Swap Trading Systems Should Be Broadest Possible, ISDA Says

U.S. regulators should define a new way of trading derivatives more broadly than any existing exchange or system so that requirements mandated by financial reform are as flexible as possible, according to Wall Street’s swap industry and lobbying group.

The rules should also allow institutions that conduct request-for-quote trades to qualify as swap execution facilities, the International Swaps and Derivatives Association said in a letter to regulators. Request-for-quote trades involve an investor such as a hedge fund asking banks to compete against one other to offer the best price based on terms given for the transaction.

Congress gave the CFTC and SEC authority to define “swap-execution facilities” when it passed the Dodd-Frank Act in July. The facilities will be an alternative to regulated exchanges where investors can trade interest-rate, credit-default and other swaps.

“The definition of SEF thus encompasses all trading facilities as a subset of swap execution facilities, indicating that a greater variety of platforms and/or systems beyond trading facilities, boards of trade and exchanges, should be permissible for executing swaps,” ISDA said in the Oct. 1 letter to the Commodity Futures Trading Commission and Securities and Exchange Commission.

Protecting Profits

The way credit-default or interest-rate swaps are allowed to be traded under the new law is a contentious area of regulation for banks because of the wide profit margin they make by keeping their prices private. The definition of swap execution facilities went through at least five changes from the time the U.S. House of Representatives began deliberating financial reform in 2009 to it becoming law three months ago.

Dodd-Frank defines swap execution facilities as trading systems that allow transactions to be done among multiple users in the $615 trillion over-the-counter derivatives market.

Swap execution facilities “must include not just the many-to-many platforms already included in the definition of ‘trading facility,’ but also other kinds of platforms admitted by the plain language of the definition, including, for example, RFQ platforms,” ISDA Executive Vice Chairman Robert Pickel wrote in the letter.

RFQ is the abbreviation for request for quote.

Need for Change

U.S. lawmakers sought to regulate swaps after the trades complicated efforts to solve the financial crisis. In most cases rule makers 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.

ISDA also said not all market users need be aware of a trade in a swap execution facility for the SEF to meet the multiple-users-to-multiple-users criteria.

Congress said a swap execution facility didn’t have to adhere to “competitive” and “open” bidding rules that exchanges are subject to, ISDA said.

“This supports the conclusion that a SEF need not require participants to make bids and offers available to all other participants,” the lobbying group said.

The new law also requires real-time price reporting of both cleared and un-cleared swap trades, with the Commodity Futures Trading Commission given the authority to create reporting delays for block trades.

“In order for block trading to be a viable option, all trades that are of a certain size or that are characterized by lower liquidity must benefit from appropriate delays before being made public to enable the liquidity provider or risk intermediary to lay-off the associated risk without being ambushed in the market,” ISDA said.

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