Budget Cuts Threaten to Bleed OTC Swaps Reform Dry

As regulators work to implement the most profound reform of the nation's financial system since the FDR administration, a looming budget cut threatens to slash their resources, even as the workload multiplies.

Industry experts argue that if House Republicans succeed in rolling funding for securities and commodities regulators back to 2008 levels, they'll fail to meet rulemaking deadlines, exposing the market to further systemic risk. Meanwhile ineffective rules will be the end result if federal watchdogs are forced to stretch their already limited resources too thin.

"It sort of defies common sense that they can carry out these duties on the same budget. They need more money," says Robert Litan, an economist at the Kauffman Foundation, a non-partisan think-tank devoted to entrepreneurship. "In essence what we're talking about is trying to prevent another AIG. That's what all these reforms are aimed at."

Nevertheless House Republicans, who rode to power last November on a pledge to rein in federal spending, presented a bill earlier this month that would trim some $61 billion off the nation's ledger. Tucked within that proposal is a $56.8 million cut from the Commodity Futures Trading Commission's $168.8 million budget, and a $25 million pruning from the Security and Exchange Commission's $1.12 billion budget.

At the CFTC, which was given oversight over most of the $600 trillion over-the-counter swaps market under Dodd-Frank, such a cut could prove particularly painful.

While speaking at an industry conference in January, CFTC Commissioner Scott D. O'Malia pointed out that the agency was forced to chop $11 million from its technology budget in order to hire 77 new employees in fiscal 2010. That cut also led the regulator to slow down development of an automated trade surveillance system designed to help it police the swaps market.

But without a cash infusion, the CFTC could run out of data storage space by October, O'Malia warned in a speech at a Tabb Group conference last month. Meanwhile SEC Inspector General David Kotz cautioned the SEC would have to shave 600 jobs under the Republican proposal, with the CFTC facing potential layoffs of its own.

The Dodd-Frank Act would bear the brunt of the collateral damage as a result, according to Stanford University finance professor Darrell Duffie.

"There is a significant risk that if the regulators don't have the people to write the rules sufficiently carefully and the people to supervise their implementation, then the intent of Dodd-Frank will come to naught," Duffie contends.

"The problem is they've been asked to do a lot more than in the past. And even if they're not cut, that means doing more with the same resources, which means you do each thing less well," says Duffie.

Agreeing with this school of thought, President Obama released a budget proposal earlier this month that would allow the SEC to hire 780 new employees, of whom 468 would focus exclusively on drafting and enforcing hundreds of new rules under Dodd-Frank. That budget would also enable the CFTC to add 238 employees for the same purpose.

Obama's plan dictates the SEC and CFTC can raise money by collecting user fees from the firms they regulate. But it drew a mixed reaction within the CFTC. CFTC Commissioner Bart Chilton praised the plan for striking a balance between the need for fiscal restraint, while making a way for regulators to get what they need.

But O'Malia called the user fee an "uncollectable" tax and said its blueprint for beefing up staffing at the CFTC is unsustainable over the long haul.

Congress has until March 4 to agree on a budget for fiscal 2011.

However, should the Republicans - who nearly unanimously opposed passage of Dodd-Frank - manage to tighten the nation's purse strings, regulators can maneuver around their constrained budgets by leaning on the National Futures Association, argues Sam Peterson, a senior adviser at Chatham Financial. "They could rely on the NFA to do more. Meaning the NFA will charge, as it does now, membership fees to market participants," says Peterson, whose firm advises companies on interest rate and currency hedging. "Through that they can fund some of the rote oversight and compliance work."

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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