CFTC Proposal May Force Ownership Changes at LCH.Clearnet, Tradeweb, NYSE
LCH.Clearnet Ltd., Tradeweb Markets LLC, NYSE Euronext and other companies may be forced to change their ownership structure under proposed rules by the Commodity Futures Trading Commission.
The CFTC is considering capping ownership stakes in swaps clearinghouses, exchanges and trading systems at 20 percent for individual banks and other users of derivatives, people familiar with the matter said yesterday. The CFTC, which will present its first proposed rules tomorrow for the $615 trillion over-the- counter derivatives market, may not grant exemptions for existing companies, said the people, who declined to be identified because the talks haven’t been made public
“What is an LCH.Clearnet going to do, that’s almost completely dealer-owned?” said Kevin McPartland, a senior analyst with Tabb Group in New York. “I can’t see how they’d expect that kind of massive divestiture of these clearinghouses that control trillions of notional” in swaps trades, he said.
The rules are still being formed and may change before they’re released, one of the people said. Groups made up of bank holding companies, non-bank financial firms, major swaps users or dealers may not own more than 40 percent of clearinghouses, the people said. Another option for clearinghouses is that restricted owners would have no limits on a combined stake if none of them exceed 5 percent, they said.
Representative Stephen Lynch, a Massachusetts Democrat, proposed a similar plan last year that wasn’t enacted. The effort was opposed by the Securities Industry and Financial Markets Association, and the International Swaps and Derivatives Association, two banking groups, as well as by the Futures Industry Association, Wall Street’s industry group for exchange- traded derivatives.
“If they were against the Lynch amendment then you can guess the banks will be against this new proposal,” said Darrell Duffie, a finance professor at Stanford University in Palo Alto, California.
London’s LCH.Clearnet owns the world’s largest interest- rate swap clearinghouse and is majority-held by banks. Tradeweb, a derivatives trading platform, is a partnership between Thomson Reuters Corp. and banks including Goldman Sachs Group Inc. and JPMorgan Chase & Co. Bloomberg LP, parent of Bloomberg News, competes with Thomson Reuters in selling financial and legal information and trading systems.
LCH.Clearnet already has a 5 percent ownership limit for voting rights in place, Andrea Schlaepfer, a spokeswoman, said in an e-mailed comment. “Clearing houses are systemically important and should have a diverse ownership as well rigorous oversight from regulators.”
Clearinghouses, which are capitalized by their members, increase stability in OTC derivatives markets because they lessen the effect of a default by sharing risk among the members. They also use daily margining procedures to keep accounts current and allow regulators to see market positions and prices.
The CFTC plans to ask for public comment on whether there should be a collective ownership level established for regulated exchanges and swap-execution facilities, similar to the aggregate level for clearinghouses, the people said.
The proposals reflect “a general distrust by the Commission of the banks to embrace regulatory changes in the OTC derivatives market,” said Robert Webb, a finance professor at the University of Virginia. “This distrust is understandable given the weaknesses in certain segments of the OTC derivatives market highlighted during the financial crisis.”
Conflict of Interest
Lynch wanted last year to contain conflict-of-interest issues by limiting banks’ ownership of swaps companies they must use to clear trades under new regulations designed to overhaul Wall Street and reduce systemic risk. His amendment was stripped from legislation before final passage, with Congress giving the CFTC the authority to set limits.
Lynch said at the time that he was concerned that the banks would limit which types of trades they accept for clearing. Dealers earn higher profits when trades are executed in the unregulated over-the-counter market, which doesn’t use clearinghouses.
U.S. lawmakers sought to regulate swaps through the Dodd- Frank bill passed in July after the trades complicated efforts to solve the financial crisis. In most cases regulators have until July 2011 to write the new guidelines, which mandate that most interest-rate, credit-default and other swaps be processed by clearinghouses after being traded on exchanges or swap- execution facilities.
Under Lynch’s plan, companies in existence as of Jan. 1, 2010 wouldn’t have been affected if their ownership doesn’t change. That grandfathering may not exist in the proposed CFTC rules, with firms having two years or two elections for boards of directors, to come under compliance, the people said.
Clearinghouses may be allowed to file temporary exemptions to the CFTC related to the ownership rules, the people said.
“It just doesn’t seem practical,” McPartland said, referring to the two-year time frame. “It’s too extreme, especially in the short term.”
One issue that needs to be determined is how the CFTC defines the type of companies which will face the ownership restrictions. The commission is now deciding how to write the definitions of “swaps dealer” and “major swap participants,” both categories of market users that will face stricter oversight. Those same companies will face the ownership restrictions, according to the Dodd-Frank Act.
The CFTC will also propose that 35 percent of the board of directors of clearinghouses, exchanges and swap-execution facilities be made up of directors who have no ties to the industry, known as public directors, the people said. The commission plans to ask for public comment on whether that level should be increased to 51 percent, the people said.
The composition of the board will apply to the regulated entity, such as a clearinghouse, and to the parent company, they said.
Tradeweb, based in New York, also partners with Morgan Stanley, Citigroup Inc., Bank of America Corp., Credit Suisse Group AG, Deutsche Bank AG, UBS AG, Royal Bank of Scotland Group Plc and Barclays Plc.
Other companies that are bank-owned or majority-controlled by banks include NYSE Euronext’s new exchange, NYSE Liffe U.S., which signed an agreement last year to sell stakes to Goldman Sachs, Morgan Stanley and UBS, among other financial firms.
Banks own more than 20 percent of FXall, an online currency-trading network based in New York, while six of the 10 owners of Kansas City, Missouri-based BATS Global Markets, operator of the third-largest U.S. stock market, are brokers.
A call to the New York office of FXall was answered by a recording saying it was after business hours. Randy Williams, a BATS spokesman, declined to comment.
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