The CFTC held a public meeting today to consider the pre-trade transparency module that includes the swaps block rule, the swap execution facility rule and the made available to trade rule. Opening statements were made by Chairman Gary Gensler, Commissioners Jill Sommers, Bart Chilton, Scott D. O’Malia and Mark Wetjen discussing key aspects of the rules and their impact on the swaps market. The commissioners focused on both the benefits and shortcomings which they viewed as critical to the success of the reforms.
Chairman Gensler delivered remarks to open the commission meeting with a focus on the transparency and increase in competition which these reforms are designed to institutionalize in the swaps market. The swaps block rule, the swap execution facility (“SEF”) rule and the made available to trade rule will provide the public with the price and volume of every transaction in real time, allowing anyone in the market to compete and offer to buy or sell a swap and communicate that to the public. Trading on SEFs and designated contract markets (“DCMs”) will only be required between financial institutions, and the rules are flexible enough to allow companies to continue relying on customized transactions to meet their particular needs. To be a registered SEF, the trading platform will be required to provide an order book to all its market participants, allowing the public – for the first time – to gain access and compete in this market. SEFs will have the flexibility to offer trading through requests for quotes; the rule mandates that such requests must go out to a minimum of three unaffiliated market participants before a swap can be executed (an initial phase-in period will allow a minimum of two participants). With the major building blocks of swaps market reform – those of transparency, clearing and swaps dealer oversight – complete, Chairman Gensler noted that the CFTC’s priority is to finalize guidance on the cross-border application of swaps market reform as applied to U.S. affiliates operating offshore. The CFTC is also pursuing an appeal of the district court’s adverse position limits ruling, and Chairmen Gensler has directed the staff to prepare a new proposed rule to implement the speculative position limits required by the Dodd-Frank Act.
Chairman Gensler supports the final block rule for swaps because it promotes transparency. The methodology for determining block sizes is appropriately tailored to asset class, product and rate. The CFTC’s phased-in approach for setting block sizes allows 50 percent of the notional amount of a particular swap category to benefit from pre- and post-trade transparency, and bases the block sizes for foreign exchange and other commodity asset classes upon the block sizes that designated contract markets have set for economically related futures contracts. Beyond this initial period, the block sizes will be determined based on data collected by swap data repositories, such that 67 percent of the notional amount of a particular swap category will benefit from the pre- and post-trade transparency. The rule also includes measures to protect the identities, market positions and business transactions of swap counterparties.
Chairman Gensler also supports the final rulemaking to implement the process for SEFs and DCMs to “make a swap available to trade” (“MAT”). The Dodd-Frank trade execution provision requires that swaps be traded on SEFs or DCMs if they are (1) subject to mandatory clearing and (2) made available to trade. The MAT rule establishes a flexible process for SEFs and DCMs to make a swap available to trade: they first determine which swaps are to be made available to be traded, and then such determinations are submitted to the CFTC either as self-certified or for approval under the Part 40 rules. For the phase-in period, market participants have 30 days after the determination is either self-certified or approved before the swaps are subject to the trade execution mandate.
Chairman Gensler also supports the rule on SEFs, which will allow a significant portion of interest rate and credit derivative index swaps to be in full view to the marketplace before transactions occur, while giving SEFs the flexibility to offer trading through requests for quotes. As long as minimum requirements of the rule and its core principles are met, the SEF can conduct business through any means of interstate commerce.
Finally, Chairman Gensler supports the Interpretive Guidance and Policy Statement regarding disruptive practices on SEFs and DCMs. The provisions implement the express Congressional prohibition of certain trading practices that were deemed disruptive of fair and equitable trading on CFTC-registered entities, in particular the practices that impede critical price discovery functions.
Commissioner Sommers delivered remarks discussing some of the shortcomings of the rules being considered. With respect to setting block sizes, Commissioner Sommers identified the difficulty of establishing appropriate minimum thresholds on markets that are not “one size fits all,” and stated that the CFTC should not be adopting the “one size fits all” approach without appropriate data. She specifically pointed to the 67% automatic adjustment after the one-year phase-in period, without regard to what the data may show, and stated that minimum block sizes should be driven by the most current objective data available, not an automatic across-the-board formula. Additionally, she found the MAT rule to be lacking because it does not provide for a list of objective standards by which the CFTC may use to determine whether a swap is “suitable” for mandatory execution requirements. She stated that the current approach allows a single SEF or DCM to bind the entire marketplace to a trade execution requirement as long as the swap must be cleared, even if the liquidity is lacking, and concluded that this approach is “overly broad [and] . . . just plain bad policy.” Commissioner Sommers also commented that the disruptive trading practices guidance could have been more helpful in some areas. Finally, with regard to the SEF rulemaking, Commissioner Sommers found that it went beyond Congressional intent by imposing requirements not called for by the statute, which would desynchronize the CFTC from the SEC and possibly foreign regulators. She emphasized the importance of basing such rules on objective data and questioned the rejection of a framework that would allow for exempt SEFs and exempt DCOs, which are included in the statute.
Commissioner O’Malia acknowledged that the adoption of these rules will bring the CFTC in compliance with three of the four principles agreed to by the G-20 nations that finalized the Pittsburgh Communique in September 2009. These three principles are: (1) reporting of all trades to a trade repository; (2) requiring that “all standardized OTC derivatives should be traded on exchanges or electronic trading platform, where appropriate”; and (3) “clearing through central counterparties.” The fourth principle calls for higher collateral charges for all non-cleared OTC contracts, and the CFTC has published a proposed rule to address this issue. Commissioner O’Malia then stated that “data is a foundational element” of regulatory oversight, and criticized the underuse of available data in formulating the rules. Specifically, he stated the CFTC was ignoring the available data with regard to shifting the minimum number of traders on an RFQ from two to three participants and, as a result, he provided amendments to both the SEF rule and the swap block rule requiring the CFTC to conduct a timely analysis of the liquidity on the SEF and relevant asset classes when setting block levels. The amendment would require the CFTC to collect data to identify the depth of quality of liquidity and subsequently to determine whether to change the RFQ requirements. Similarly, the swap block rule imposes an “arbitrary and automatic increase” without consideration of transaction data. Additionally, he noted that the rules fail to create flexible trading platforms for sophisticated traders, such as Eligible Contract Participants, and that the rules did not expressly permit other methods of execution, including voice, which would have promoted trading on SEFs.
Commissioner O’Malia also criticized the MAT rule as providing “illusory comfort” to the CFTC by granting a mere “rubber stamp” on an SEF or DCM’s initial determination, without any specific objective criteria. The process for removing a MAT determination also “lacks any logical or legal basis and is the exact opposite” of the requirements to make the initial MAT determination. Finally, Commissioner O’Malia commented on the Disruptive Trade Practices guidance, stating that it does not provide clear guidance on how algorithmic or automated trading should be viewed in the context of disruptive trading, among other deficiencies. He urged the CFTC to work closely with market participates to develop a better understanding of trading strategies used by algorithmic and high-frequency traders in order to identify strategies that could lead to disruptive trading, and stated that the CFTC should enhance the technological infrastructure to conduct proper market analysis in identifying disruptive trading.
Commissioner Chilton stated that greater transparency could have been implemented via these rules and that he believed the rules still “leave in place unregulated dark markets” which contributed to the 2008 economic crisis previously. He stated that, by not acting, the CFTC has elected to essentially encourage “the futurization of swaps to take place.”
Commissioner Wetjen stated that the rules strike an acceptable balance in resolving the concerns raised in comment letters. He emphasized that the rules improve pricing for the buy-side, commercial end uses and other participants that use these markets to manage risk; the rules also allow SEFs as registered entities to establish and enforce comprehensive compliance and surveillance programs. One understated potential benefit, he added, was the improved ability for clearinghouses and their members to manage risk during times of market stress. Ultimately, these final rules allow the CFTC to oversee a transparent, risk-reducing swap market structure. However, Commissioner Wetjen emphasized the importance of being open to reassessing the policy judgments implemented in these rules as the CFTC is provided new information. He highlighted that a significant number of commenters cautioned the CFTC against imposing specific trading protocols because it might unintentionally increase hedging costs for liquidity providers, or dislocate illiquid swap markets, among others concerns. Commissioner Wetjen noted that the rules allow participants to have clear choices – choices concerning margin treatment, modes of execution, clearing venues and, in some cases, counterparties, allowing them to make those choices based upon their own economic interests. He was concerned about supporting a competitive landscape for derivatives execution and brought attention to suggestions that some of the rules may unfairly or inappropriately favor futures execution. He reiterated that the CFTC has a responsibility to revisit its approach as it receives new data.
Opening Statement of Chairman Gary Gensler;
Statement of Support of Chairman Gary Gensler;
Opening Statement of Commissioner Jill Sommers;
Opening Statement of Commissioner Scott O’Malia;
Opening Statement of Commissioner Bart Chilton;
Opening Statement of Commissioner Mark Wetjen.
Fact Sheet: Final Rulemaking on Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades; Further Measures to Protect the Identities of Parties to Swap Transactions;
Questions & Answers: Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades; Further Measures to Protect the Identities of Parties to Swap Transactions;
Fact Sheet: Process for a Designated Contract Market or Swap Execution Facility to Make a Swap Available to Trade under Section 2(h)(8) of the Commodity Exchange Act;
Questions and Answers: Process for a Designated Contract Market or Swap Execution Facility to Make a Swap Available to Trade and Schedule to Phase In Compliance with Section 2(h)(8) of the Commodity Exchange Act;
Fact Sheet: Final Rulemaking Regarding Core Principles and Other Requirements for Swap Execution Facilities;
Questions & Answers: Core Principles and Other Requirements for Swap Execution Facilities;
Fact Sheet: Interpretive Guidance and Policy Statement on Disruptive Practices;
Questions & Answers: Interpretive Guidance and Policy Statement on Disruptive Practices.
SIFMA Statement Disagreeing with CFTC’s Final SEF Rules.