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Clearing interpretation mix-up could cost swaps users

Craig Pirrong

The swaps industry misinterpreted clearing rules that it assumed allowed up to nine months to transfer swaps to clearinghouses, a move that could force derivatives users to scramble for cash and Treasuries to back trades.

Davis Polk & Wardwell LLP, which represents the Securities Industry and Financial Markets Association, sent an email earlier this month to clients saying that firms that deal in $648 trillion of outstanding swaps contracts expected that trades conducted during a phase-in period would not need to be processed by a central clearinghouse, Bloomberg reports.

The 2010 Dodd-Frank Act mandates that trades be moved to central clearinghouses in order to reduce risks that fueled panic during the recent financial crisis.

“Customers are scrambling to get arrangement with clearing brokers, so this is going to increase the operational complexity and challenge,” Craig Pirrong, a finance professor at the University of Houston, said, adding that customers will have to find margin required by clearinghouses to cushion against losses on swaps “that are all of a sudden going to be cleared, so there’s the liquidity demand that’s also going to be fairly acute,” according to Bloomberg.

Anshuman Jaswal, a senior analyst at financial research company Celent, said that clearing trades sooner than expected may absorb as much as $50 billion in extra collateral for swaps users. Jaswal also said that amid the confusion, dealers may still choose to enter new contracts, though the mix-up could reduce trading volume by as much as 50 percent.

Pirrong said that unless the CFTC eases up on the rule, it will be “expensive and risky” for swaps users.

“This is another example of the unintended consequences of Dodd-Frank,” Pirrong said, Bloomberg reports. “We have sorcerer’s apprentices waving their wands to bring all these mandates into the effect, and now we’re having to live with the consequences.”

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