Friday, April 23, 2010

Derivatives industry opposes Lincoln reform bill

Original posted on Reuters by Karen Brettell:

Representatives for the $460 trillion, privately traded derivatives industry on Thursday fought back against growing momentum for reforms that would require contracts to be traded on exchanges, calling it unnecessary and likely harmful to industrial companies.

Calls for wider reforms of the unregulated derivatives industry have intensified in recent weeks as credit default swaps came back into the spotlight for their role in spreading the risk of mortgages that caused the global financial crisis.

Senator Blanche Lincoln, who chairs the agriculture committee, last week unveiled an aggressive draft bill to regulate privately traded derivatives, which would require that banks spin off swaps desks if they are protected by federal deposit insurance or access the Federal Reserve discount window.

The bill would also require most swaps to trade on regulated exchanges and pass through clearinghouses. For more, see: [ID:nN16137927]

Conrad Voldstad, chief executive officer at derivatives trade group the International Swaps and Derivatives Association and former head of JPMorgan's first swap unit, said Lincoln's bill is likely politically motivated and overrides prior, more "sensible" efforts made by the committee.

The bill is "driven by politics - the administration wanted to have a victory and the victory was to beat up the banks and do something they dislike," Voldstad said at a meeting with reporters at ISDA's annual meeting here.

Mandating contracts to be traded on exchanges would damage the ability of industrial companies to hedge their business risks, he said.

"Mandating that all swaps be exchange-traded will increase costs and risks for the manufacturers, technology firms, retailers, energy producers, utilities, service companies and others who use over-the-counter derivatives," Voldstad said. "That's because the risk-hedging products that they want and need will no longer be available."

A key debate in derivatives reform is how many trades are ultimately put into central clearinghouses, which may then be subject to electronic trading. This has the potential to narrow trade margins and shift market share away from dealers to newer players, including exchanges.

ISDA Chairman Eraj Shirvani, who also heads fixed income for Europe, the Middle East and Asia at Credit Suisse, said that not all derivatives are appropriate for central clearing, wherein a central counterparty stands between two trading parties and assumes the risks of the contract.

Deputy Treasury Secretary Neal Wolin, however, said dealers should make greater efforts to clear more contracts.

"Not every derivative contact can be cleared. But many can," Wolin said at the ISDA conference. "The large OTC dealers do not have a sufficient incentive to speed up the process of standardization. Large dealers profit too handsomely from the current system in which they have far more information and far more leverage than other market participants."

Revenue lost by dealers could be significant in the event trading moves toward exchanges. Research and advisory firm TABB Group estimates the top 20 dealers generate around $40 billion annually from privately traded derivatives, excluding credit default swaps.

Jamie Dimon, chief executive of JPMorgan Chase & Co (JPM.N), told bank analysts earlier this month that forcing dealers to trade derivatives on exchanges could cost his firm up to a couple of billion dollars in revenue annually.

Theo Lubke, senior vice president at the Federal Reserve Bank of New York, said clearing needs to be expanded to more contracts, but warned that only contracts with liquid pricing should be routed through central counterparties.

Buy-side participants have been slow to adopt central clearing of contracts including credit default swaps. Ted MacDonald, treasurer at hedge fund DE Shaw Group, said a key reason for this is the limited number of contracts on offer, though he added that expects this range to broaden over the coming year.

Companies that use derivatives to hedge against interest rate, currency, commodity and other risks are likely to win exemptions from clearing because they say that margin requirements would be too costly.

The Commodity Futures Trading Commission and Securities and Exchange Commission, which will enforce the rules, may push for few exemptions.

CFTC Chairman Gary Gensler has said exemptions should be narrowly applied, and that all financial companies, including insurance companies and hedge funds, should be required to centrally clear eligible positions.

Gensler has further said that contracts that are not cleared should still be traded on electronic trading platforms to promote transparency and reduce trading costs.

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