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March 1, 2013

Year of Decision

Only Big Derivatives Dealers Will Compete, Analyst Says

By Gregory Bresiger

This will be the year that the much-awaited over-the-counter derivatives rules will be finalized, according to Will Rhode, Tabb Group's swaps expert and its director of fixed-income research for the advisory and research firm. 

Will Rhode, Tabb

But how will the much-awaited reforms, the result of the Dodd-Frank Wall Street Reform Act and Consumer Protection Act of 2010, play out? Will OTC swaps, now most of which are using clearing and largely shunning the once popular bilateral model, be safer and more competitive, as envisioned by those who pushed reforms through Congress?

Sometimes reforms don't work out the way regulators and lawmakers envision.

And Rhode had some interesting and surprising answers in a recent question-and-answer session with CQ&D. He's not sure there will be more competition, because most of these contracts will be more transparent and cleared instead of privately processed. The biggest dealers will remain strong in the OTC derivatives business, he predicts. Rhode also thinks that, after all these reforms go into effect, the OTC market will contract, although he isn't sure by how much. He also thinks that reforms of OTC derivatives might have an unintended consequence: Owing to the incredible costs of clearing these controversial contracts, Dodd-Frank might make the futures business more popular.


CQ&D: What has been settled and what needs to be settled on the swaps rules for clearing these contracts?

Will Rhode: We have a timeline for clearing for each market participant. You can count on the most standardized rates and credit products to be first out of the gate.


CQ&D: Which will be when?

Will Rhode: In March, swaps dealers and active funds have to start clearing; in June, it will be asset managers; and in September, ERISA and pension plans will have to start.


CQ&D: The first ones to be cleared will be...

Will Rhode: Standardized interest rate swaps and index CDSs.


CQ&D: So the relatively easy ones go first, right?

Will Rhode: Yes.


CQ&D: Institutional firms have been lining up to obtain more swaps clearing business. Doesn't that mean there will be more competition to trade, process and settle these contracts? But you're not sure that will actually happen. Why?

Will Rhode: Well, I think the clearing space is actually going to be a prohibitively difficult space, from an intermediary perspective.


CQ&D: How?

Will Rhode: You need capital to clear swaps, and capital is becoming more expensive. Swap-clearing brokers will need scale to compete. There is the potential for FCMs to start to participate, but I think it is not as easy to clear swaps as it is to clear futures.


CQ&D: Why?