A panel of U.S. regulators plans to designate some swaps clearinghouses as systemically important as soon as tomorrow, putting them under heightened supervision, according to two people familiar with the officials’ work.
Clearinghouses are required to process most swaps in the $708 trillion over-the-counter derivatives market under provisions of the 2010 Dodd-Frank Act. The designation will be the Financial Stability Oversight Council’s first delineation of which companies aside from banks would threaten the financial system in the event of a failure. The panel is next scheduled to meet tomorrow.
“The big clearinghouses are providing the freeway on which these financial products can trade,” said Mark Williams, a former Federal Reserve examiner who teaches finance at Boston University. “The regulators are saying, ‘We need to understand what sort of activities are on it, and we need to control the speed limit on this freeway.’”
CME Group Inc., the world’s largest futures exchange, said last year it will have its clearinghouse designated. The Chicago-based company guarantees interest-rate and credit-default swaps. The designation of so-called financial-market utilities is taking place under the Dodd-Frank Act overhauling financial regulation and will entail tougher examination and reporting requirements.
The panel of regulators, known as FSOC, also is in the process of determining which non-bank financial companies are systemic. Treasury Secretary Timothy F. Geithner, the panel’s chairman, has said it would make that designation by the end of the year. U.S. bank holding companies with assets of $50 billion or more are automatically deemed systemically important.
An administration official told reporters at a briefing that at tomorrow’s meeting FSOC will discuss designation of financial market utilities such as swaps clearinghouses, as well as the JPMorgan Chase & Co. trading loss of $2 billion and the proposed Volcker rule. The Volcker rule would ban banks from proprietary trading while providing exemptions for hedging and market-making. The rule also limits banks’ investments in private equity and hedge funds.
Anthony Coley, a U.S. Treasury Department spokesman, declined in an e-mail to comment on tomorrow’s decision.
The Dodd-Frank act aims to reduce risk and boost transparency in the swaps market after largely unregulated trades contributed to the 2008 credit crisis. Clearinghouses, which are capitalized by their members, guarantee trades by standing between buyers and sellers.
Under Dodd-Frank, the designated utilities may be subject to Federal Reserve supervision, requiring them to open an account at a Federal Reserve bank, develop a risk-management framework and procedures and resources for a possible default. The Fed also may provide access to its discount window in “unusual and exigent” circumstances.
The Fed “hopefully will do a lot of strong modeling and scenario analysis, and also have minimum requirements that need to be put in place,” Williams said. “There’s a lot of operational risk analysis.”
Credit-default swaps were closely tied to the 2008 financial crisis. Insurer American International Group Inc. collected fees by selling banks and other investors credit-default swaps that would pay out if their mortgage securities defaulted. When the housing market collapsed, AIG was unable to meet its promises, and the U.S. government stepped in to honor the contracts.
Atlanta-based Intercontinental Exchange Inc. owns the world’s largest credit-default swaps clearinghouse, and London-based LCH.Clearnet Group Ltd., is owner of the biggest interest-rate swap clearinghouse.
In July 2011, FSOC finalized a rule for how it would determine when clearinghouses require extra scrutiny because of their importance to the financial system.
The council must approve a designation by at least a two-thirds vote, including the support of the council’s chairman. Its 10 voting members include Fed Chairman Ben S. Bernanke; Commodity Futures Trading Commission Chairman Gary Gensler; Securities and Exchange Commission Chairman Mary Schapiro; and Comptroller of the Currency Thomas Curry.