US financial regulators gave over-the-counter ("OTC") swap dealers an extra month to comply with new derivatives trading rules set to take effect on Thursday, 8 August, after Asia's market ground to a near halt due to uncertainty about changes that could increase global funding costs by more than US$500 billion.
The rules directly affect US and Japanese banks, which will be required to post and collect collateral or "margin" against OTC trades, a development set to dramatically raise the cost of trading in the US$500 trillion global swaps market.
The US Commodity Futures Trading Commission ("CFTC") said it will not pursue disciplinary action before 3 October against swap dealers that do not meet new requirements because some were unable to make necessary arrangements in time for Thursday's deadline. The agency said the delay was appropriate when dealers were making "diligent, good faith implementation efforts."
CFTC staff have heard that small and foreign dealers in particular, need more time, Chairman Timothy Massad said in a statement. They believe that "this situation has improved in the last few days, and that the largest dealers may no longer face significant issues," he said.
Two groups representing swap dealers, the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association, had requested the delay.
Regulators in Europe, Singapore, Hong Kong and Australia also recently delayed the implementation of margin rules amid fears their banks were not ready, a move some experts said has created an uneven playing field. India said it was delaying its margin rules on Thursday.
Priya Misra, head of global rates strategy at TD Securities in New York, said the CFTC's delay "might help smooth out some of the market dislocations that could have happened" if US regulators had stuck to their original deadline.
"Every client I spoke with was concerned about the impact of these rules on liquidity and bid-ask in the affected markets, particularly swaptions or cross-currency basis swaps," Misra told Reuters.
Traders and market insiders earlier told Reuters that some major banks in Asia had halted dealing in a range of OTC derivatives products, including foreign exchange non-deliverable forwards ("NDFs") and interest rate swaps. They were not yet able to comply with the rules, first proposed by global regulators following the 2007–09 financial crisis, traders said.
"There is a lot of confusion," said one interest rates trader in Singapore. "The margining is an issue. The big banks are covered under that rule, and some of them don't yet have systems and the back-end documentation processes in place."
Following the financial crisis, global regulators drew up rules to increase transparency and reduce risks in the OTC derivatives market, which was largely responsible for the collapse of Lehman Brothers and bringing insurance giant AIG to its knees.
These included pushing some OTC trades onto exchange-like platforms and through clearing houses, which guarantee payment in the event either party defaults.
The margin rules aim to secure trades that are too complex or illiquid for exchanges and clearing houses to handle. The global cost of funding the margin rules is likely to ultimately exceed US$500 billion, according to US and European regulators.
Large US and Japanese banks have been scrambling to prepare for the first phase of the margin rules, which require changes to risk models, legal documents, and custody arrangements.
The new rules will not be enforced in Europe until mid-2017, after the European Commission announced earlier this year that it would delay implementation.
In practice, European banks had been working toward the 1 September US and Japanese deadline, according to the International Swaps and Derivatives Association.
Still, banks from Europe, Singapore, Hong Kong and Australia have stopped trading OTC products with US and Japanese banks, lest they are forced to post collateral to trade with them, said Kishore Ramakrishnan, a director at PricewaterhouseCoopers Consulting in Hong Kong.
"This regulatory arbitrage won't change until we have a level regulatory playing field next summer," Ramakrishnan said.