May 27, 2024

DealBook: Derivatives Firms Face New Capital Rules

Financial regulators proposed new rules on Wednesday that would require large derivatives trading firms to bolster their capital cushions, the latest attempt to reduce risk in the $600 trillion swaps market.

The rules, proposed by the Commodity Futures Trading Commission, are largely aimed at swaps dealers — brokerage firms, big energy trading shops and Wall Street bank subsidiaries that arrange derivatives deals. The plan also would apply to so-called major swaps participants, companies that are either highly leveraged or have huge positions in swaps contracts.

The agency’s commissioners voted 4 to 1 in favor of advancing the proposal to a 60-day public comment period, after which they must vote on a final version of the rules. Scott D. O’Malia, one of the agency’s two Republican commissioners, voted against the proposal.

The proposed rules are a result of the Dodd-Frank Act, the financial regulatory law enacted last year. The law mandated an overhaul of swaps trading, an unregulated industry that was at the center of the financial crisis.

The commission has already proposed rules that would require many swaps — a type of derivative contract that can be tied to the value of commodities, interest rates or mortgage securities — to be traded on regulated exchanges.

But for months, the commission had declined to say which types of swaps would face the new rules. On Wednesday, after months of deliberation, the commission said its swaps definition would include foreign currency options and foreign exchange swaps and forwards.

The commissioners voted 4 to 1 to propose the definition, which would exempt insurance products and consumer transactions like contracts to purchase home heating oil.

The commission’s separate proposal to build capital cushions in the derivatives industry could help prevent a repeat of the 2008 financial collapse, regulators say.

In the lead-up to the financial crisis, investors bought billions of dollars worth of credit default swaps as insurance policies on risky mortgage-backed securities. When the underlying mortgages soured, American International Group and other companies that sold the swaps lacked the capital to honor their agreements.

Under the commission’s new plan, those firms would have to put aside enough cash to cover unforeseen calamities. Regulators, until recently, had little authority to set any rules for the swaps market.

“Capital rules help protect commercial end-users and other market participants by requiring that dealers have sufficient capital to stand behind their obligations,” Gary Gensler, the commission chairman, said in a statement.

Still, there is no guarantee that enhanced capital levels will avert future disasters. And there is no magic capital number that regulators see as a cure-all; different firms will face different requirements.

Swaps dealers and major trading firms that are already registered with the commission as futures brokers would have to hold at least $20 million of adjusted net capital, on top of existing requirements.

Other firms that are subsidiaries of big banks would have to meet the same capital standards as the parent company, while storing away at least $20 million of Tier 1 capital.

Yet another set of firms would have to keep tangible net equity equal to $20 million, in addition to putting aside funds to cover market and credit risk.

The commission’s proposal covers more than 200 firms expected to register as swaps dealers and major swaps participants.

The commission also voted to reopen or extend the public comment period 30 days on its earlier rule proposals. The agency plans to finalize most Dodd-Frank rules by the fall.

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