Dodd-Frank May Squeeze Swaps Dealers’ Profit Margins

The opaque nature of OTC swaps trading has been lucrative for the large banks that control 80% of the market, but they may find themselves in uncharted waters in the Dodd-Frank era.

Industry groups have resisted many of the new rules, citing the costs of compliance and the negative effect on liquidity and the number of transactions thereby cutting into dealer profits. Their efforts, however, have been undermined by a series of scandals, especially the LIBOR rate-fixing revelations, that has provided regulators with arguments for greater regulation.

“Transparency lowers the risk of the swaps market,” CFTC Chairman Gary Gensler said recently. “Whether it’s non-financial end-users, pension funds, mutual funds, community banks or insurance companies, they all benefit from the lower costs and greater pricing information of a more transparent, accessible and competitive swaps market.”

As the CFTC finalizes swap execution facility (SEF) rules in the coming months, giving smaller market participants market access, large swap dealers may see the cozy OTC days become a thing of the past.

One possible effect of the new rules may be a shift towards futures. Last week, ICE announced that all OTC energy swaps that it clears will be converted into futures contracts beginning in January.

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Photo credit: Images Money

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