US derivatives market liquidity could be boosted by speeding bank capital rule, CFTC chief Tarbert says

25 March 2020 16:54 by Neil Roland

US derivatives markets that are parched by the Covid-19 pandemic could benefit from a liquidity injection that a speedier introduction of a new bank capital rule could provide, Commodity Futures Trading Commission Chairman Heath Tarbert said.

He said he has asked federal banking regulators to consider a more immediate start date than April 1 for a change in banks’ methodology for measuring the exposure amount of derivatives contracts.

“This is an issue we’ve raised, that if they were going to make changes that they’ve already decided are consistent with prudential requirements, but at the same time would perhaps provide more liquidity to critical players in our markets, that they consider any measures they can take to make that happen,” he said yesterday at a CFTC advisory committee meeting.*

Tarbert added: “It’s an ongoing dialogue.”

A US Federal Reserve spokesman declined comment. The authority for changing implementation of the rule, which was finalized last November, resides with the Fed, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency.

More risk-sensitive approach

The new standardized approach for measuring counterparty credit risk, called SA-CCR, is a more risk-sensitive approach that better reflects industry practices than the Current Exposure Methodology it replaces. The new rule aims to make it easier for some banks and brokerages to keep less capital tied up.

It is scheduled to go into effect on a voluntary basis on April 1, with mandatory compliance due by Jan. 1, 2022.

Rob Creamer, CEO of Geneva Trading, a Chicago-based liquidity provider in derivatives markets, said he would welcome any action to allow banks to immediately adopt the new approach.

“As liquidity providers approach the end of the month, they are going make sure that they are underneath the capital limit” as prescribed by parent banks and banks that are clearinghouse members, said Creamer, who sits on the CFTC advisory committee that met yesterday.

“If you are approaching your limit, you may stop providing liquidity, and if you need to reduce inventory, you are going to be exiting positions at a time when there’s already a lack of liquidity in the markets,” he added. “This could lead to significant and unnecessary price dislocations.”

Capital limits for liquidity providers are in the form of risk-weighted assets.

CFTC market-intelligence analysts said at the meeting yesterday that liquidity has declined in the futures, swaps, foreign exchange and non-deliverable forward markets since the Covid-19 pandemic began.

*CFTC Energy and Environmental Markets Advisory Committee meeting; Washington, D.C.; March 24, 2020.

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