For much of the last decade the derivatives industry has been caught in the gravitational pull of the Dodd-Frank act, the sweeping piece of legislation meant to contain the risk of another financial crisis.
Six years after its passage, US president-elect Donald Trump wants to dismantle the law. The industry, however is not racing to join him.
At this week’s Global Financial Leadership Conference, a gathering of derivatives traders, discussions dwelled on topics such as the UK’s Brexit vote and artificial intelligence, not repealing Dodd-Frank.
“You can’t dismantle something after it was just put into law, when the country was basically almost knocked into the Stone Age in 2007 and 2008,” says Terry Duffy, chief executive of CME Group, the world’s biggest futures exchange and host of the conference.
Dodd-Frank contained specific remedies for over-the-counter derivatives markets, blamed for exacerbating the last crisis and the reforms sparked robust lobbying from banks and brokers at the start of the decade.
Gary Gensler, then chairman of the Commodity Futures Trading Commission sought to break the bank-dominated dealer model and cut the web of interbank exposures. New rules mandated that generic swaps, with notional values in the billions, had to be traded on electronic marketplaces known as swap execution facilities (Sefs). More of the market, with a gross market exposure of $20tn, was pushed through central clearing houses and reported to data warehouses.
“I haven’t seen calls to dismantle Title 7 [the derivatives section of Dodd-Frank]. Quite the contrary — what I’ve seen is a growing consensus that the reforms made sense,” says Timothy Massad, the current CFTC chairman.
For some in the swaps industry, Mr Trump’s victory offers hope of minor but significant tweaks. Michael Spencer, chief executive of ICAP, calls the rules well intentioned but “overdesigned and overengineered … a repeal or review of Dodd-Frank would be a good thing for the market as a whole”.
Even so, many executives think abolishing the law is a step too far. “I think there’s some fringe things that he can do on Dodd-Frank, [but] there’s no way in my opinion that he can go in there — I think it would even scare the Republicans — and say we’re going to dismantle it and have no laws and go back to what we had in 2007 and prior,” says Mr Duffy.
One reality is that Dodd-Frank and a push to electronic trading have become embedded in markets.
“In some respects it will be just as costly to take out as put in,” says the chief executive of a swaps trading venue who declined to be identified. “People have changed their methods for interacting with the market. Regulations have helped drive the changes. In Treasuries it took 10 years [to go electronic] but in swaps it was just one year.”
There are also potentially limits to change as the mandate was part of a global G20 commitment to bolster over-the-counter markets with clearing and trade reporting. Many have recognised the US’s rules as equivalent.
Complaints around the rules are legion, particularly for Sefs. Many market participants complain that these venues have split the global swaps market, particularly as traders in Europe shy away from interacting with US counterparts.
Trading between European and US dealers comprised 28.7 per cent of market share at the time of the introduction of Sefs in September 2013. That had fallen to 7.6 per cent by the end of last year, according to data from Isda, the trade association.
That bifurcated market creates pricing problems. Brokers at ICAP’s London-based Sef talk to dealers about prices “on-Sef” and “off-Sef”. “Every day there’s a conscious decision to switch trading to a Sef from a European platform,” says one broker.
Others say Sefs are not the lightly-controlled markets they were intended to be. “There’s not a big gap between running a Sef and running a futures market,” says the chief executive of another Sef, who declined to be identified.
But industry executives say it’s possible for regulators to fix problems without ripping apart the law. Annette Nazareth, partner at Davis Polk in Washington, points out that “there’s an awful lot an agency can do outside the legislative process, via rules interpretations or amendments.”
“Right now the US is on the bleeding edge in implementing this part of the 2009 G20 agreements … so the swaps execution mandate would be the easiest to roll back and most at risk,” says David Weiss, an analyst at Aite Group, a capital markets consultancy.
Furthermore, a blueprint for reform already exists. Two years ago Christopher Giancarlo, a commissioner at the CFTC, published an 89-page white paper advocating reforms. As the sole Republican commissioner, he has also been widely discussed as a possible new CFTC chairman under a Trump administration.
While he backed central swaps clearing and reporting trades to repositories, he also strongly criticised trading rules. They were overly prescriptive, had significant policy changes buried in footnotes, and had failed to achieve their goals by misapplying the futures market model to the swaps market.
More critically, he argued that the rules had overstepped their mandate from Congress. Instead, he advocated more flexible regulation based on existing practices and allowing for greater choice for dealer and brokers. “It would promote healthy global markets by regulating swaps trading in a manner well matched to the underlying market dynamics,” he argued.
Putting significant policy rulings into footnotes makes them easier to change, lawyers say.
However, the changes may have other effects, particularly for global efforts to harmonise financial regulations to similar standards. The European Commission says it is too early to tell what the priorities will be and is continuing its daily contacts with counterparts in the US.
“We very much hope that the future US administration will work with the EU to help consolidate the G20 financial reform agenda,” a spokesperson said.