By Jessica Titlebaum
The Futures Industry Association (FIA) held their 30th annual Expo in Chicago last week featuring over 4000 delegates representing 30 countries and showcasing the latest in technology and services with 130 exhibitors.
While attendees and speakers were optimistic about the state of the markets, serious issues impacting the derivatives industry were discussed. Topics included the status of Dodd Frank implementation, concerns about insufficient funding at the regulatory level and the continuous need to manage market risk.
Status of Dodd Frank Implementation
The conference kicked off with the Commodity Futures Trading Commission (CFTC) Chairman Timothy Massad providing a status update on the implementation of Dodd Frank legislation. Key elements were agreed upon by the G-20 nations to help shed light on the over the counter derivatives markets, which went unregulated before the 2008 financial crisis.
Massad touched upon four key commitments embodied in the Dodd Frank Act, the first which included the need for increased oversight of the major swap market players.
According to Massad, currently 106 swap dealers and 2 major swap market participants are provisionally registered with the CFTC. Registration requires firms to observe strong risk management practices and business conduct standards.
Another major element of Dodd Frank regulation is that clearing of standardized transactions, such as interest rate and credit default swaps be mandated.
Massad shared industry estimates regarding the amount of standardized transactions taking place.
“In December 2007, only 16% of outstanding transactions measured by notional value were cleared,” said Massad. In September 2014, that number had grown to 74%.
Transparent trading of standardized transactions on regulated platforms, such as swap execution facilities (SEFs), was another commitment made under the Dodd Frank Act.
“Today, there are 22 SEFs temporarily registered and 2 applications pending,” he said. “SEF trading is new, there are issues to work out but use continues to increase.”
According to Massad, total notional traded volume on SEFs was up 42% in September versus August. Volumes in October were up again by 11%.
The final point the CFTC Chairman touched upon, regarding the status of Dodd Frank, was the need for regular reporting for increased market transparency. While he said this was a work in progress, he believes the public has much more information about the swaps market. This enables more competition and better oversight.
Massad concluded his speech on a note about the CFTC’s resources, which he says falls short when it comes to efficient monitoring of the markets.
“Our current budget does not permit us to conduct as many examinations as we should,” he said. “The simple fact is that without additional resources our markets cannot be as well supervised; customers cannot be as well protected; market transparency and efficiency cannot be as fully achieved.”
His stance on the need for additional resources was echoed in his fellow Commissioner Sharon Bowen’s remarks later in the day.
“The Commission continues to face a crisis that has lasted for years; chronic underfunding compared to the scope of its mission,” said Bowen. “The scope of the markets overseen by the CFTC has expanded massively over the decades.”
According to Bowen, the North American futures and options markets have grown to over $41 trillion in notional value, as of June 2014. In addition to these markets, the CFTC has been tasked to regulate the majority of swap transactions, totaling oversight of markets valued at about $400 trillion dollars.
“Our budget is insufficient, and the Commission and staff consistently have to make difficult choices about how to allocate scarce resources amongst our many regulatory priorities,” she said. “This situation jeopardizes our ability to effectively fulfill our vastly increased responsibilities.”
Cross Border Harmonization
Another important topic talked about in detail at the conference was the need for cross border harmonization, related to the new regulatory framework.
While the US was the first to implement regulations, some of the guidelines conflict with actions taken by other G-20 nations. The timing of rule implementation, margin requirements and the EU’s lack of acknowledgement for America’s Central Counterparty Clearinghouses (CCPs) as an efficient clearing solution are of the most concern.
While Massad believes the G-20 nations have agreed on basic principles for regulating swaps, he said inevitably there would be differences in the specific rules as reforms are implemented.
This too is still a work in progress.
While Dodd Frank has increased the need for risk management procedures, many of the industry’s buy side firms are re-evaluating stress tests and the tools they use to manage risk.
A panel moderated by Marta Chaffee, Division of Trading and Markets at the Securities and Exchange Commission (SEC), explored this topic with representatives from Goldman Sachs, Apex Clearing, the Options Clearing Corporation (OCC) and the International Securities Exchange (ISE).
The Options Clearing Corporation, the world’s largest equity derivatives clearing organization, recently raised capital requirements for their member firms. While putting the increase into perspective, Apex Clearing’s Jud Pyle said the costs are passed down to the consumer.
“In January 2013, capital requirements were at $2.5 billion, in April 2014 that number grew to $4.6 billion and in September 2014 that number had reached $7.8 billion,” said Pyle. “Members need more than double now to run their businesses.”
Alicia Crighton, managing director at Goldman Sachs, stressed the need for more transparency when it came to increasing capital requirements.
“We have revamped stress tests and informed clients for transparency purposes,” she said. “You don’t want any clients to be surprised by requirements when it comes to default funds.”
Besides capital requirements, the Options Clearing Corporation will continue to provide principles to better protect the markets; including pre and post trade controls. However, they don’t believe a uniformed approach is the right one.
“It’s better that we provide principle guidelines and then Exchanges have the freedom to create tools that will meet those principles,” said John Fennel, Executive Vice President, Financial Risk at the OCC.
He made note that what one Exchange, like the ISE for example, implements could be a successful tool and another Exchange, like the Chicago Board Options Exchange, could learn from that action and take a similar approach, and vice versa.
However Pyle believes in uniformity.
“Different ideas are good but the OCC needs to manage and balance those different ideas and a uniformed approach might be easier for the OCC to manage.”
While the FIA Expo highlighted issues in the derivatives space that still need clarification, the industry has made significant progress in the past few years. We have implemented Dodd Frank and now moved on to harmonizing rules across different jurisdictions. We are exploring risk management procedures in depth, continually working towards more transparency in the markets and evaluating how much efficient monitoring will cost. There is still work to be done but market participants cannot forget how far the derivatives industry has come.