The CFTC published the text of the three final rules adopted last week. These rules cover the following:
(i) core principles and other requirements for swap execution facilities (“SEFs”);
(ii) the process for a designated contract market or swap execution facility to make a swap “available to trade”; and
(iii) procedures to establish appropriate minimum block sizes for large notional off-facility swaps and block trades.
Section 733 of Dodd-Frank enumerates 15 core principles that all SEFs must fulfill. These include matters such as the ability to monitor trading, having sufficient financial resources and having a chief compliance officer. The big-print version of the proposed release runs over 500 pages, much of which is substantive. Many of the core principles will be fairly expensive to implement, including the development of an audit, compliance and enforcement system. The rule does allow SEFs to contract with third parties to provide many of these compliance services.
The requirement that attracted the most comments before the adoption of the SEF “request for quote” provision require, the person seeking the quote to obtain at least three bids (on only two for the first year). It seems odd that the CFTC believes it is helping swap customers by forcing them to obtain more bids than they want to, even when the CFTC acknowledges that this solicitation process could move the market against the customer. This process presumes that the CFTC can establish a rule for all circumstances which is effectively “smarter” than the judgment that a market participant can make at the time that it trades. See May 10th post of Craig Pirrong’s blog, which does a good job of asking how the CFTC can be confident that it is smarter than swap customers.
“Available to trade” means, contrary to the implication of the term, that a swap is to be traded on a CFTC-regulated market – either a fully regulated Derivative Contract Market (“DCM”) or a SEF. A swap may be found “available to trade” only if the subject is subject to mandatory clearing.
As a starting matter, the CFTC declared that a swap would not be found available to trade simply on the basis of the fact that it was required to be cleared. A separate finding had to be made by either the CFTC or by a DCM/SEF that the swap is available to trade based on a consideration of of seven factors, including whether there were willing buyers and sellers, and the frequency or size of transactions.
A DCM/SEF that, on its own initiative, submitted a certification that a swap was available to trade would be required to list the swap for trading before the swap was ultimately deemed available to trade so that market participants were forced to trade on the exchange. However, the level of trading functionality that the DCM/SEF would be required to provide would only be the minimum amount required by law for any DCM/SEF and, thus, a full range of order types or trading procedures might not be available.
As part of its cost-benefit analysis, the CFTC estimated that it would cost a DCM/SEF no more than $938.40 to prepare a submission that a swap is available to trade. Interestingly, the CFTC elected not to consider the cost to market participants of an available-to-trade determination, saying that this was not relevant to its required analysis.
See also the related news stories below, including “CFTC Adopts Rules Regarding SEFs” and “Timeline for Implementation of SEF Trade Execution Requirements (Prepared by Delta Strategy Group).”
Clearly, the rule is structured to encourage DCMs/SEFs to make an available-to-trade finding, or at least to make doing so inexpensive. Presumably, the end result of this procedure is that every swap which is required to be cleared is also found to be available to trade.
The Block Trade Final Rule establishes measures to protect the identities of swap counterparties and to maintain the anonymity of their business transactions and market positions in connection with the public dissemination of publicly reportable swap transactions by amending existing CFTC regulations to establish the “cap sizes” for notional and principal amounts that mask the total size of a swap transaction based upon a 75-percent notional amount calculation for a given swap category. “Cap size” means the maximum limit of the principal or notional amount of a swap that is publicly disseminated.
The Block Trade Final Rule is also intended to protect market participant anonymity by establishing limits on the public dissemination of certain otherwise reportable swap transactions in the other commodity asset class, such as swaps with certain delivery or pricing points.