New rules mandating that swaps be backed by clearinghouses and executed on regulated systems are complicating investors’ ability to exit the derivatives trades, according to money manager AllianceBernstein Holding LP.
Regulation created by the 2010 Dodd-Frank Act will require that most swaps be traded on exchanges or similar electronic systems known as swap-execution facilities. Investors who want to terminate contracts that are no longer the most actively traded, such as a five-year interest-rate swap with only three and a half years left before expiration, are still required to use those systems rather than negotiate a price directly with dealers as they typically would.
“A lot of real-money, buy-side trading practices have been ignored in this process,” James Wallin, senior vice president at AllianceBernstein in New York, said in a telephone interview. How investors can terminate trades in compliance with the Dodd-Frank Act “is a crucial step in building something that addresses all of the trading needs,” he said. “Essentially it’s only a complete market once you have this.”
TrueEX Group LLC, an interest-rate swap exchange in New York, will begin testing its Portfolio Termination and Compactions service this week, which aims to allow investors to electronically offset their cleared swaps in clearinghouses owned by CME Group Inc. (CME) and LCH.Clearnet Group Ltd., Sunil Hirani, chief executive officer of trueEX, said in a telephone interview.
“It’s needed because the participants spend way too much time terminating swaps,” he said. “It’s operationally inefficient and prone to errors.” In the privately-negotiated market, investors send a spreadsheet with the transactions they want to terminate to one or several dealer banks.
Reforms related to swap-execution facilities and other changes to the $639 trillion over-the-counter derivatives market will be discussed this week in Boca Raton, Florida, at the annual conference of the Futures Industry Association. Executives from BlackRock Inc., Nasdaq OMX Group and Vanguard Group, as well as Hirani, are expected to speak in panel discussions.
Under the new regulations, the process for exiting a portfolio of such trades should be similar to how block futures trades are negotiated off exchange, Hirani said.
“Long-term, traders should be able to terminate specific trades in a clearinghouse by using the trade identifier rather than having to offset the transaction with a new trade,” Matt Scott, a trader at AllianceBernstein in New York, said in a telephone interview. “Terminating trades will allow us to reduce the number of line items we have,” Scott said.
The CFTC and U.S. Securities and Exchange Commission are writing Dodd-Frank rules for swap execution facilities that compete with exchanges, including those operated by CME Group and Intercontinental Exchange Inc., for trading of interest rate, credit and other swaps. The rules are meant to reduce risk and boost transparency after largely unregulated swaps helped fuel the 2008 credit crisis.
The five-member CFTC has been negotiating since late last year on final regulations for trading platforms. The agency has yet to schedule a vote on the rules to govern trades by firms such as JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc.
Investors may also get better prices to terminate cleared swaps if large trades are treated as blocks as in the futures market, Scott said.
“We think they’ve done a good job of constructing a rubric for it, and we are looking forward to seeing this functionality elsewhere,” Wallin said of trueEX’s termination service.
Bloomberg LP, the parent company of Bloomberg News, has said it intends to register with the CFTC as a swap-execution facility.
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