Prop-Trading Firms Said to Face Dodd-Frank Swap Dealer Rules

Gary Gensler
Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission (CFTC), testifies at a House Financial Services joint subcommittee hearing in Washington, D.C., on Wednesday, Jan. 18, 2012. Photographer: Joshua Roberts/Bloomberg

The U.S. Commodity Futures Trading Commission may require companies that trade swaps on their own behalf to register with the agency as dealers as the regulator considers ways of limiting their capital requirements, according to three people briefed on the regulation.

The dealer registration requirement would allow the CFTC, the main U.S. derivatives regulator, to have direct oversight of firms that use high-frequency and algorithmic strategies to trade their own money, according to the people, who spoke on condition of anonymity because the rule isn’t public.

DRW Holdings LLC, Infinium Capital Management LLC and RGM Advisors LLC are among more than two dozen proprietary trading firms that have told the CFTC they shouldn’t face capital requirements designed for swap dealers, which trade on behalf of customers.

The CFTC swap dealer rule will determine which banks, hedge funds, energy companies and other firms will be considered dealers subject to capital and collateral requirements to reduce the risk in trades in the $708 trillion global swaps markets.

The CFTC, which can still change the rule, may vote on the final regulation as early as March 9 after the agency delayed consideration from a Feb. 23 meeting. The capital requirements are governed by a separate Dodd-Frank rulemaking that Gary Gensler, CFTC chairman, said commissioners would vote on after April.

The CFTC and Securities and Exchange Commission are leading U.S. efforts to revamp derivatives rules after largely unregulated swaps helped fuel the 2008 credit crisis. Dodd-Frank requires most swaps to be guaranteed by central clearinghouses and traded on exchanges or other venues in an effort to reduce risk and increase transparency.

Wall Street banks are the largest swap dealers with JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Morgan Stanley and Goldman Sachs Group Inc. controlling 95 percent of cash and derivatives trading for U.S. bank holding companies as of Sept. 30, according to the Office of the Comptroller of the Currency.

Increasing Scrutiny

High-frequency traders came under increased scrutiny following the May 6, 2010 plunge in which the Dow Jones Industrial Average briefly dropped 9.2 percent.

The proprietary trading firms oppose being subject to minimum regulatory capital requirements as swap dealers. In July, 27 proprietary trading firms told the agency that existing regulations and their own futures brokers require them to have financial resources to reduce the risk in their trades. Their letter was in response to an April 27 proposal requiring non-bank swap dealers to have at least $20 million in tangible net equity as well as capital set aside to reduce risk in the market.

“Where a market participant does not have customers it does not require minimum capital to carry out market functions on their behalf, nor must it have regulatory capital to ensure an orderly wind down in order to keep customers whole,” the companies wrote in the Jan. 11 letter. The agency is considering ways to limit the capital requirements for proprietary trading firms, one of the people briefed said.

More Rules Considered

The CFTC is also working on a so-called concept release of possible regulations to test and supervise high-frequency and automated trading strategies, Gensler said in January. The agency is also in the process of setting up an agency advisory panel to help define high-frequency trading.

Separately, the CFTC is holding a roundtable starting today on possible regulatory changes to protect client collateral in the futures market following the collapse of MF Global Holdings Ltd.

The CFTC, Securities and Exchange Commission and Justice Department are investigating a shortfall in client funds in the MFGlobal case. James W. Giddens, the trustee overseeing the liquidation, estimated that there is a $1.6 billion gap between customer claims and the amount of money available to pay them.

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