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The regulatory foundations we are putting in place today could be around for your grandchildren, Richard Prager, MD and head of global trading at BlackRock told an audience at FIA Boca.
“This isn’t too different from the laws passed in the 30s. The foundations we are building now are similar to the foundations that we are living with now, when you consider the significance those rules had on capital raising in the U.S.”
Now there’s a scary thought -- makes you wonder if the Congressmen and regulators back then were just as confused as the ones today. Probably not. Glass-Steagall was about 30 pages; Dodd Frank is over 2,000 -- plenty more opportunity for confusion.
Looking 10 years out Donald Wilson, CEO of DRW Trading, said a key theme will be standardization driven in part by Basel III and in part by a desire to manage capital more efficiently.
“If a vast majority of market participants are willing to trade more standardized products, a much bigger percentage of trade will be in central order limit books and a smaller percentage in private transactions.”
He expects that a lot of volume will run into futures and standardized contracts
“Assuming the CFTC has issued SEF rules 10 years from now, there should be a decent volume in SEF as well.”
The market will still have some room for bilateral transactions, he added, as in energy where more trades are customized.
Michael Yarian, MD and head of agency derivative services at Barclays, said some of his clients don’t want to use a central order limit book.
“They want to transfer their risk and know it is done.”
Prager, however, thinks that the markets will see a lot of standardization.
“On the buyside, we don’t need a lot of bespoke anything. We need deep and liquid markets with very standardized products. What will dictate the behavior is economics.
If clearing continues to be more difficult than easy, you will see tipping to a listed market like futures. If the OTC market can evolve in a more standardized, easy-to-understand, margin-efficient way, they will coexist. If we don’t see agreement from different actors on how to evolve that market in a standardized way, the futures market will take hold.”
Mandatory clearing of swaps took effect at the beginning of last week for major swaps users -- the large banks -- and will be extended in two steps in summer and early autumn. About $600 billion notional was cleared in the first two days without major problems.
Some traders voluntarily began clearing their trades ahead of deadlines to learn how the process works and to work out any problems, or because they preferred the risk profile of a cleared trade over an OTC transaction. Perhaps the biggest surprise for participants was how long it took to develop and negotiate execution and clearing agreements.
BlackRock’s Prager said the firm saw a clear differentiation between those who were easy to deal with and those who weren’t. He didn’t name names.
Piers Murray, global head of fixed income prime brokerage at Deutsche Bank Securities, said many of their clients were still negotiating documentation ahead of the June deadline. He expects round two will be more of a problem because it has ten timesas many clients going into clearing as the first round.
Yvonne Downs, COO in the futures divisions at Jefferies, said many of her customers were still asking questions and negotiating documents. Some have decided to use futures instead of swaps while they work out the complexity of legal documentation and system testing.
“What is extremely important is trying to get out in front of it,” said Bryan Durkin, COO of CME Group. “We have spent a great deal of time working with this population and our partners to make sure there is readiness and that the end user client, particularly in the buyside, understands the complexity of getting the legal documentation done and being very rigorous about testing well in advance. In terms of preparedness for Phase II, we are well into that process in client outreach, getting people to understand this is real, there will not be any delays or deferrals.”
He hopes the second phase will go as well as the first, he added.
“Some had been preemptively clearing for weeks or months,” said David Olsen, co-head of futures and options at J.P. Morgan Securities.
“Of the small universe required to go live, only a handful were doing it for the first time.”
On the whole, participants were pleasantly surprised, he added. One area of frustration was not seeing uniform readiness at each liquidity provider they wanted to trade with and the time it took for the FCM or the execution desks to get the trade into the platform, which sometimes took several hours.
The process, panelists said, takes a lot of work, a lot of integration, plenty of lawyers and also testers.
Murray said clients have experienced different broker experiences and readiness of different desks, even in the same institution in different geographies.
“Training in Dodd Frank varies by where they are sitting; it is difficult to get uniform experiences across 12 to 15 liquidity providers.”
Dodd Frank Rule 174, which requires trade clearing in 60 seconds, is fine for plain vanilla trades when all systems are functioning well, said operations experts, but Deutsche Bank’s Murray said feeds will have to improve to make sure that can happen day in and day out.
“The most material weakness is that the rule precedes the availability of technology to support pair trades or any type of spread that has one leg risk-increasing and one leg risk-reducing. Since we don't necessarily know what is in the queue, one leg of a trade may come in at a different time so we may reject a trade that is risk-reducing.”
ICE Clear Credit is developing a model to deliver certainty of execution at the point of execution, said Peter Barsoom, COO. Checking on a pre-trade and post-trade basis, it should be available by the third quarter.
“One purpose of Dodd Frank is to create transparency and efficiency. That can conflict with risk management. The unintended consequences of all the different rules being issued at the same time have led us to places that are undesirable. We need to educate regulators and offer solutions that can meet the overall goals while being compliant with the spirt of the rules and Dodd Frank.”
