Amidst all the ISDA protocols and risk policies that swap dealers are preparing for the ever-shifting Dodd-Frank registration deadline, there is a little-known section of the internal business conduct (IBC) rule that must be addressed. It is §23.605 – Conflict of Interest Policies and Procedures, and it aims to address two possible situations in swaps, one that appears simple but is actually complicated and one that appears more complicated but is actually simpler.
1. Research Conflicts
The one that appears simple, but is actually complicated, involves research reports on derivatives. What the rule attempts to address is the possibility that trading positions might influence the content of research reports, a problem that past New York attorney general Eliot Spitzer highlighted several years ago.
On the surface, this appears to be a manageable requirement; but writing a rule about it, and implementing one, is anything but simple. To see why, let’s look at two very different situations:
In the first, a firm’s research group comes to the conclusion that a certain kind of swap is attractive. Before the report goes public, the traders in that product area need to prepare the firm to respond to anticipated customer demand, so they take positions in line with the research recommendations.
In the second scenario, the trading desk finds itself in positions that have losses and it needs to get out. To assist in that effort, the traders enlist the research department to publish favorable reports, which may not be supported by objective analysis. So here we have two diametrically opposed situations with identical outcomes – the trading and research orientations are aligned.