In the wake of the CFTC passing position limit regulation mid-October, we put up a post contending that, if application of the rules mirrored application of prior limits, it would likely have a non-existent impact on our industry. The final rule is now in the Federal Register, and can be viewed here.
Fair warning- it’s a beast of a document at over 300 pages, the bulk of which is spent defending the CFTC’s rule from comments it had received from industry participants- most notably the CME.
For those following the situation, you know the rumor mill is ripe with speculation that one of the larger industry entities may sue the CFTC over the rule. The interesting part of the document, as it pertains to this possibility, is that the CFTC determined that they did not have to prove that speculation caused spikes in prices. Direct quote from the document:
The Commission does not believe it must first demonstrate the existence of excessive speculation or the resulting burdens in order to take preventive action through the imposition of position limits. Similarly, the Commission need not prove that such limits will in fact prevent such burdens.
To be fair, this comment is based on their interpretation of the directive given in the Dodd-Frank act- specifically the word “shall,” which they interpreted to mean that the limit imposition was mandatory. The response to this interpretation is that the law also mandates that the CFTC determine whether or not it is “necessary,” which would require conclusive data in one direction or another. We couldn’t find an effective response to this anywhere in the document. To us, that’s a problem.
We also mentioned in our recent post that the potential impact to watch would be on the regulation of swaps in a manner similar to exchange traded futures. The term “swap” still needs definition, but if current research is any indication, such a definition may be exceedingly hard to construct. From the International Swaps and Derivatives Association on Nov. 1st (emphasis ours):
What else can we find out from the trades in SwapClear? They recently analyzed nearly one million trades in their clearinghouse and identified the number of instances there were five or more trades that had 10 identical terms. It sounds like a lot of terms but it’s not. Currency, start date, end date, fixed rate, index (e.g., Libor), index tenor (e.g., 3-month), day count, business day convention, holidays and roll date. Seems like a pretty standardized trade to us. Yet we were surprised to learn that less than 9% of SwapClear’s trades met this definition of standardized.
To date, SwapClear has done primarily dealer trades and dealers typically write “standardized” trades with one another. What the analysis tells us is two things. First, there just aren’t that many six-year sterling or dollar or euro swaps written in any day. If we think there might be 20 full-year maturities in the 17 currencies, that amounts to 340 possibilities alone and SwapClear clears probably around 2,000 trades a day. You do the math. Second, it seems dealers fine tune some of the terms they negotiate with other dealers. Fine tuning transactions is, of course, one of the great strengths of the OTC derivatives market. And keep in mind, these trades are all cleared, so it is not fine tuning for the sake of fine tuning.
Another interesting fact stands out in the SwapClear analysis. Over half of SwapClear’s trades are unique. So much for trading like futures.
We’ll have to wait and see how this plays out, but interesting food for thought.