U.S. securities regulators are expected to be less heavy-handed than U.S. futures regulators in moving privately negotiated swaps onto trading platforms when they meet Wednesday to vote on their proposal.
Securities and Exchange Commission staff have taken a slower approach than the Commodity Futures Trading Commission, carefully incorporating input from commissioners' offices, according to one person familiar with the discussions.
The CFTC was given authority in last year's Dodd-Frank financial law for the majority of the over-the-counter swaps, but the SEC is expected to carefully tailor its rules to the narrower slice of the markets that it will regulate. These include often illiquid equity swaps and certain kinds of credit-derivatives that may not lend themselves to exchange-style trading.
Dodd-Frank aimed to improve price transparency in the roughly $600 trillion global swaps market by allowing investors for the first time to see the prices that dealer banks like JPMorgan and Goldman Sachs are charging their customers.
The law requires certain over-the-counter products to be traded on exchanges or a new kind of alternative platform known as a "swap execution facility" or "SEF."
The requirements placed on SEFs by regulators will have a major impact on competition in the sector, where companies from IntercontinentalExchange to ICAP are vying for a slice of the business.
The industry hopes for a final SEF definition that embraces multiple trading models, including some that offer less transparency than a traditional exchange so that traders won't be forced into the open when executing large, illiquid orders.
The SEC and CFTC are both required to complete the SEF rules by July.
The SEC is already over a month behind the CFTC in unveiling its proposal. But unlike the CFTC, which was forced to scale back its initial proposal amid outcry from commissioners who said it was too inflexible, the SEC isn't expected to have the same kind of drama.
"We think the SEC will take arguably a more balanced or rational approach," said one attorney involved in discussions with the agency.
Examples of the types of credit-derivatives the SEC will oversee includes hedges against the default on a single company's bonds.
"Single-name credit-default swaps... is a unique market unto itself... and may not lend itself to a pure exchange type of model," said the attorney.
The proposal ultimately put out for public comment by the CFTC in December is more flexible than what CFTC Chairman Gary Gensler had hoped it would be.
Initially Gensler had tried to make SEFs more like exchanges, with a central order book that continuously updates bids and offers. Now, the proposal allows for a "request for quote" model popular in the industry in which traders can seek quotes from dealers through the click of a mouse.
That model would stay intact under the CFTC's plan as long as traders can send the request to at least five market players and as long as the SEF makes available both firm and indicative quotes. Indicative quotes suggest what someone is willing to pay for a trade.
The SEC is expected to embrace the request-for-quote model, and may even make it more flexible than the CFTC's. But because the SEC has held its derivatives proposal close to its chest, few experts have been able to tease out details.
"Apparently this is quite a mystery even to those in the industry very close to the situation," said Kevin McPartland, a senior analyst with the TABB Group and an expert on SEF regulation.
But even if the SEC's proposal is more industry-friendly, its impact will be limited due to the smaller slice of the derivatives market that the agency will cover.
"I don't want to be glib," said one attorney involved in SEF talks. "But as an observer, it really doesn't matter what they say. The CFTC is driving this."
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