Traders Take Their Swaps Deals to Futures Exchanges

On Friday, Oct. 15, a rule designed to improve government oversight of the multitrillion-dollar market for derivatives took effect. The following Monday, many energy traders moved their swaps business to a futures exchange. After the U.S. Commodity Futures Trading Commission put two years into building its regulatory framework for swaps, a slice of the market simply sidestepped it. The CFTC was caught off guard by the move, says Scott O’Malia, one of five commissioners. “All these people left the swaps market due to regulatory uncertainty and confusion,” he says. “That is fundamentally a big problem with the swaps rules.”

As economic officials worldwide have tried to improve regulation after the financial crisis, getting a grip on swaps has been a top priority. And it’s proven to be extra tricky. Broadly speaking, these unregulated contracts are agreements between two parties to exchange payments based on such things as interest rates, currencies, or changes in credit quality. To make things more complicated, either party to a swap is generally free to sell its position. The most notorious of these instruments are credit default swaps, which provide protection against a borrower failing to pay its debts. By creating a huge unseen web of financial obligations, credit default swaps added to the uncertainty that froze credit markets during the financial crisis. They were also responsible for the government’s $182 billion bailout of insurer American International Group, which had sold billions of dollars of them.