear through those CCPs, which will no longer be able to maintain direct clearing member relationships with EU firms and will be ineligible to clear contracts subject to the EU clearing mandate anticipated later this year.
Such a divisive outcome could be particularly problematic for MNCs looking to hedge globally their currency and interest-rate exposures using more standardized, cleared swaps.
“Needless to say, this outcome will be destructive to both the US and European economic interests and lead to further market fragmentation and contraction of liquidity, market disruption and dislocation in the global derivatives market,” Commissioner Giancarlo said.
Similar complications may arise for uncleared swaps because of the CFTC’s unwillingness to exempt dealer affiliates from having to post margin, Commissioner Giancarlo said. Since the CFTC’s proposed rules on margin for uncleared swaps are inconsistent with the approach by Europe and the International Organization of Securities Commissions (IOSCO) to exempt swap transactions between certain dealer affiliates from having to post margin, the cost of initial margin in internal risk transfer trades will likely be borne by end users.
Commissioner Giancarlo noted a US auto manufacturer looking to hedge US dollar/Japanese yen interest rate risk through the use of an interest-rate swap provided by a Japanese headquartered dealer.
“The added cost of initial margin on that dealer’s internal risk transfer trades will likely make that transaction cost prohibitive for the US end-user, who will instead turn to a domestic dealer without access to the global market offering a necessarily wider bid/offer price spread,” Commissioner Giancarlo said. He added that a second likely effect will be the “ring-fencing” of risk in the US by increasing the costs of risk hedging in broader global markets.
Commissioner Giancarlo pointed to numerous other issues “burdening” end users, including the revised Rule 1.35, which requires the retention of oral and written records leading to a transaction in a commodity interest and related cash or forward transaction in a form that’s “identifiable and searchable by transaction.” Although this requirement directly impacts swap market intermediaries and not end users, the burden it imposes coupled with historically low rates has resulted in the number of FCMs halving over the last few years, Commissioner Giancarlo said. He pointed to Jefferies Group’s decision announced April 9 to sell its Bache Futures business to Societe Generale.
Another concern is the reduction over the next few years of the de minimus threshold of swap business per year, over which a swap market participant is recognized as a swap dealer, requiring clearing of trades and adherence to a complex rule framework
“Unquestionably, an arbitrary 60 percent decline in the swap-dealer registration threshold form $8 billion to $3 billion creates significant uncertainty for non-financial companies that engage in relatively small levels of swap dealing to manage business risk for themselves and their customers,” Commissioner Giancarlo said.