Donna Parisi, Partner and head of Shearman & Sterling’s Derivatives and Structured Products practice, sits down with theglasshammer.com to share her thoughts on the outlook for the derivatives industry in 2015 and beyond. Donna was profiled back in 2010 on theglasshammer.com.
Donna will be a panelist at our Annual Navigating Your Career event on 26th February that will address the topic of “Engaging Men as Diversity Champions.” Shearman & Sterling is a sponsor of this event alongside Goldman Sachs and BNY Mellon.
Nicki: What have been the highs and lows for the derivatives industry in 2014?
Donna: In many ways 2014 was the year the derivatives markets took a pause to digest the avalanche of new rules and regulations spawned by the credit crisis. The CFTC in its rush to finalize rulemakings required by Title VII of Dodd Frank had to issue and extend a number of no-action letters to address significant unintended consequences of these rulemakings or delay impracticable implementation timelines. Market participants used 2014 to build and stabilize the legal and operational infrastructure necessary for robust compliance with the rules.
Interest rate and credit derivatives that were required to be cleared became subject to a new requirement of being executed on an exchange known as a swap execution facility.
Cross-border application of CFTC rules relating to business conduct, reporting, clearing and trading of derivatives continued to be a topic of international interest.
There were some changes to the players in the market and in June of 2014 a new CFTC Chairman, Tim Massad, was sworn in. There is hope that Mr. Massad will dial down the rhetoric of his predecessor and guide the agency to a stance on the cross border application of US rules and recognition of other nations’ laws that respects the sovereignty of countries and achieves the industry’s need for harmonization of global businesses, while protecting U.S. persons and markets.
Nicki: What will 2015 possibly hold?
Donna: Well, I think that 2015 will be focused on two “C’s” – capital and collateral. Bank regulators worldwide have finalized a number of capital rules that will significantly impact the derivatives markets. As banks strive to achieve a return on equity that that will meet investors’ expectations, they will need to make choices regarding the business lines that are allocated precious capital. A bank will find it much more difficult to be all things to all customers. Rather, banks will make choices as to which segments they are strong in and that warrant an investment of capital and which lines of business should be shrunk.
It remains to be seen how banks will profitably conduct prime brokerage and clearing of derivatives. With respect to collateral, it is proposed that margin requirements for uncleared swaps will come into effect at the end of 2015. Significant amounts of collateral in the form of initial margin will need to be posted between dealers as well as between dealers and funds. In addition, this collateral must be held with a third party custodian and not re-hypothecated or used by the collateral receiver.
As a result, there will be demand for good collateral and an increase in repo and securities lending activity designed to “transform” ineligible collateral into eligible collateral under the margin regulations. Much of this activity may move to the “shadow” banking sector outside the direct ambit of banking regulators.
Nicki: Are there any other trends that we should be keeping an eye out for?
Donna: A related trend to keep an eye on is whether funds will begin facing each other directly on transactions, which will lead to a disintermediation of the banks. The combination of the Volcker Rule’s prohibition on proprietary trading and increased capital requirements may result in less liquidity as banks pull out of certain markets. This will leave an opening for aggressive, innovative funds to step into the breach.
Nicki: How likely are we to see more legislation being fully implemented in 2015?
Donna: It remains to be seen whether 2015 will bring additional rollbacks of the Dodd Frank Act. The jury is out on whether Congress will be successful in watering down some of the regulatory reforms implemented by the Dodd Frank Act. At the end of 2014, banks were successful in lobbying Congress to essentially repeal (other than with respect to structured finance swaps) the swaps ‘push out’ rule that would have required certain swaps activity to be conducted outside of an insured depository institution.
I will say however, that is likely that increased attention will be paid to clearinghouses and whether Dodd Frank’s push for clearing of derivatives has in fact created the next generation of systemically important institutions.
2015 may finally be the year that the SEC implements its rules for security-based swaps. The industry will be focused on achieving harmonization of the SEC and CFTC rules to the extent possible.
By CEO Nicki Gilmour