The Wholesale Markets Brokers' Association Americas
Remarks of J. Christopher Giancarlo
Chairman, WMBA, Americas
The Third Annual Swap Execution Facility Conference
November 13, 2012
I am Chris Giancarlo, Chairman of the Wholesale Markets Brokers Association, Americas and your host for today's program.
On behalf of the WMBA, I want to welcome all of you to the third Swap Execution Facility Conference - SEFCON III. We began this program in Washington in 2010 with the goal of helping industry and regulators define and develop the "Swap Execution Facility" under Title VII of the Dodd-Frank Act. That goal still remains important today - our third annual conference.
The WMBA is an independent industry body representing the world’s largest wholesale brokers, sometimes called “inter‑dealer” brokers. The five founding members are:
- BGC Partners,
- GFI Group,
- Tradition, and
- Tullett Prebon
The WMBA was formed to promote the quality and standards of our industry and the role of wholesale brokers in world financial markets. We seek to address matters of public policy in ways that are thoughtful and constructive. Our views are informed by decades of experience operating marketplaces for professional market participants.
As we speak this morning, employees of WMBA member firms are hard at work around the globe. They are executing billions of dollars in transactions across the range of foreign exchange, interest rate, treasury, credit, equity, commodity and energy products. The roots of the industry go back over a century in the world’s major financial centers. Our members help institutional clients in transacting both exchange-listed and unlisted products. They also operate trading platforms for instruments that are traded “over the counter” such as swaps and other derivatives. They support financial markets by gathering and spreading bids and offers and completing trades as trusted intermediaries.
More than two years have passed since the passage of Dodd Frank. And yet regulators are still at work on detailed SEF regulations that will impact the entire process of trading swaps in the United States. Getting those rules right will impact not just the large banks and swap dealers that make markets in swaps or the hedge funds that trade them. Those rules will also impact the American businesses and end users that use swaps to lessen their balance sheet risk to better manage their capital for growth and their ability to invest in US jobs. Those rules will affect not just the insular world of Wall Street, but economic conditions on Main Streets across the country and around the world.
The WMBA stands for a swaps regulatory regime that improves regulatory transparency, promotes competition and increases market participant access. We have been vocal in support of the clearing, execution and reporting mandates of Dodd Frank through dozens of public writings and formal Congressional and regulatory testimony. We continue that support today.
Yet, decades of experience in global financial markets have led us to voice concern that some currently-proposed SEC and CFTC rules are overly proscriptive, may harm market liquidity, increase trading costs and, worse, may drive trading in some swaps products offshore.
It is calculated that in the past four years trading in both exchange-traded and over-the-counter equity and fixed income derivatives has declined approximately by as much as a third.
With futures and swaps markets trading at a cyclical low, opportunities are reduced for hedging risk. It is not surprising, then, that US lending and investment are similarly reduced, as seen in the pared extension of credit by the largest American banks and sharply lower trading volumes on US stock exchanges.
Despite the popular revulsion at Wall Street, America needs healthy financial markets, including sound, transparent and, indeed, liquid swaps markets. Yet, instead of furthering the recovery of US swaps markets, regulatory uncertainty is complicating it. Several rule proposals have been issued that impose practices that are incompatible with the efficient trading of swaps. These rules, wittingly or unwittingly, are causing a restructuring of much of the US swaps marketplace and the roles, risks and rewards of its participants. The result is that full implementation of Dodd Frank will take many more months, if not years, while swaps markets – and US capital markets generally - remain in confusion holding back US economic revival and job creation.
Nowhere is the impact of ill-designed rule proposals more troubling than globally, where US trading firms are being shunned by foreign counterparties that seek to avoid having to register with the CFTC as swaps dealers. A few weeks ago, Singapore's DBS Group and Sweden's Nordea Bank were the first major institutions to declare publicly that they would not register with US regulators to trade swaps. More firms have said so privately and have stopped trading with US persons.
It is critically important that the CFTC and the SEC implement the key swaps reforms of the Dodd-Frank Act - central clearing, regulated execution and enhanced transparency - with balance and proportion. In this, regulators deserve the full support of the industry. They should adopt a flexible, principles-based approach that respects the importance of these markets for US economic recovery.
Perhaps the biggest example of one-size-fits-all rule proposals is in the area of method of swaps execution. In passing Dodd Frank, Congress recognized that global swaps markets were widely served by established intermediaries such as WMBA member firms. In adopting the legislative language "any means of interstate commerce," for SEF activities, Congress recognized that our firms use a range of swaps trading methods - methods that are specifically tailored to the variable and episodic liquidity characteristics of individual swaps markets.
- electronic, central limit order book platforms;
- request for quote systems or “RFQ”;
- electronic work up features;
- electronic matching and auction based trading sessions; and
- traditional voice execution over intercom speaker or “squawk box” systems in a many to many environment supported by pricing screens.
Yet, the CFTC's published rule proposals would restrict modes of swaps execution for cleared, non-block transactions to just two "means of Interstate Commerce:" Central limit Order Book and Request for Quote.
We believe such restrictions are not supported by the legislative history of the Dodd Frank Act or a plain reading of the Act itself. Worse, they will constrain the very “hybrid” systems that are needed to support liquidity in US swaps markets and economic recovery.
In swaps markets without retail customer participation, we question what useful protections are afforded to large banks and hedge funds by regulations that limit methods for trading swaps on behalf of end user customers.
Some may argue that these limitations on customer choicer are needed to enhance regulatory and market transparency. This is not the case. Our firms provide pre- and post-trade transparency regardless of execution method. Our members have no objection to requirements that all transactions - of any means - be subject to a complete time-stamped, audit trail of the process of the trade for purposes of regulatory supervision.
We call on the CFTC to adopt several important rules for the health and vibrancy of US swaps markets:
First, clarify that Dodd Frank's "any means of Interstate Commerce" includes the full range of swaps execution methodology, expressly including voice execution.
Second, make clear that any requirement that trades be “exposed to the market” not be a rigid process as in the proposed “15 second rule," but will allow flexibility suited to the quality of liquidity in a given instrument.
Third, withdraw risk management requirements for DCOs that impose margin calculation rules that favor futures over swaps. As currently in effect, DCOs must utilize a one-day liquidation time horizon for futures and a five- day liquidation time horizon for most swaps. Thus, labeling a product as a “future” and listing it on a DCM results in more favorable margin treatment over a product called a “swap” even though the economic characteristics of the particular products may be the same. Other regulations that favor futures over cleared swaps should similarly be withdrawn. If a swap is brought to the market as a future, it should have the same margin, tax treatment and reporting requirements as a swap managing the same risk.
Finally, withdraw proposed amendments to DCM Core Principle #9 which would set an 85% volume requirement for futures contracts traded on designated contract markets. As proposed, the rule will neither assure price improvement nor materially enhance pre-trade price transparency. It will, however, create unnecessary market disruption and increase trading costs. The Rule should be replaced with a flexible approach that favors customer choice of venue and mode of swaps execution.
We kick of the program knowing that CFTC Commissioners have before them a draft set of final rules covering SEFs, block trading, “made available to trade” and extraterritoriality, among other issues. We understand that the draft rules have significant modifications from the initial proposals.
Once these rules are approved by the Commissioners and published in the Federal Register, we will all start scrambling. Some of us to register as SEFs and others to comply with the new rules for trade execution, block trading, margin setting and trade reporting. Using the imagery of Bart Chilton, our keynote speaker: the Dodd Frank "boarding process" has begun. We are getting ready for regulatory take-off. In Chiltonian terms, "We have been waiting around the boarding gate since July 2010, eating Cinnabons and watching cable news. Now it is time to get onboard."
Bart Chilton is right, we are indeed embarking on a journey - a ride up into the wild blue yonder of SEF regulation. We don't know what things will look like when we get there. We don't know whether the flight will improve and or fracture US capital markets, increase their safety and soundness, enhance utility to global investors or secure their competitiveness against overseas markets.
We KNOW that is the goal. But, we don't know if that will be the result. All we know is that it is going to be a wild ride with unforeseeable implications for US capital markets.
In fact, market conditions and structures are already changing. Futures and swaps are competing for customers, with stark differences in how they are traded, cleared and margined. Asian and European capital markets are competing with New York and Chicago for trading liquidity and customers. At home, some swaps markets have moved to listed futures. Abroad, we are worried that some trading is moving away from US trading counterparties and American markets.
I began earlier noting that the roots of the wholesale brokerage industry go back over a century in the world’s major financial centers. I fully expect that the industry will continue to operate for at least another century. That is because market participants will always need the services of knowledgeable and neutral intermediaries to help them find trading partners in products in which liquidity is scarce or pricing is too wide. If regulations restrict those services in US markets, they will be performed abroad. The losers will be US trading firms and financial sector workers.
So, let us kick off SEFCON III and let us focus on this exciting, and anxiety-filled, giant leap into the sky. Let us look forward and not behind. SEFCON III is about the future and what to expect.
We will discuss changes in market structures with senior executives, the impact of these upcoming rules on trading liquidity, the nuts and bolts of SEF registration and technological challenges and opportunities in the SEF space.
We will also sit down with respected journalists who work the beat in Washington and New York and having a unique position to observe and report on financial regulatory reform.
Of course, it wouldn’t be a complete day without hearing from the legislators and regulators themselves. I look forward to hearing from Congressman Jim Himes, and the panel being moderated by CFTC Commissioner Scott O’Malia. I am certain the CFTC Commissioner Bart Chilton will provide a keynote address to remember. I look forward to hearing their views not just on particular rule proposals, but how they anticipate those rules will impact US capital markets and economic recovery.
Thank you all for joining us today.