August 19, 2022

DealBook: Derivatives Industry Awaits Rules, and a Timeline

With or without new rules, the derivatives industry is gearing up for big changes.

Three years ago, the complex securities wreaked havoc on Wall Street, prompting Congress to overhaul the long-unregulated market. The Dodd-Frank financial regulatory law requires companies to trade credit-default swaps and many other derivatives contracts through regulated exchanges or on a new invention known as swap execution facilities, or S.E.F.’s.

Now, even as regulators miss deadlines to complete the rules, some industry players say they are well prepared for the looming changes.

“Banks, hedge funds, insurers and other sophisticated entities are very eager and ready to begin trading on S.E.F.’s,” Ben Macdonald, global head of fixed income for Bloomberg, told the Senate Banking Committee on Wednesday. The infrastructure needed to set up the new trading platforms “certainly exists,” he added.

Regulators have estimated that 30 to 40 firms — ranging from big names like Bloomberg to growing online marketplaces like Tradeweb — will line up to become swap execution facilities, a term coined under Dodd-Frank.

Wall Street, however, is waiting for Washington to catch up. Amid internal wrangling and a broader political divide over the derivatives rules, regulators have fallen behind on several crucial issues.

The Federal Reserve announced last week that it would allow the public two additional weeks to comment on some derivatives proposals. Earlier this month, the Commodity Futures Trading Commission announced a six-month delay for many of its new derivatives regulations, including the proposal that will spell out rules for the trading facilities.

On Wednesday, the Securities and Exchange Commission finally proposed a series of new ethics standards for the derivatives industry. The proposal came more than six months after the commodities commission introduced a similar plan.

The S.E.C.’s proposed code of conduct would for the first time require banks, hedge funds and other firms that trade the opaque products to bolster their compliance departments and act in the best interests of the pension plans and local governments that use derivatives to hedge risk. Under the rules, the firms would also need to disclose a battery of information, including potential conflicts of interest and risks posed by derivatives deals.

“The standards we propose today are intended to establish a framework that protects investors and also promotes efficiency, competition and capital formation,” Mary L. Schapiro, the agency’s chairman, said at a public meeting in Washington on Wednesday.

The S.E.C. previously outlined proposals that, if enacted, would mandate how derivatives trading platforms operated.

But the pressing question is when the rules will take effect.

“We are ready to go,” Chris Bury, co-head of rates sales and trading for Jefferies Company, told the Senate committee. “The market needs the certainty of when the rules will become applicable.”

Some of the holdup stems from Wall Street’s own attacks on the rules. Industry lobbyists and Republican lawmakers led the push to delay the swap regulations. Bloomberg and other trading firms are asking regulators to tread lightly with the new rules.

“Sophisticated market participants do not really need or want federal regulators micromanaging execution protocols,” Mr. Macdonald told the banking committee.

But some advocates of regulation say delays are jeopardizing the safety of the financial system.

Before the crisis, investors bought billions of dollars’ worth of derivatives as insurance on risky mortgage-backed securities. When the underlying mortgages soured, the American International Group and other firms that sold the deals failed to honor their obligations. The government ultimately rescued A.I.G. with a $180 billion bailout.

“The biggest threat is that every day we don’t have financial reform rules in place is a day that the American taxpayers’ pockets are at risk,” said Dennis M. Kelleher, the president of Better Markets, an advocacy group.

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