Warren Davis, a partner with Washington-based law firm Sutherland, said the consequences of fragmenting the swap market had not been thought through, even if they pass during a final Congressional vote next week.
“The problem is, when you force derivatives into different clearing houses, you're creating problems,” he argued. “There’s more fragmentation from an end user point of view. If anything, you're getting more systemic risk, because you're losing the benefit of netting.”
He said the bill’s provision for a new Consumer Financial Protection Bureau would be ineffectual in monitoring the build up of such risks, since its focus would not be on the derivatives markets.
Davis also suggested there would be many winners out of the reform act, however, in particular those in the clearing space. “I think we’re going to see a lot of new players,” he said. “Look at BNY.”
This week, the New York-based bank formed a new clearing company, BNY Mellon Clearing LLC, to clear futures and derivatives trades for institutional clients. The firm says it plans to become a clearing member on major exchanges and central clearinghouses on a global basis.
Asked if he thought there were any provisions remaining in the bill which might catch Wall Street unawares, Davis said new margining requirements for derivatives were of primary concern. “I think people are going to be shocked by how much collateral they’ll have to post,” Davis said, “especially the hedge funds.”
Margining malaise
“The big question is,” Davis concluded, “how is this going to impact banks in the US, as versus UBS, Barclay etc. Will they be playing under the same rules?” He said it was still unclear, even at this stage, how wide-reaching the application of the bill would be for banks not headquartered in the US. “I’ve got foreign clients whose recourse would simply be to use non-US headquartered financial institutions,” he declared.
Of still greater concern was the potential retroactive application of new margining requirements to existing derivatives contracts, Davis said. “No one [in Congress] wants to touch it. They want to leave it to the regulators. I think it’s outrageous. They [would be] retroactively applying new rules – effectively rewriting people's contracts,” he argued. “I’ve talked to a lot of people on the Hill and they agree it’s a huge problem, but no one wants to do anything about it.”
Tom Osborn +44 207 779 8361 tosborn@fow.com