Some of the world's biggest financial firms are locked in a battle over the control of large banks in the $300 trillion market for privately traded derivatives in the United States.
The fight pits dealers such as JPMorgan, Morgan Stanley and Deutsche Bank against much of the rest of the financial industry.
At the heart of the dispute is a set of seemingly obscure rules that, however esoteric, may help decide the winners and losers in the industry, an opaque market blamed as a major contributor to the 2008 financial crisis.
Derivatives are undergoing a dramatic overhaul, mandated by last year's Dodd-Frank financial reform, which is designed to reduce market risks. The current fight may help determine how much impact new rules have on the industry.
The debate centers on triparty agreements that require investors to agree in advance who they will partner with to trade derivatives. Big banks say they are necessary for some investors to maintain access to the markets.
But big money managers such as Citadel, Vanguard, and AllianceBernstein, say they could limit competition.
The triparty initiative has proved so controversial that Gary Gensler, chairman of chief regulator the Commodities Futures Trading Commission, proposed banning them - the first time a regulator is thought to have intervened in such an issue.
Gensler's move also divided the five CFTC commissioners along political lines, reflecting a widening rift over how far new rules should go as the regulator struggles with how to pursue its burgeoning responsibilities on a limited budget.
In Reuters interviews with more than 20 firms that have been involved in talks on the issue, participants say it is one of the most divisive issues the industry has seen.
The documentation issue is still the most polarized of the issues, said Kevin McPartland, analyst at TABB Group in New York. It's very hot or cold depending on who you talk to.
In spite of the arcane nature of the issue, the stakes are large. Intermediating derivatives is estimated to generate around $50 billion in annual revenues for the small group of banks that dominates the industry, according trade group the Swaps and Derivatives Markets Association.
The market is highly concentrated. The largest eight banks account for 63 percent of the market, according to the International Swaps and Derivatives Association (ISDA).
For fund managers and other new entrants to the market, regulatory change brings the opportunity to diversify trading partners, obtain increased price transparency and reduce trading costs.
Derivatives are used to speculate on moves in financial markets or to hedge against unwanted outcomes. They run the gamut from bets on interest rates to perceptions of a country or company's credit quality.
The dispute traces its origins back to the 2008 financial crisis, after which the New York Fed set targets for the large banks to route trades through central clearing houses.
Clearing houses, which have financial firms as members, stand between trade parties and guarantee financial obligations of the counterparties.
When banks and fund managers began discussing document guidelines for clearing in an industry working group, many assumed banks would retain their key roles as middlemen.
This gave support to documentation that required investors to specify in advance their partners for trading derivatives -- the triparty agreements at the center of the current dispute.
The issue became contentious in January, when Chicago-based fund manager Citadel raised its concerns in an industry group, which was later communicated to Gensler, that the model could be used to restrict competition.
Soon others, including PIMCO, BlackRock, AllianceBernstein and Vanguard, also voiced concerns, people involved in the talks said.
The documents give banks clearing arms undue influence on a customer's choice of counterparties, James Wallin at AllianceBernstein recently said in a submission letter to the CFTC supporting the ban.
As tensions rose, skirmishes focused on three banks pushing hardest for triparty agreements -- Morgan Stanley, JPMorgan and Deutsche Bank.
Some hoped the issue would be put to rest after PIMCO's chief risk officer Bill DeLeon in April had private phone calls with the banks and had them back away from some of their preferred language, people involved said.
Clients should not be forced to negotiate with three parties with regard to their ability to clear, said DeLeon, who declined to comment on details of the calls.
Fund managers argue that there is no need to involve trading desks in clearing agreements, which would normally only involve an investor and the clearing agent.
Some funds were disappointed in May, however, when the banks proposed the triparty framework as an addendum to the document, instead of dropping it altogether.
MADE HIM MADDER
Banks say the documents are needed until technology is better developed so they know an investor has credit capacity left to execute a trade, or banks may be reluctant to trade with them.
Critics say the documents would encourage investors to choose fewer partners and larger firms. Banks could also use the information to channel even more business their way.
Officials at fund managers and banks that were in regular talks with Gensler said he was also angered by the addendum, having already expressed frustration with the documents in the past. It made him madder, said one bank source.
Gensler warned some banks that he would make a rule if the issue wasn't resolved though it was not necessarily clear that he was asking that the option be absent entirely.
Fund managers argue that even having triparty agreements as an option can be damaging and even coercive because banks could set different pricing terms to encourage investors to use them.
One large dealer has already used this language on this in some agreements with clients.
The triparty document provides banks more legal certainty that if certain conditions are met the trades are more likely to clear, said this agreement, a copy of which was seen by Reuters. This, should amount to better pricing.
Angered by the triparty addendum, Gensler brought a ban of triparty up for commissioners' approval at their July 19 meeting. It passed with Democratic support, and Republican opposition, making it an official proposal and open for comment before a final vote.
The move surprised most banks.
This was a brutal, protracted, heated argument to get to a template, said one bank source. After all that work, it was frustrating.
The proposed rule has also exposed a widening political rift in the CFTC, with a composition of two Republican Commissioners, Jill Sommers and Scott O'Malia, and three Democrats, Gary Gensler, Michael Dunn and Bart Chilton.
Sommers, who worked as a derivatives industry lobbyist before being appointed to the CFTC in 2007, views the rule proposal as overreach. We didn't need to get involved in derivatives documentation, she said in an interview.
The voting record of the CFTC so far shows that the five commissioners regularly vote along party lines. In many votes Democrats have been swayed by concerns over potentially anti-competitive elements in rules.
In one recent example, the Democrats approved lower capital requirements for clearinghouse members than banks had been arguing for, for fear higher minimums could be used to refuse more members. The Republicans voted against this rule.
The Democrats are seen as more aggressively seeking to open the market to new entrants and break up the dominance of the large banks.
Much of the tension between the two parties also reflects ideological tensions between the parties.
Democrats have sought more aggressive rules to offset what they perceive as difficulties in the CFTC's ability to enforce and investigate due to budgetary limits.
I've stated my concern that budget constraints and the efforts of those who would delay, weaken, or eliminate Dodd-Frank would force us to be more prescriptive than we should otherwise be in promulgating our final rules, Dunn said at a CFTC meeting in July in response to one rule.
If not for our budget constraints I would vote against this rule, he said.
O'Malia, meanwhile, was put out by what he says a lack of warning heading into the triparty ban vote, and has called for further industry discussion on the issue.
In the July 19 meeting he said he had grown increasingly frustrated with the rulemaking process.
However, judging by Gensler's own words, there may be no letup in the tensions, especially as the final, and hardest, phase of derivatives rulemaking gets going in earnest.
It's rational that you may not like everything that we're doing, Gensler told a room full of bankers at an industry conference in New York this month.
(Editing by Burton Frierson and Theodore d'Afflisio)