Eventually, the new Dodd-Frank regulations for OTC derivatives will be ready for prime time, compelling firms to face a timetable for implementing them. William Thum, principal and senior derivatives counsel for mutual fund giant Vanguard, thinks that firms should be allowed to ease into the brave new OTC world rather than endure a wrenching transition. I couldn’t agree more with his much-needed pragmatism.
Thum and Vanguard are urging a reasonable timetable that phases in reforms over an 18 to 24-month period; he spoke at a Sifma conference panel earlier this month focused on the regulatory changes underway for OTC derivatives. Thum also made the same suggestions last month before the US Senate Banking, Housing and Urban Affairs Subcommittee on securities, insurance and investment.
Vanguard’s proposed implementation schedule is as follows:
- Six months from final rules: Swap data repositories (SDRs), derivatives clearing organizations, SEFs (swap execution facilities) and middleware providers must complete the build-out of their respective infrastructures.
- Six to 12 months from final rules: All participants should voluntarily engage in reporting, clearing and trading platforms.
- 12 months from final rules: All participants should be mandated to report all swaps involving all parties. Dealers and major swap participants should be mandated to clear the first list of standardized swaps.
- 18 months from final rules: All participants should be mandated to clear the first list of standardized swaps. SEFs and commissions can analyze SDR swap data for liquidity across trade types to make informed SEF trading mandates, block trade size and reporting delays. Dealers and major swap participants should be mandated to trade the first list of standardized swaps made available for trading on SEFs.
- 2 years from final rules: All participants should be mandated to trade the first list of standardized swaps made available for trading on SEFs with delayed public reporting of block trades based on historical relative liquidity.
While Vanguard supports the Dodd-Frank push to find and mitigate systemic risk, the firm also has some key objectives of its own:
- Prioritize risk reduction over changes to trading practices and market transparency
- Prioritize data reporting to inform future rulemaking related to trading practices and market transparency, and to minimize any negative impacts on liquidity
- Harmonize US and global regulatory efforts; and
- Enable immediate and voluntary access for “all party types” to new OTC platforms with mandated compliance to apply initially to swap dealers and major swap participants.
Vanguard’s timetable and these objectives will allow the industry to “digest the final rules and develop industry infrastructure,” Thum says. Firms will also need time to “implement complex operational connections” necessary for reporting, clearing and exchange trading. Firms will also have to educate clients on these changes and persuade them to trade in the revamped OTC environment. Firms will also have to negotiate new trading agreements for their incumbent relationships.
Thum says recent studies support the need for a phased implementation schedule by pointing out the “significant differences in liquidity” of the swaps and futures markets.
“While futures trading is characterized by high volumes of a limited range of trade types of small sizes and limited duration, the swaps market has an almost unlimited range of trade types of much larger sizes with a much longer duration,” according to Thum in his remarks to the subcommittee. “Swaps liquidity varies dramatically with high liquidity for two-year US dollar interest rate swaps, and much smaller liquidity in credit default swaps on emerging market corporate entities.”
I would only add to Thum’s argument the simpler point that the OTC market players have to make the best of a weak recovery; it only makes sense to apply caution and prudence. This is especially true now as we know all too well what happens when we forge ahead with reckless abandon.
Need a Reprint?
Leave a Reply