Budget Cuts Threaten to Bleed OTC Swaps Reform Dry
Calling the GOP’s bluff?
As the dogfight over the government's balance sheet inches towards a climax, some market participants contend the GOP is merely threatening to defund portions of the finance reform bill in order to extract concessions in other areas from across the aisle.
Because if they prevail in thwarting true reform of the OTC derivatives market in the aftermath of the unpopular AIG bailout, the Republicans could be handing the Democrats a winning argument to make during the 2012 campaign season, according to Matt Samelson, the principal and equity market analyst at market research firm Woodbine Associates.
"The Republicans know that financial reform is a favorite of the Democrats and the president," Samelson says. "In this instance there was such groundswell, mainstream support of financial regulation that if the Republicans did try to play hardball and choke off funding, it would be political suicide."
But even though such a move would stoke populist anger towards Wall Street, some industry participants argue this scenario is actually a blessing in disguise since it would give overworked regulators more time to get implementation right.
"There are a lot of economists who understand that it's scary if you screw up implementation of this regulation because love it or hate it, it's a massive market and a lot of people depend on it," Peterson notes. "Pretty much everyone in the industry thinks the rulemaking process is going too quickly. They only gave one year. That's Congress' fault."
Meanwhile with OTC derivatives trading volume set to spike in the wake of reform, banks also have a financial stake in dragging out the rulemaking process since their profits could take a hit with trades set to move onto swap execution facilities, Litan points out.
"It's true that when you move all these derivatives onto exchanges and take them out of the shadows, the big banks are going to lose money off of it," Litan explains. "So it is in the interest of big banks to try to slow the reforms down."
Yet Litan warns that the longer market goes without new rules, the more they're exposed to the type of risk that nearly derailed the global economy in 2008. The lack of clarity also hurts banks, which are preparing to make a major infrastructure investment in order to comply with Dodd-Frank.
"You've got a lot of private sector money bet on the creation of these markets and if these rules don't come out in a timely way a lot of money is at risk," Litan says.
As a compromise, lawmakers should slowly enact the new regulation by focusing on the systemically important players first, before turning their attention towards the rest of the market, Peterson argues. That way, the CFTC and SEC can make better use of their strained wallets, while reigning in systemic risk. It would also give banks more time to absorb the thousands of new participants they're expected to get.
"In terms of moving back the effective date for rulemaking," says Peterson, "there's absolutely a lot of interest." As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio
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