CFTC Rules To Spark Scrutiny

WASHINGTON — Market participants attending a federal roundtable here Tuesday are expected to raise concerns about price reporting requirements for dealer counterparties to municipal swaps that will be proposed in coming months by the Commodity Futures Trading Commission.

The roundtable, sponsored jointly by the CFTC and the Securities and Exchange Commission, is to focus on provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act that are designed to increase the transparency of pricing in the over-the-counter swaps market.

But some market participants plan to highlight the increased costs municipal borrowers may face unless regulators agree to allow a reporting lag for dealers’ public disclosure of the prices of large swaps based on the Securities Industry and Financial Markets Association’s muni swap index.

The issuers are expected to qualify for an end-user exemption from the price reporting that was provided by the act.

Though the size of the muni swap market is believed to be declining, no precise figures are immediately available.

Matt Fabian, managing director at Municipal Market Advisors, estimates the market is between $300 billion and $400 billion in notional value, or slightly smaller than the total amount of outstanding variable-rate demand notes and auction-rate securities.

Market participants said the vast majority of swaps entered into by tax-exempt issuers are based on the SIFMA index, but these swaps are much more illiquid than those based on the London Interbank Offered Rate.

As a result, it can be harder and more costly for dealers to enter into simultaneous or subsequent transactions hedging the risks they take on as counterparties for swaps based on the SIFMA index — costs that they may have to pass onto issuers.

Dealers often try to enter into such swaps as quietly as possible so they can line up their offsetting hedges in an orderly way without alerting hedge funds or banks that could engage in front-running and make the transactions more expensive.

“You don’t want an excessive cost to be passed along to issuers or end-users because the dealer is exposed to greater hedging risk on large or illiquid positions,” said Peter Shapiro, managing director of Swap Financial Group in South Orange, N.J.

Shapiro is testifying on a panel on a section of the Dodd-Frank act that would allow for an “appropriate time delay” for reporting block trades or large notional swap transactions to the public.

Another swap adviser, who did not want to be identified, said: “If news of the deal gets out, it has a potential to create a situation where the Street knows the dealer’s positions, and it’s going to move the market before the dealer gets off its hedges. So it will cause the dealer to lose money on the transaction or build in more hedging costs in anticipation of that happening, which may cost a borrower more money.”

“There’s no desire to make these swaps less transparent,” Shapiro said. “It’s just to build in a logical time lag for large, market-moving transactions.”

A close observer of the swap market, who also did not want to be identified, was skeptical about the need for a reporting lag, arguing that generally more transparency tends to be better for the market.

“The issuer may be paying a bit more because of this squeeze, but in exchange it knows that it’s getting a fair price,” the observer said.

But Shapiro disputed that a lag would negate efforts to boost swap-price transparency, saying it would not apply to most swaps.

“The lion’s share of transactions would continue to benefit from transparent, real-time reporting,” he said.

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