JPMorgan Chase & Co., Goldman Sachs Group Inc., and theworld's largest banks won rollbacks in final Dodd-Frank Act rulesthat promise to transform the private swaps market by increasingcompetition.

The Commodity Futures Trading Commission voted 4-1 in Washingtonlast week on rules determining how buyers and sellers must tradecredit-default, interest-rate, and commodity swaps in a $633trillion global market. The rule weakened a proposal by reducingthe number of price quotes buyers must seek on swap-executionfacilities, after banks and asset managers said a five- quoterequirement was onerous and would impair trading.

The vote on the rules represents “the start of a process thatcould eventually lead to a seismic change in trading ofover-the-counter derivatives,” Richard Repetto, an analyst withSandler O'Neill & Partners LP in New York, said in a telephoneinterview before the meeting. “It is a switch from an opaque,bilateral market to something where there is some pricetransparency and a more open and automated market.”

The trading regulations are the latest step in efforts by theCFTC and Securities and Exchange Commission to curb risk andincrease transparency in the swap market. Largely unregulatedtrades helped fuel the 2008 credit crisis that led to the collapseof Lehman Brothers Holdings Inc. and a U.S. rescue of NewYork-based American International Group Inc.

'Information Advantage'

CFTC Chairman Gary Gensler has pushed for rules to improvecompetition by shifting the “information advantage” away from WallStreet banks.

“This rule significantly benefits mid-market America, mid-marketpension funds, mid-market insurance companies, community banks,small corporates,” he said after last week's vote.

Five Wall Street banks dominate the U.S. swaps business withJPMorgan, Goldman Sachs, Bank of America Corp., Citigroup Inc., andMorgan Stanley controlling 95 percent of cash and derivativestrading for U.S. bank holding companies as of Dec. 31, according tothe Office of the Comptroller of the Currency.

The rules may erode bank profits by reducing their currentability to trade directly with other banks or clients in thebilateral market. The trading, clearing, and other rules may costJPMorgan $1 billion to $2 billion in revenue, according to a Feb.26 presentation by the bank.

New Platform

The rules represent the final definition of a new type oftrading platform set up under Dodd-Frank that is intended to serveas an alternative to exchanges operated by CME Group Inc. andAtlanta-based Intercontinental Exchange Inc. Bloomberg LP, theparent company of Bloomberg News, has filed a lawsuit challenging aseparate CFTC rule that the company said will harm its plannedswap-execution facility. Tradeweb LLC, Icap Plc, and GFI Group Inc.have said they plan to set up so-called SEFs.

Dodd-Frank would have most swaps traded on SEFs or exchangesthat let buyers and sellers interact with multiple participants.About 80 percent of interest-rate swaps will be guaranteed atclearinghouses and traded on SEFs, Credit Suisse AG analysts IraJersey and Michael Chang estimated in a May 2 note.

“The ground has been plowed and turned. Now it's up to marketparticipants to see what we can grow here,” said Shawn Dorsch,president of Charlotte, North Carolina-based Clear Markets Inc., anelectronic swap-trading company.

CFTC commissioners changed the proposed quote requirement aftertalks faltered late last year over the plan to mandate five quotes.JPMorgan, Deutsche Bank AG, and other swap dealers lobbied againstthe five-quote requirement, telling regulators that it isunnecessary, will increase trading costs and reduce liquidity onfacilities using request-for-quote systems.

Buyers of derivatives represented by the Securities Industry andFinancial Markets Association, International Swaps and DerivativesAssociation Inc., and Managed Funds Association told regulatorsthey wanted a one-quote requirement and would consider using othermarkets if the five quote requirement was put into place.

The final rules require buyers to request at least two quotesinitially and then three quotes after a phase-in process, accordingto a CFTC official. Gensler agreed to the quote compromise afterfailing to persuade Republican and Democratic commissioners thatfive were needed. The three-quote requirement would begin in aroundOctober 2014.

Dealers 'Win'

“It is going to be perceived as a win for the dealers,especially the two included in the RFQ,” Sunil Hirani, chiefexecutive officer of the trueEX Group LLC swap-trading platform,said in a telephone interview. “I see it as a capitulation forthose who wanted a higher number.”

In a statement after the vote, Sifma said it still stronglydisagreed with the final CFTC rules and the minimum vote rule.

Mark Wetjen, one of three Democratic commissioners, said therule provides flexible trading protocols that represent a“fundamental shift” away from market practice. “'Flexible tradingprotocols' is not code for 'status quo' as some might suggest. Itis not code for 'pro-dealer' trading protocols,” Wetjen said.

In addition to the RFQ measures, the rule requires tradingplatforms to have an order book available to all marketparticipants. Those bids and offers would be communicated to therest of the market.

“Nothing in the statute mandates these minimum tradefunctionalities. We made them up,” Jill Sommers, one of twoRepublican CFTC members, said at the meeting. “I believe we willregret this restrictive approach because it may cause the U.S. tolose this business to foreign jurisdictions that do not stifleilliquid contracts in this way.”

The final rule would also allow companies that execute tradesover the telephone or any form of technology to operate as SEFs.Brokers such as GFI and Icap, which facilitate trades betweenbanks, lobbied the agency to permit trades conducted by voice andnot require electronic-only methods.

“These are short-term gains for the status quo,” James Cawley,CEO of Javelin Capital Markets LLC, said in a telephone interview.“The market is moving to cheaper and more electronic trading ofswaps. The argument that the products are bespoke and toocomplicated to be traded on a screen are unfounded.”

Block Trades

A separate rule approved on a 3-2 vote sets the threshold forwhen trades are large enough to be traded off the platforms intransactions known as blocks. The rules for blocks also allow for aphase-in process.

Under the rule, a trade would be considered a block if it islarger than the 50th percentile for notional value in a givencategory of swaps. Starting in April, the threshold would rise tothe 67th percentile. About 14 percent of interest-rate and creditswaps might be traded as blocks until the higher threshold takeseffect, a CFTC official said.

The CFTC rejected two amendments offered by Scott O'Malia, aRepublican commissioner, to require the CFTC to conduct furtherstudy of swap data to determine block thresholds. The final rulesimpose an “arbitrary and automatic increase” in the threshold basedon limited data, he said.

The CFTC voted 3-2 on a separate rule governing how SEFs andexchanges determine which swaps are made available for trading. TheCFTC's ability to review the determinations is limited under therule, according to Sommers.

The rule will “bind the entire marketplace to a trade executionrequirement as long as the swap must be cleared, even if liquidityis lacking,” she said. “This is overly broad, potentiallyinconsistent with foreign regulations, and just plain badpolicy.”

The commission also voted unanimously to publish guidelinesabout how the CFTC plans to combat disruptive trading practices,such as action during a closing period that has an intentional orreckless disregard for orderly execution.

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