Forcing Your Hand
The dawn of the new age of regulation is upon us and it is truly embodied in both the legalese and spirit of the Dodd-Frank Wall Street Reform Act. Spurned by the crisis, Dodd-Frank has created some changes for the greater good, but has also become a burden to many firms within the industry that are forced into a higher spend on compliance and elsewhere.
Similar to the financial crisis of 2008, OTC derivatives are at the center of the Dodd-Frank Act and are addressed in a brash new way. The mandate of bringing products that are meant to be traded off an exchange on to an exchange is perverse by default. Perhaps if terms were more structured and clear cut, the industry would be able to adapt more quickly. But the crawl of regulators in hammering out final rules, the massive infrastructure overload and creation of swap execution facilities takes lots of time and money.
Things are clearly a miss when JP Morgan Chief Executive Jamie Dimon is busy calling the act “Dodd-Frankenstein.” Some would argue that the move is a natural extension of the progression of the markets.
“We’re talking about a real change in market structure. Moving from a market maker type of world to a new, OTC onto clearing role. It’s all driven by regulation. If it wasn’t for regulation, we wouldn’t have to deal with this,” said one employee of a swap execution facility.
The need for SEFs and tighter regulation could be a step in the wrong direction, however. A new report from the International Swaps and Derivatives Association (ISDA) indicated that 84% of over the counter products are adequately backed by collateral that includes cash, Treasuries and other securities.
Still, despite pushback from the industry, both regulators and most market participants see the use of central counterparties and clearinghouses as a net positive, despite the costs associated with implementation. Bringing trades traditionally done on the phone in to the electronic marketplace provides transparency, as well as liquidity.
“Customers that have been exclusively on the phone are going to have to figure out how to use a mouse,” said the employee at one of the world’s largest SEFs. “They’re going to have to come to the screen to quote and do price discovery. That’s part of the change that’s affecting both the buyside and sellside. The clearing and reporting aspect is going to force a lot of firms to adjust and adapt.”
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