CFTC’s DMO Provides Time-Limited No-Action Relief to SEFs and Market Participants

The CFTC’s Division of Market Oversight (DMO) issued a time-limited no-action letter providing relief for temporarily registered swap execution facilities (SEFs) from any enforcement responsibilities with respect to market participants trading on those SEFs under the following CFTC Rules: 37.200(a), 37.200(b), 37.201(b)(1), 37.201(b)(3) , 37.201(b)(5), 37.202(b) and 37.203.  The no-action relief in this letter only applies to entities that have achieved temporary registration status as SEFs as of October 2, 2013.

DMO stated that market participants should be provided additional time to review SEF rulebooks and technological specifications before making any written consent to a SEF’s jurisdiction under CFTC Rule 37.202(b) and so subject themselves to the rules and requirements of such SEF.  DMO further stated that SEFs should be provided additional time to ensure compliance with its enforcement responsibilities under CFTC Rules 37.200(a)37.200(b)37.201(b)(1)37.201(b)(3)37.201(b)(5), and 37.203, due to remaining work related to customer legal documentation, processing customer information, and technological connectivity between SEFs, customers, swap data repositories, and third-party regulatory service providers.

The Division emphasized that while this letter relieves SEFs from certain enforcement responsibilities with respect to participants in their markets, this letter does not relieve SEFs from their current regulatory responsibility to establish and maintain the rules, systems and procedures necessary to carry out those enforcement responsibilities.  This no-action relief expires on November 1, 2013 at 12:01 am EST.

Lofchie Comment:   Another set of ambiguous and unworkable rules with another unworkable deadline delayed by another near-deadline no-action letter.  There is a pattern here (although perhaps the CFTC staff deserves credit for issuing the no-action letter before October 1).  The remarkable thing to me is that it just does not seem to matter.  A broken scheme of regulation seems to be the political equivalent of a tree falling in the forest with no one to hear it: unless the mainstream press finds a story here, it may as well be a non-event.

As to the no-action relief itself it is, as usual, inadequate to deal with the problem.   First off, why is the relief only available for a month?  Numerous SEFs have been provisionally registered in the past few weeks, and the CFTC Chairman has been widely quoted in the financial press saying that the CFTC has given only a “cursory” review to each of the applications.  At the same time, the user trade associations have written to the CFTC that the rules are not clear and the required compliance systems are not in place.  On what basis does the CFTC consider that a month is sufficient to deal with these issues?   Will that one-month delay provide the CFTC with sufficient time to conduct a more thorough review of SEF applications?  Notably, on the same day that the CFTC staff issued its no-action letter, it provided guidance as to trading procedures that will apply to SEFs (see related news story).  Even CFTC Commissioner Chilton said that a two-month delay in the CFTC’s SEF rules would be “reasonable” (see related news story).

In any case, given the extreme uncertainty around this rulemaking process and the related CFTC Rules, market participants who use a SEF might consider either (i) not entering into final SEF documentation until the “deadline” or (ii) executing the SEF documentation with the understanding that the agreement will not become effective until the SEF rules actually come into force.  As it is, there is no certainty as to what one is signing up for, or whether market participants will be better off or worse off for having agreed to comply with a set of rules that seems to still be a moving target.

See CFTC Letter 13-57.
See also:  Trade Associations Say “No SEFs Tonight, Please”

CFTC Issues Staff Guidance on Swaps Straight-Through Processing (with Delta Strategy Group Summary)

In response to the mandatory swap execution facilities (“SEF”) registration date approaching on October 2, the CFTC Division of Market Oversight and Clearing and Risk issued an interpretive Guidance on a number of issues regarding trades on an SEF or designated contract market (“DCM”) that are cleared at derivatives clearing organizations (“DCO”) by clearing futures commission merchants (“FCM”). 

Delta Strategy Group Summary of the Guidance:

1. The CFTC confirms that an FCM must screen all SEF/DCM orders, both customer and proprietary, against credit limits prior to execution regardless of how the trade is executed (automated or non-automated).  Off-platform swaps can be screened post-trade.

2. For swaps intended for clearing on a SEF, the clearing member must be identified prior to execution.  Also, a SEF must facilitate pre-execution credit screening by the FCM on an order-by-order basis.  Lastly, the Commission confirms that once an order passes the pre-screening limit check, the FCM may not reject the trade (meaning the FCM guarantees the trade without a last look).

3. The CFTC confirms SEFs must route swaps intended for clearing to a registered DCO as soon as technologically practicable.  Staff reiterates that affirmation hubs are a viable means for routing trades, but restates that the trades must be routed as quickly after execution as would be technologically practicable if automated systems were used. 

4. DCMs must coordinate with DCOs and route executed swap transactions to the DCO for clearing. 

5. In the previously issued Guidance by the Commission, a DCO had 60 seconds to accept or reject a trade based on the FCM’s credit limits at the DCO.  Based on data collected since previous Guidance was issued that shows 99% of trades are accepted or rejected within 10 seconds, the Commission shortens the 60-second window to 10 seconds. 

6. Should a trade not be accepted within the 10-second window, Staff considers the trade void ab initio.  The Staff also states that breakage agreements are not necessary due to the previous statement and declares them to be an impairment to impartial access to SEFs.  The Guidance explicitly states that DCMs, SEFs, FCMs, and swap dealers cannot require breakage agreements as a condition for access to trading on a SEF or DCM.  

See: CFTC Staff Guidance.

CFTC Chairman Gensler Speaks Before International Group of Treasury Associations and U.S. Chamber of Commerce

CFTC Chairman Gary Gensler delivered a speech before the International Group of Treasury Associations and the U.S. Chamber of Commerce, addressing the CFTC’s progress since swaps market reforms began in 2010 as well as discussing future plans. 

Chairman Gensler seemed generally pleased with the CFTC’s progress.  He began by recalling the state of the U.S. economy in 2008 and comparing it to what he views as a much more transparent and efficient swaps market today.  He credited the CFTC with making the markets more transparent through initiatives such as requiring swap execution facilities to be registered, which he believes caused “a transition from a mostly dealer-dominated market to one where others have a greater chance to compete for your business.” 

Gensler also spoke about other areas where CFTC has reformed the markets; for example, bringing transactions among financial institutions into central clearing, as well as bringing oversight to swap dealers.  According to Gensler, there are now 82 swap dealers and two major swap participants registered, including the G16 dealers and a number of energy swap dealers.  Gensler also noted the CFTC’s increased coordination with global regulators, highlighting reforms such as the CFTC’s completed guidance on the cross-border application of Dodd-Frank, and other swaps market reforms that cover transactions between non-U.S. swap dealers and guaranteed affiliates of U.S. persons. Gensler ended his speech by stating his view that the CFTC is an underfunded and understaffed agency, and should be allocated proper funding in order to continue monitoring the swaps market. 

Lofchie Comment:  CFTC Chairman Gensler said that one of the positives of the CFTC’s new swap rules is that persons other than dealers now have a chance to compete for swap business.  However, there are at least three factors that would argue against this hope.  First, the way that the swaps registration rules work, effectively only swap dealers can do business with ERISA plans and other special entities, which would seem to significantly limit trade partners for those firms.  Second, many non-U.S. dealers that do not want to register with the CFTC are limiting the size of their U.S. business to avoid registration, which would also seem to reduce the number of trading partners for U.S. firms.  Third, some U.S. firms are limiting the scope of their swaps trading activities so that they are not classified as swap dealers.  That said, if  there has been in fact an increase in the number of available trading partners available for commercial entities, that would be a good thing.  Hopefully, the CFTC will release the relevant trading data.

See: Chairman Gensler’s Speech.

CFTC Commissioner Chilton Statement on Effective Compliance Date for SEFs

CFTC Commissioner Bart Chilton issued a statement regarding the upcoming October 2 effective date for reporting rules for swap execution facilities (SEFs).  Commissioner Chilton stated his support for the new reporting rules, saying that they will shine a much needed light into the “dark markets” that contributed to the financial crisis in 2008.  However, Commissioner Chilton said the CFTC should provide a targeted, time-limited relief for companies to comply with the new reporting requirements of CFTC Rule 43 (“Real-Time Public Reporting”) and Rule 45 (“Swap Data Recordkeeping and Reporting Requirements”).  Commissioner Chilton also addressed the issue raised by footnote 88 in the CFTC SEF rule, which pulls permitted transactions into SEF procedures.  He stated that the CFTC should permit an extension of two months, and it should not be limited to any certain class or type of swap category for this limited time period, in order for all impacted parties to comply with the new rules.

Lofchie CommentFrom the standpoint of internal co-ordination at the CFTC, it seems odd that one of the CFTC Commissioners who is a great advocate for the new regulatory scheme would issue a statement on one day that a two-month delay in the SEF rules might be necessary to avoid “causing serious market disruptions and possible serious liquidity crises” and, later on that same day, the CFTC staff issues a one-month delay.  Is there internal disagreement as to either the magnitude of the risk or as to the time needed to address the risk?  Is there an internal communications issue?  Does this mean that the one-month delay is likely to be extended?

One might dismiss these questions as simply administrative issues within the agency, but they are indicative of problems with the regulatory scheme.  If, several days before the launch of a new rule set, one of the Commissioners concedes that the rules may cause serious market disruptions, that is worrisome.  Beyond that, the adoption of flawed rules, combined with mixed messaging as to what rules go into effect and when they go into effect, is simply not consistent with the way that a regulatory scheme should function. 

See: Commissioner Chilton’s Speech “Reasonable”.

“The Right Measure of the Money Supply” by Professor Peter Ireland

In his article titled “The Right Measure of Money Supply,” Professor Peter Ireland of Boston College explores the usefulness of monetary aggregates in signaling monetary policy in real time. In his analysis he uses four series: the Federal Reserve’s M1 and M2 and CFS’ Divisia M1 and M2.

Professor Ireland finds the Divisia measures particularly helpful: “Rather than simply adding up the values of funds held in various types of bank accounts, as the Federal Reserve’s measures do, the Divisia aggregates draw on methods that explicitly recognize, for instance, that a dollar held in a NOW account is more liquid—and can therefore be said to provide a larger flow of “monetary services”—than the same dollar held in a three-month CD. Quite helpfully, too, the CFS aggregates also adjust the Federal Reserve’s official measures to remove the distortionary statistical effects of computerized problems that most banks now use to invisibly “sweep” funds on deposit in customers’ checking accounts into savings accounts for the purpose of minimizing statutory reserves requirements.”

Professor Ireland has done extensive work with Divisia monetary aggregates. “[My] colleague Michael Belongia and I have shown that when Divisia measures of the money supply are used in place of the Federal Reserve’s official simple-sum aggregates, strong statistical links between movements in Divisia measures of money and subsequent changes in output and prices can be found in data spanning the Great Inflation of the 1970s, the Great Moderation of the 1980s and 1990s, and the Great Recession of 2008.”

He concludes with warm comments for CFS Director and originator of the Divisia aggregates, William A. Barnett. “It is clear that economists owe a debt of gratitude to Barnett, and to his colleagues Richard Anderson and Barry Jones, for their careful work in adjusting the official measures of the money supply. Less clear is why the Federal Reserve cannot or will not simply make those adjustments to the official statistics themselves.”


In addition to being a professor of economics at Boston College, Professor Ireland is a research associate at the National Bureau of Economic Research and a member of the Shadow Open Market Committee.

To read the full article, click here.

CFTC Commissioner O’Malia Blasts Cross-Border Guidance and Potential Position Limits Rule

CFTC Commissioner Scott O’Malia spoke at the Global Forum for Derivatives Markets regarding regulatory harmonization, among other topics. The Commissioner began by highlighting his concerns regarding the CFTC Cross-Border Guidance that was finalized in July. He stated that the guidance failed to justify its overbroad extraterritorial reach under the statute’s “direct and significant standard,” noting that this standard was meant to act as a limit on the CFTC’s authority, not “to bring the world under the Commission’s jurisdiction.” Additionally, Commissioner O’Malia stated that the CFTC should have issued the document as a rulemaking and not an interpretive guidance. The Commissioner explained that an interpretive guidance does not have a force of law, unlike a CFTC rule which imposes a practical binding effect. Additionally, he noted that the interpretive guidance allowed the CFTC to avoid both a proper cost-benefit analysis and the requirements of the Administrative Procedure Act, which ensures public participation and accountability from the CFTC. The Commissioner stated that the CFTC “got the process and order of things all wrong.” He stated that finalizing the interpretive guidance was a preemptive unilateral move that will make the task of reaching a harmonized global framework more difficult. In order to combat the flawed interpretive guidance from the CFTC, Commissioner O’Malia discussed a key part of global harmonization, which is supervisory memoranda of understanding (“MOUs”). The Commissioner stated that MOUs have the flexibility to fill the gaps left by similarities and differences in jurisdictions. He noted that the rest of the world cannot and will not abide by a one-size-fits-all regulatory standard, and stressed the importance of regulators having a mutually agreed upon solution to resolving differences.


Commissioner O’Malia went on to voice his optimism about the potential innovative trading opportunities which swap execution facilities (“SEFs”) can provide to the futures marketplace. He stated that markets will be improved by the increased liquidity and will evolve as these platforms become more standardized. He further noted that it would make sense to delay the October 2 compliance date in order for market participants to transition to new venues. Commissioner O’Malia also touched on numerous concerns that marketplace participants brought up during the Technology Advisory Committee Meeting.

Lastly, Commissioner O’Malia discussed two rules currently being considered by the CFTC. First, he mentioned a draft final rule that is currently before the CFTC to make various reforms to accounting standards and reporting requirements, and to introduce a controversial new provision requiring FCMs to maintain enough residual interest in their segregated customer accounts in an amount that would ensure that at no point does a customer’s funds margin or extend credit to another customer. Second, he noted that the CFTC is considering a new proposed rule for position limits, stating that this is an “unsavory maneuver” to execute while the current rule is being argued in courts. 

Lofchie Comment: I agree with Commissioner O’Malia that procedural issues with the cross-border guidance are not going to disappear. In addition to the substantive flaws that are present in the “guidance” resulting in part from the fact that there was no opportunity for corrections resulting from public comments, the CFTC is likely to experience significant problems with bringing any enforcement actions based on the “guidance,” which does not have the same force of law as does a rule.

See: Commissioner O’Malia Speech “Regulatory Harmonization, Not Imperialism: A Workable Cross-Border Framework”.
See also: CFTC Technology Advisory Committee Meeting (with Delta Strategy Group Summary) (September 16, 2013); CFTC Commissioner O’Malia’s Opening Statement at Cross-Border Guidance and Exemptive Order Open Meeting (July 15, 2013); Commissioner O’Malia Speaks on Cross-Border, ”Made Available to Trade” and Data Management (June 13, 2013); SIFMA President Bentsen Takes a Side on Cross-Border Conflict (June 10, 2013); CFTC Commissioner O’Malia on Ensuring a Backup Plan on Cross-Border Guidance to Give Markets Certainty (June 7, 2013).

SEC Requests Public Comments on Regulatory Initiatives under Dodd-Frank

The SEC has created an online forum on which members of the public who are interested in commenting on recent SEC rulemaking can publicly post their views even before an official comment period opens. The SEC will post all submissions on the comment page on the SEC website, and all submissions will be posted without change. The SEC is requesting public comments on the following matters:

  • Title II – Orderly Liquidation of Covered Broker-Dealers;
  • Title III – Transfer of Powers to the Comptroller of the Currency, the Corporation, and the Board of Governors;
  • Title IV – Regulation of Advisers to Hedge Funds and Others;
  • Title VI – Improvements to Regulation of Bank and Savings Associations Holding Companies and Depository Institutions; 
  • Title VII – Wall Street Transparency and Accountability;
  • Title VIII – Payment, Clearing and Settlement Supervision;
  • Title IX – Investor Protection and Improvements to the Regulation of Securities; and
  • Title XV – Miscellaneous Provisions.

Lofchie Comment: This is a good and interesting concept: to foster a device for the meaningful public discussion of issues that can occur before the formal rulemaking process starts, at which point many possible options are likely foreclosed as market participants are reduced to commenting on a rule. It would be great if the site could be developed in a way that would make summaries of the letters available (ideally, persons who submitted letters would also submit summaries) and reduce or eliminate the noise caused by form letters.

See: SEC Public Comment Page.


MSRB Adopts Policy for Integrating Economic Analysis into Rulemaking Process

The MSRB adopted a policy for the formal use of economic analysis in MSRB rulemaking which is intended to ensure that regulations support a fair and efficient municipal market, as well as balance the benefits of protections for investors and municipal issuers with the burdens placed on regulated entities. The policy incorporates the core principles of the SEC guidance on economic analysis, which include:

  • identifying the need for a proposed rule;
  • evaluating alternative regulatory approaches; and
  • assessing the benefits and costs, both quantitative and qualitative.

Lofchie Comment: The SEC (and related SROs), on the one hand, and the CFTC, on the other, appear to be moving in opposite directions on cost-benefit analysis, with the SEC apparently embracing the requirement and the CFTC resisting it in court. Leaving aside the question of which agency is on the right side of the issue generally (and, obviously, I favor the acceptance of cost-benefit analysis), this complete split between the commissions is a further demonstration of the absence of any logic to the structure of our financial regulatory system, where two commissions regulating many overlapping matters take such divergent approaches to the rulemaking process.

See: MSRB Policy on the Use of Economic Analysis in MSRB Rulemaking; MSRB Press Release.

CFTC Closes Investigation Concerning the Silver Markets

The CFTC Division of Enforcement announced that it was closing an investigation into the silver markets that had been publicly announced in September 2008. The Division of Enforcement did not recommend charges to the Commission from the investigation. Based upon law and evidence, the CFTC said it that does not believe there is a viable basis to bring an enforcement action with respect to any firm or its employees. The CFTC said that it was also taking the unusual step of announcing the closing of the investigation since the launch of the investigation had received so much attention.

The investigation stems from September 2008, when the CFTC confirmed it was investigating complaints of misconduct in the silver market. The CFTC launched an investigation after receiving numerous complaints regarding the manipulation of silver prices from silver futures contracts that were traded on the Commodity Exchange, Inc. (“COMEX”). According to the CFTC, the Division of Enforcement utilized more than seven thousand enforcement staff hours reviewing and analyzing position and transaction data, including physical, swaps and futures trading data, and interviewing witnesses. The investigation also included an evaluation of silver market fundamentals and trading within and between cash, futures, and over the counter markets.

The CFTC noted that it takes these complaints seriously and it does not hesitate to use its authority, including the new manipulation authority in the Dodd-Frank Act, to bring market manipulation charges that are supported by evidence.

Lofchie Comment:  Given the amount of effort that was put into the investigation, it would be a good thing if the CFTC could issue some public report of the analysis.  The release of a report which shows that markets do strange and unexpected things, even in the absence of human misconduct, would serve the public interest.  As things stand now, it sometimes seems that every unfavorable or unexpected turn in prices can serve as the basis for criticism of the conduct of financial market participants, and sometimes as justification for regulations that may end up impeding rather than aiding the efficient workings of the market.

See: CFTC Press Release.

FRB Issues Two Interim Final Rules Regarding Basel III Regulatory Capital Reforms Incorporation

The Board of Governors of the Federal Reserve System (“FRB”) issued two interim final rules intended to clarify how companies should incorporate the Basel III regulatory capital reforms into their capital and business projections during the next cycle of capital plan submissions and stress tests.  Rules to implement the Basel III capital reforms were finalized in July, and will be phased in beginning in 2014 or 2015, depending on the size of each banking organization. 

The FRB’s first interim final rule applies to bank holding companies with $50 billion or more in total consolidated assets, and clarifies that, in the next capital planning and stress test cycle, these companies must incorporate the revised capital framework into their capital planning projects and into the stress tests required under Dodd-Frank using the transition paths established in the Basel III final rule.  

The second interim final rule provides a one-year transition period for most banking organizations with between $10 billion and $50 billion in total consolidated assets.  These companies are conducting their first company-run stress tests this fall, and will be required to calculate these stress test projects using the Board’s current regulatory capital rules to allow time to adjust their internal systems to the revised capital framework. 

The interim final rules are effective immediately, but are subject to comment (with a comment deadline of November 25, 2013).   

See: FRB Press Release; Interim Final Rules.
Related News: FDIC Publishes Basel III and Capital Requirement Rules (Fed. Reg.) (September 12, 2013); FDIC and OCC Adopt Rules Regarding the Implementation of Basel III Capital Requirements (July 10, 2013); Delta Strategy Group: Summary of New Basel Capital Proposals (July 3, 2013).