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Swap Markets Developments in 2015

Changes in the functioning of the swap markets continue to hit the news—and generate controversy. With recent stories focusing on international comity, proposed margin requirements and position limits, we thought it would be helpful to look at the key changes that market participants may face in the coming months and consider them in the context of the developing regulatory structure for the swaps market place. (RFG clients have already received detailed materials on the specific issues they currently face when trading swaps and an analysis of the proposed margin requirements.)

Looking ahead we see these significant developments to focus on in 2015:

First, margin. Here the regulators are in the process of adopting a regulatory initiative that has the prospect of changing—in a big way—the manner in which traditional uncleared swaps trade. In short, if a swap is not cleared and a swap dealer or bank is dealing with a financial entity (remember these include commodity pools and employee benefit plans), then new mandatory, more expensive margin requirements will apply. The CFTC and Fed have said that their proposed rules will go live in December 2015 with a four-year phase-in based on the level of swap trading activity undertaken by the counterparties to the trade. Increasing costs for uncleared swaps may be a backhand way to make the use of cleared trades more attractive.

Second, the possible designation of new types of swaps for mandatory clearing, with non-deliverable foreign exchange forwards the expected next candidate. As future types of swaps are designated for mandatory clearing, the requirements will be phased in over a 270-day time period.

Third, the need to carefully review contract terms with counterparties and industry infrastructure. Since the cleared swap market is relatively new, many of these contract terms are new. In some cases the contracts incorporate the terms of “rulebooks” which can themselves have provisions that impact end customers. RFG’s Deborah Prutzman has an extensive background in financial services industry utilities of various sorts and RFG would be pleased to assist your analysis in this area.

Fourth, and a related area, continued evolution in the services offered by counterparties. As we have noted previously, banks are morphing their services offerings to reflect regulatory pressures on capital, liquidity, leverage and restructuring options. However, if you use a swap dealer that is not regulated by the bank regulators, watch out for capital requirements they will face under CFTC rules that have yet to be proposed for comment.

Central clearing counterparties (CCPs) and Swap Execution Facilities (SEFs) will also face their own challenges this year. The CFTC has said that preventing CCPs from becoming a vector of systemic risk will be an area of focus The CFTC approved about two dozen SEFs without reviewing their rulebooks, but is in the process of undertaking reviews this year. Observers expect a major consolidation (down to 3-5) if SEFs are to achieve the liquidity needed to make them useful. Software challenges both at the SEFs and their members will also need to be worked through.

Fifth, the need to assure compliance with position limits—should they be modified to include swaps, as the CFTC has proposed. These limits, which will vastly expand existing rules that cover a limited set of futures, apply to investors and require aggregation across accounts and some types of managed funds. Fortunately there are exceptions that apply even under the existing framework.

Lastly, developments in international markets are continuing to evolve and if you trade internationally there is every reason to expect significant activity on this front in the coming year.

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