SIFMA and the International Swaps and Derivatives Association, Inc. (“ISDA”) submitted comments to the CFTC regarding the available-to-trade submissions by Javelin SEF, LLC and trueEx, LLC for certain interest rate swaps, pursuant to CEA Section 5(c) (“Common Provisions Applicable to Registered Entities”) and CFTC Rule 40.6 (“Self-Certification of Rules”). According to the letter regarding Javelin, SIFMA and ISDA do not believe the Javelin submission is ready for action in its current form because it “lacks the specificity needed” to determine whether it meets the six factors set out in CFTC Rule 37.10(b) (“Process for a Swap Execution Facility to Make a Swap Available to Trade”) and the listing requirement set out in CFTC Rule 37.10(a)(2).
Regarding the trueEx submission, SIFMA and ISDA support trueEx’s “contract-by-contract approach” with respect to the six factors set out in CFTC Rule 37.10(b), and believe that trueEx should show that it will meet the listing requirements in CFTC Rule 37.10(a)(2) by demonstrating how it will support trading of the Submission Swaps.
Additionally, SIFMA and ISDA requested that the CFTC address the cross-border and packaged swap issues, which the agencies believe will become more important as a result of an available-to-trade determination.
When the CFTC adopted its rules regarding “made available to trade,” it seemed that the standard that the CFTC was setting, by which all trading in a particular swap could be forced onto a SEF, was remarkably low. Thus there seemed to be a great danger to the financial markets that SEF trading might not function as expected, yet the CFTC would have prohibited OTC trading of swaps, with the risk of severely impeding the market’s ability to trade.
There are two causes for concern: (i) the CFTC has not conducted any inspections of the SEFs to determine if their technology functions properly – so far, its entire supervisory system consists of a cursory review of their various rule filings – and (ii) the CFTC’s “rules” governing SEFs are moving targets, with very new material “guidance” issued only last week as to how these markets are supposed to function. This results in even less certainty as to how SEFs will function.
Given all the technology mishaps that have occurred this year (from those involving Knight, to the Facebook IPO, to the recent problems in the options markets), the standard that the CFTC has established for forcing all OTC trading in a particular type of swap onto a relatively novel and essentially unsupervised SEF market seems imprudent. In this regard, it would seem the better course of action would be for the CFTC not only to attend to the cautions of swap market participants as expressed in the SIFMA/ISDA letter but, more fundamentally, to reconsider whether it has established reasonable procedures for forcing OTC trading onto SEFs.
To put this concern into perspective, the Bank for International Settlements reported that, in June of 2013, there were $561,299 billion in notional amounts of swaps outstanding. When the CFTC adopted the rules by which it would require all swaps of a certain type to be traded on a SEF, the CFTC estimated that the SEF would be required to undertake a study that would cost $938.40 in order to demonstrate that the government should mandate SEF trading (and prohibit OTC trading). 78 Fed. Reg. 33621 (June 4, 2013). The disproportion between the size of this market and the extent of the study is stunning. It seems incomprehensible that a government regulator would mandate moving a long-established market of that size onto a completely novel trading venue on the basis of a study that would cost less than a thousand dollars ($61.60 less than a thousand dollars). Certainly, if a private market participant were to undertake such a drastic action on the basis of a study that cost $938.40, they would be subject to government criticism.