US CFTC warns against some derivatives documents, after investors balk
NEW YORK, Sept 27 (Reuters) - The U.S. Commodity Futures Trading Commission has warned against the use of controversial documents that have been at the center of disputes in the $300 trillion derivatives market in recent weeks, after some fund managers accused big banks of trying to use the proposed agreements to maintain their market control.
The derivatives market is nearing a deadline next week that will kick-start a trading regime in which the majority of the market is expected to gradually shift to new electronic trading platforms which are meant to help promote price transparency and draw in new market entrants.
The CFTC, the main U.S. derivatives regulator, has been rushing through approvals for companies planning to offer trading platforms, called swap execution facilities (SEFs), that will go live Wednesday, as part of an overhaul of Wall Street after the financial crisis.
But the process has been marred by disputes over some terms regarding trading.
Some of the trading platforms have asked investors to sign documents that specify what happens to trades in the event they are not accepted into clearinghouses, known as "breakage agreements," said four people familiar with the situation. Other platforms have been pressured by banks to require the documents, but have refused, the people said.
Fund managers balked at signing the agreements, saying they were unnecessary and were meant to benefit the largest banks that already dominate trading. The fund managers said they would struggle to finalize paperwork with trading partners beyond the largest banks that already offer the most liquidity.
"If there (are) 1,000 participants that come into this market, you need 1,000 participants to have arrangements with 1,000 participants, which would mean a million agreements," which would benefit the incumbent banks, CFTC Chairman Gary Gensler told reporters at a conference in Washington on Friday.
Some banks have also tried to require that the documents be enforced on order-book platforms, where trades are meant to be anonymous, said one person familiar with the requests.
The CFTC, in a letter sent on Thursday to trading platforms, clearing organizations, and banks that act as clearing agents for the trades, said that the use of the documents would go against rules that require SEFs to allow investors impartial access to trading.
A rejection of a trade by a clearinghouse is also rare because banks and trading platforms use credit checks before trades to ensure that they will be accepted to clearing, and because trades are accepted by clearinghouses within seconds, the CFTC said in the letter.
Clearinghouses stand between trading partners and guarantee trades. By removing the credit risks associated with trade counterparties, central clearing is the first step to opening the market to new competition. Open trading platforms that hook into clearing will now enable any investor to trade with any other, and to bypass the banks as intermediaries.
The dispute was the latest in a series of arguments between market participants as the CFTC implements rules mandated by the 2010 Dodd-Frank legislation to reduce the risks of the markets. Though rare, it's not the first time that the CFTC has intervened on a documentation issue.
The regulator last year banned the use of triparty documentation for clearing that was being pushed by banks through the International Swaps and Derivatives Association and futures trade group the Futures Industry Association, after critics alleged that the documents would have a coercive effect of restricting investors to trading only with the largest banks.