November 26, 2011
Slipping Backward on Swaps
By GRETCHEN MORGENSON
WALL STREET loves to do business in the shadows. Sunshine, after all, is bad for profits.
So it is perhaps unsurprising that players in the derivatives market want to thwart one of the worthier aims of the Dodd-Frank financial regulation: to bring transparency to the huge market for instruments known as swaps. Now some in Congress, on both sides of the aisle, are trying to block that goal, too.
Dodd-Frank focused on adding transparency to derivatives in a couple of ways. The area now under fire involves its directive that the Commodity Futures Trading Commission create rules to “promote pre-trade price transparency in the swaps market.”
The idea is that customers should get a clear picture of prices. Right now, many swaps are traded one-on-one, over the telephone. The price is usually whatever the dealer says it is.
When markets are opaque, the risks grow that problematic positions, like those that felled the American International Group in 2008, might once again create financial turmoil and spread through the system. Dodd-Frank sensibly asked that market participants provide trade and position details to regulators so this arena could be monitored better.
That mission has pretty much been accomplished. But a lack of transparency in the market as it relates to swaps customers hasn’t been addressed. And it is here that many on Wall Street, as well as some in Congress, are pushing back.
Opacity hurts customers because they can’t see a wide array of prices. But dealers can — so they have an edge that plumps up their profits. One estimate from the Swaps and Derivatives Market Association puts transaction costs in the swap markets at $50 billion annually. These costs would decline by $15 billion a year, the group recently estimated, if pricing were transparent.
The C.F.T.C. is trying to get there. Dodd-Frank requires it to oversee so-called swap execution facilities that will trade or process derivatives transactions. Late last year, in the interest of price transparency, the commission proposed that entities applying to be S.E.F.’s must agree to provide market participants with the ability to post prices on “a centralized electronic screen” that is widely accessible. One-to-one dealings by phone would no longer be allowed.
Those on Wall Street who favor the status quo are upset, and have found some sympathy in Washington.
Representative Scott Garrett , a New Jersey Republican, has teamed up with Representative Carolyn B. Maloney, a New York Democrat, to introduce the Swap Execution Facility Clarification Act. It would bar the Securities and Exchange Commission and the C.F.T.C. from requiring swap execution facilities to have a minimum number of participants or mandating displays of prices. Both mechanisms promote transparency.
Mr. Garrett said the bill directed regulators “to provide market participants with the flexibility” they need to obtain price discovery. This means maintaining the old system that can keep prices in the shadows.
On Nov. 15, a House subcommittee approved the bill by a voice vote.
Because Mr. Garrett opposed Dodd-Frank, his efforts to stop the proposed rule are not surprising. But Ms. Maloney supported Dodd-Frank, so I wondered why she had lent her name to the bill.
In an interview last Wednesday, Ms. Maloney said she had heard concerns about the C.F.T.C. rule from financial firms in her district. “I just felt like that Congress intended multiple competing trade execution platforms and that included voice,” she said. “If you say you can’t have any voice, aren’t you limiting the modes of trade execution?” She also said she was concerned about job losses on Wall Street