Challenging Times for OTC Markets

Terry Flanagan

The U.S. Commodity Futures Trading Commission has always regulated futures markets, but swap market oversight is a new responsibility. How the complex swap market rules are implemented and enforced by the CFTC is of critical importance to market participants.

“After Dodd-Frank, swap market regulation is a primary mission of the CFTC as they implement Dodd-Frank and adopt new rules,” Michael Loesch, partner in the Washington, D.C. office of law firm Norton Rose Fulbright, told Markets Media.

Loesch joined Norton Rose about five years ago directly from the CFTC, where he served as chief of staff. Prior to that, he served in various positions at the Securities and Exchange Commission in the enforcement division as well as council to the chairman.

“While the impact of the swap markets and the need for information and the potential for oversight was an issue that was certainly on the radar of the financial regulators during the time that I was in the government, swap-market oversight was not the CFTC’s priority or responsibility,” he said.

Michael Loesch, Norton Rose Fulbright

Michael Loesch, Norton Rose Fulbright

Loesch’s practice has been focused on commodities and derivatives, regulation and enforcement matters. “We serve a broad base of financial and commercial market participant clients who are focused on trying to understand and make sense of the OTC derivatives markets as they adapt to the new rules,” he said.

Market participants are dealing with the costs and the burdens of implementation and compliance and are now keeping an eye on the potential for enforcement of the new swap market rules that are in place.

They’re also cautiously waiting to see how the markets will continue to evolve as a result of the implementation of the reforms in the US and across the globe. “There are always winners and losers when there’s significant regulatory change in the market place and that process is playing out now,” Loesch said. “Market participants are trying to do their best to comply with the rules as best they can while continuing their operations.”

CFTC commissioner Christopher Giancarlo, a Republican and a strong critic of Dodd-Frank prior to joining the agency, said in a recent speech: “I believe that the current CFTC is more mindful of the regulatory concerns of its European counterparts. Similarly, European regulators must recognize that the CFTC’s approach is naturally drawn from its successful record of respecting the integrity of the parallel regulatory regimes that govern the clearing activities of dually-registered US-EU CCPs.”

For market participants, it’s a very challenging time because this is all new for the derivatives markets in many ways, he added. “The rules of the road in terms of swap regime enforcement are still being written, so swap market participants must be vigilant in terms of compliance and the management of regulatory risks.”

The CFTC, which is the primary regulator in the US of the new swaps regime, has made it a top enforcement priority to pursue violations of the new swap rules. The enforcement division at the CFTC is very active in policing potential misconduct under the new rules and is cooperating with other regulators in the U.S. and abroad, said Loesch.

That means more investigations, new inquiries, and repeated requests for information from swap market participants. Not all investigations are public and many inquiries will take some time to develop into actual public enforcement actions.

“If you are a swap market participant, you have to be concerned that you’re in the cross hairs of the enforcement division in a way that you haven’t been in the past prior to the passage of Dodd-Frank,” Loesch said. “The CFTC’s enforcement division is going to be looking at compliance with the swap reporting rules, compliance with the clearing mandate, and the use of the end user clearing exception as well as a continued focus on manipulation and market abuse.”

Featured image via Comugnero Silvana/Dollar Photo Club

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