CFTC May Soften Swap Conduct Rules for Pensions, Municipalities
January 11, 2012, 3:19 PM ESTBy Silla Brush and William Selway
Jan. 11 (Bloomberg) -- U.S. regulators may soften Dodd- Frank Act rules designed to protect less-sophisticated customers in swap trades after banks, pension funds and municipalities said the original plan could damage the market.
The U.S. Commodity Futures Trading Commission, meeting in Washington today, may grant Wall Street banks a series of exceptions to rules requiring dealers to reasonably believe their derivatives are suitable for clients and in the best interests of endowments and other so-called special entities.
A measure scheduled for a final vote at today’s meeting would provide a safe harbor to banks offering swaps to the entities so long as they don’t recommend that clients buy specific swaps. It also would give banks a safe harbor from verifying the independence of a client’s adviser, allowing dealers to rely on clients’ claims.
The rules “implement requirements for swap dealers and major swap participants to deal fairly with customers, provide balanced communications, and disclose material risks, conflicts of interest and material incentives before entering into a swap,” CFTC Chairman Gary Gensler said in a statement before the meeting.
The CFTC’s five commissioners are also scheduled to hold final votes today on other Dodd-Frank provisions including a rule protecting swap traders’ collateral and a proposal to limit proprietary trading under the so-called Volcker rule.
Abuses
The agency originally proposed the business-conduct regulation in December 2010 after the Dodd-Frank Act called for regulators to crack down on abuses in the sales of derivatives to states, cities and school districts before the 2008 credit crisis. States and municipalities lost billions of dollars when interest-rate swaps that banks sold as a way to drive down costs moved against them instead. Jefferson County, Alabama, became the biggest municipal bankruptcy in U.S. history.
The proposed rule would hamper the derivatives market and impose unworkable responsibilities, said pension funds, including the California Public Employees’ Retirement System, the Government Finance Officers Association -- which represents municipalities -- and the Securities Industry and Financial Markets Association. JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley are members of Sifma.
The CFTC proposal would cause “severe market disruption” by transforming the relationship between swap dealers and clients such as pensions and municipalities, Sifma and the International Swaps and Derivatives Association Inc. wrote in a Feb. 17 letter. Under the final rule, dealers would be required to disclose material risks and daily mid-market values of contracts to their clients.
Swap Collateral
The CFTC may also complete rules designed to protect swap traders’ collateral that is used to reduce risk in trades. The rule seeks to insulate the collateral if their broker defaults, while also allowing the customer funds to be pooled before a bankruptcy, according to a CFTC summary of the regulation.
Segregation and protection of collateral gained new urgency after MF Global Holdings Ltd. collapsed last year and as much as $1.2 billion in client funds went missing. The CFTC, Securities and Exchange Commission, Justice Department and bankruptcy trustee are investigating if funds were misused before the New York-based broker filed for bankruptcy protection Oct. 31.
Moore Capital Management LP, Paulson & Co. Inc., Fidelity Investments, Tudor Investment Corp. and Och-Ziff Capital Management Group LLC are among investment companies that have urged the CFTC since November to adopt tougher standards than the agency is set to complete today. The CFTC should allow investors the option to set aside collateral in separate accounts at third-party banks instead of allowing the funds to be pooled, they said.
MF Global
MF Global’s failure had an “extremely damaging impact” on futures customers and demonstrated the flaws in allowing futures brokers access to customers’ assets, Anthony J. DeLuca, chief financial officer of Moore Capital, wrote to the CFTC on Jan. 9. BlackRock Inc., the world’s largest asset manager, urged the CFTC to complete the rules and consider more protections later.
The agency’s staff has been asked to consider additional measures to protect traders’ collateral in the swaps and futures markets, a CFTC official told reporters on a telephone briefing call yesterday. The agency may propose additional rules, said the official, speaking on condition of anonymity before the CFTC’s meeting.
The CFTC also may propose limits on proprietary trading and investments in private equity and hedge funds under the Volcker rule. The rule was included in Dodd-Frank as an effort to rein in risky trading at banks that receive federal assistance through the deposit insurance fund and Federal Reserve discount window.
The CFTC is the last of five federal agencies to propose the ban, which has been criticized by the financial industry as overly complex. The CFTC’s proposal would be open to 60 days of public comment.
--Editors: Lawrence Roberts, Gregory Mott
To contact the reporters on this story: Silla Brush in Washington at sbrush@bloomberg.net; William Selway in Washington at wselway@bloomberg.net
To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net
