GOP Seeks To Apply Brakes to FinReg

Terry Flanagan

Financial Regulatory Responsibility Act would require regulators to provide clear justification for rules.

Opposition to financial reform regulation has emerged in the form of legislation sponsored by Senator Richard Shelby (R-AL), ranking Republican on the Committee on Banking, Housing, and Urban Affairs, who has introduced the Financial Regulatory Responsibility Act of 2011.

The legislation requires regulators to provide clear justification for the rules, and to determine the economic impacts of proposed rulemakings, including their effects on growth and net job creation.

This bill is aimed at improving the transparency and accountability of the regulatory process and reduces the burdens of existing regulations.  In addition, the legislation mandates that if a regulation’s costs outweigh its benefits, regulators are barred from promulgating the rule.

Market participants have urged regulators not to take any actions that would stifle innovation and cost-effectiveness in the financial markets.

“Regulators should take note that the industry is evolving at an incredible pace, and should carefully analyze the impact of any proposed regulations that could impact competitiveness,” Jos Schmitt, CEO of Alpha Group, said at Markets Media’s Canadian Trading Network 2011 conference.

The Financial Regulatory Responsibility Act of 2011 is cosponsored by all Republican members of the Banking Committee and is supported by the U.S. Chamber of Commerce.

The Financial Regulatory Responsibility Act of 2011 is the culmination of a series of actions taken by Banking Committee Republicans over the past several months.

In February, committee Republicans wrote to financial regulators urging them to take more seriously public comments and cost-benefit analyses of proposed rules.  In May, committee members wrote to the Inspectors General (IG) of the financial regulators requesting that they evaluate the economic analysis performed by their respective agencies.

Market participants are stressing the need for flexibility in the rules around swap execution facilities and improving synergy between the rules proposed by the CFTC and SEC, especially  on allowing market participants choose the appropriate number of liquidity providers to seek pricing from in an RFQ versus the minimum of 5 dealers currently proposed by the CFTC.

The transition from a purely voice-brokered market to an electronic market, as has occurred with FX and fixed income, and now with OTC derivatives, is typically market-driven, and hence the CFTC should not limit the execution methodology employed, participants say.

Dealers, inter-dealer brokers, and industry groups have spoken out against proposed CFTC rules that would impose minimum quoting request for request-for-quote systems and a mandatory 15-second pause. They argue that the agency is seeking to import constructs from exchange-traded futures into OTC derivatives, which is a vastly different market.

The CFTC has proposed that participants using a request-for-quote facility must send the request to at least five participants. Requiring bids or offers from five dealers may make dealers hesitant to price the transaction aggressively as at least four other market participants would know their position, and could reduce liquidity.

Additionally, SEFs must provide a general timing requirement applicable to traders such as brokers who have the ability to execute against a customer’s trade (internalization) or are entering a trade for two customers on opposite sides of the transaction (crossing).

Under the CFTC’s proposal, a broker would have to provide a minimum pause of 15 seconds before entering the second side (whether for its own account or for a second customer), during which time the order would be exposed to other market participants and allowing them to join in the trade.

Dealers argue that the 15-second delay is a carryover from the futures and options world, where exchanges typically require a delay in order to prevent manipulative pre-arranged executions, and isn’t applicable to the trading off swaps on SEFs, which lack a central order book.

As U.S. regulators seek to establish consistency with international swaps regulations, large banks are urging them to limit the extraterritorial reach of rules created under the Dodd-Frank Act.

A group of money center banks, all of them major swaps dealers, have outlined recommendations to the SEC and CFTC on international issues related to Title VII of Dodd-Frank, which covers OTC derivatives.

Under the Dodd-Frank Act, the Securities and Exchange Commission and the Commodity Futures Trading Commission are required to jointly study and report to Congress on swap regulation and clearinghouse regulation in the United States, Europe, and Asia, and to identify areas of regulation that need to be harmonized.

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