The Federal Deposit Insurance Corp. has adopted new rules mandating that banks collect more collateral, also known as margin, for swaps transactions. This would serve as a type of insurance in the event that trades were to fail.
Swaps involve two parties swapping price swing risks in interest rates, currencies, commodities, and other matters. Manufacturers, financial firms, energy firms, and farmers use swaps to hedge and bet against these swings. Swap dealers and significant swap participants should be registered with the Securities and Exchange Commission and the Commodity Futures Trading Commission. They typically take part in over $8 billion in swaps yearly.
Swaps are part of a multi-trillion-dollar global market of contracts. They let counterparties trade a benchmark or fixed price for one that fluctuates. This allows companies to hedge exposure to the changes in the market in terms of its values and process. The new rules come in the wake of the 2010 Dodd-Frank Act, which required such regulations to lower the risks involved in derivatives.
According to The Wall Street Journal, the FDIC’s new rules seek to prevent the kind of risk-taking that led to the government having to bail out certain firms, such as American International Group Inc. Prior to the financial crisis AIG establish a huge derivatives book. When the trades failed, counterparties demanded that collateral be increased. Because the insurer couldn’t pay, the government had to get involved. If the new rules were in place back then, AIG would have been required to put aside more collateral before getting involved in the contracts. This would have placed a limit on its portfolio’s growth.
The final rules would obligate asset managers, banks, hedge funds, and others to raise about 30% of collateral. That’s about 30% more than the margin requirements for similar swaps that had already cleared. The initial margin could be in the form of cash, treasuries, foreign currency, or specific bonds. A “variation margin” would be required if a transaction’s values shift.
FDIC Martin Gruenberg, in his statement, said that this new rule should promote financial stability by decreasing systemic leverage in the market for swaps. The Federal Reserve, Farm Credit Administration, Federal Housing Finance Agency, and Office of the Comptroller of the Currency co-wrote the rules, along with the FDIC. OCC also adopted the rule, as did FCA. Fed and FHFA are slated to do so as well, with the rule going into effect in September 2016. The rule would apply to swaps initiated after that date and would not be retroactive. Meantime, the Securities and Exchange Commission and the Commodity Futures Trading Commission still must write their own versions of new swaps rules.
Swaps are more regulated than they used to be before the economic crisis. Now, the majority of them have to be routed via clearing houses, which are supposed to guarantee trades. That said, some trades are too complex to go through that avenue.
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FDIC Sets New Swaps Rules in Bid to Prevent AIG-Type Meltdown, The Wall Street Journal, October 22, 2015
FDIC Board Approves Joint Final Rule on Swap Margin Requirements, FDIC, October 22, 2015