The Asset Management Group of SIFMA (“SIFMA AMG”) submitted comments to the Financial Conduct Authority (“FCA”) requesting that it exclude To-Be-Announced trades (“TBAs”) from the definition of derivative contracts under European Market Infrastructure Regulation (“EMIR”).

In the letter, SIFMA AMG suggested that TBA trades should not be classed as derivative contracts for the following reasons:

• TBA trades are appropriately classified as spot trades (cash market trades) as they settle within the standard settlement cycle of the securities being purchased;
• TBA trades should be classified similarly to other transaction types that include relatively long periods of settlement and that are not considered to be derivative contracts;
• there is no regulatory imperative for classifying TBA trades as derivatives; and
• the TBA market is a distinct market based in the United States, focused primarily on transactions in securities issued and guaranteed by three U.S. government-owned or -chartered agencies.

Lofchie Comment: SIFMA AMG’s comments recommending the exclusion of Mortgage TBA’s from the definition of derivative contracts serve as an illustration that the meaning of the term “derivative” is intended to describe not something that is inherent in a financial instrument, but rather something that may be accepted by market convention or determined and imposed by regulators. There is no assumption that similar regulations be imposed on all “derivatives,” as that term can be used to describe a vast array of financial instruments, some of which are exotic, some of which are risky, some of which are common (such as home mortgages with floating rates and early repayment options), and some of which are safe.

See: SIFMA Comment Letter.

The SEC-proposed new rules for security-based swap dealers (“SBSDs”) and major security-based swap market participants (“MSBSPs”) were published in the Federal Register.

Among other things, the proposed rules cover recordkeeping, reporting, and the notification of capital deficiency requirements for SBSDs and MSBSPs.  Additionally, the rules would establish other recordkeeping requirements obliging other broker-dealers to account for their security-based swap activities.

Furthermore, the SEC proposed an additional capital charge provision that would be added to the proposed rules for certain SBSDs, as well as technical amendments to the broker-dealer recordkeeping, reporting, and notification requirements.

Comments on the proposed rules must be submitted by July 1, 2014.

See: 79 FR 25193.

The Financial Stability Board (“FSB”) published the seventh of its semiannual progress reports on the implementation of OTC derivatives market reforms. The seventh report found that substantial progress has been made toward meeting the G20 commitments, through (i) international policy development, (ii) jurisdictions’ adoption of legislation and regulation and (iii) expansion in the use of market infrastructure.

Additionally, the report identified several areas in which further work was needed. In particular, Agencies were urged to:

1. put in place their remaining legislation and regulation promptly, and in a form flexible enough to respond to issues of cross-border consistency;
2. provide clarity on their processes for making equivalency or comparability decisions (including whether additional authority may be needed to defer, where appropriate, to other jurisdictions’ regimes); and
3. continue to coordinate closely and cooperate as needed to seek to resolve cross-border regulatory issues as and when they are identified.

See: OTC Derivatives Reform Report.

In a keynote address at the New Risk in Energy 2014 Conference, CFTC Commissioner Scott O’Malia discussed how Dodd-Frank rulemakings have impacted the energy sector and its use of financial markets.

Commissioner O’Malia’s speech focused on, among others, the following key areas:

• the importance of technological innovation as the CFTC moves to implement and enforce its new rules;
• the need to limit the costs imposed on end users; and
• the “futurization” of swaps and the negative impact that has on end users’ hedging activity.

Commissioner O’Malia began by discussing the CFTC’s technological shortcomings. He urged the CFTC to adopt a broader and more effective technology footprint and to ensure that CFTC regulations keep up with technology and the evolving market structure.

In his discussion of the implications of Dodd-Frank rulemakings for energy traders and other end users, Commissioner O’Malia observed that the CFTC “rushed to implement” 68 rules, noting that it has since issued over 180 staff no-action letters offering “some relief from our hastily drafted rules.” Considering the implications of this process, the Commissioner stated that the relief issued by the CFTC often “imposed new conditions and arbitrary deadlines” and that, “in more than two dozen cases, these no-action letters provided indefinite relief.” Detailing issues with the bona fide hedging requirements and safe harbor determinations stemming from the swap definition, Commissioner O’Malia further urged the CFTC to confront shortcomings in its rules in a way that is consistent with the Administrative Procedure Act.

Commissioner O’Malia concluded his speech by discussing the futurization of swaps and, in particular, the fact that futures do not provide the same tailored hedging benefits to end users that swaps provide. Noting the expansion of this practice, the development of new products, and growing interest in FX, interest rates, and credit products, O’Malia encouraged the CFTC to hold a hearing on these matters before it makes recommendations, suggesting that a Concept Release may be useful to initiate an open dialogue.

Lofchie Comment: For the remaining post-Gensler CFTC Commissioners, and for the three incoming Commissioners, including the new Chairman, assuming new responsibilities will be a bit like cleaning up the morning after a very wild party: the place is a mess, the neighbors (i.e. the neighboring countries) are angry and no one is sure why there is a sick goat in the bathtub.  The temptation is to burn the place down and rebuild, but the Commissioners are stuck with cleaning it up.

See: Commissioner O’Malia’s Keynote Address; Commissioner O’Malia’s Slide Presentation.
Related news: CFTC Acting Chair Wetjen and Commissioner O’Malia Issue Statements Regarding End-User Issues (April 4, 2014); CFTC Commissioner O’Malia Delivers Speech Discussing Technology and the Future of Financial Standards (March 26, 2014); CFTC Commissioner O’Malia Remarks on the Impact of Dodd-Frank on Commodity Futures and Swaps Markets (March 24, 2014); CFTC Commissioner O’Malia: ”It’s Time to Review Our Rules and Make Necessary Changes” (January 28, 2014).

Futures Industry Association (“FIA”) President Walt Lukken delivered a speech at the SIFMA Compliance and Legal Seminar discussing the five trends that he believes are affecting the financial services industry and how to proceed with regulation pragmatically. 

1. The Era of Regulatory Cooperation: President Lukken stated that, since the passage of Dodd-Frank, both the SEC and CFTC have faced a tidal wave of regulatory change in attempting to finalize rule writing. When viewing this in the context of static and tightening budgets, President Lukken said, and the increasing globalization of the markets, it is clear that “regulatory compliance is going to require a cooperative and pragmatic approach across domestic agencies, foreign regulatory authorities, SROs and private sector compliance departments.” To make progress in rebuilding cooperation, President Lukken said, it is important for regulators to seize the opportunity for “mutual recognition,” the concept that one domestic agency with possible legal jurisdiction over a foreign entity is willing to defer to that foreign authority as long as the rules are comparable. President Lukken explained that the United States and Europe are facing a real test of this concept: whether the EU deems U.S. clearinghouses equivalent for EMIR by June.
2. The Lines between Securities and Derivatives Markets Are Blurring: President Lukken stated that, despite the differences between the securities and futures worlds, the industries are being pulled together “by the changes in the regulatory environment and the forces of technology.” He stated that a hybrid of these two worlds seems to have been created with the development of new clearing and trading services for swaps. President Lukken recommended that the CFTC write more technical guidance and standards for SEFs in order to avoid the complexity of problems that have arisen in the securities field.
3. Regulators Are Focused on Central Counterparty (“CCP”) Risk: According to President Lukken, one of the lessons of the financial crisis was that “clearinghouses worked to mitigate risk.” He explained that there has been an increased focus by regulators on every aspect of the clearing process, and the recent default of a clearing member at the Korean exchange KRX highlighted the risks involved with clearinghouses globally. He stated that it will “benefit both regulators and market participants alike to ensure that global CCPs meet the highest standards of risk management.”
4. Regulatory Costs for Clearing Will Begin to Be Realized with Consequences: President Lukken stated that futures commission merchants (“FCMs”) and exchanges have already seen major consolidation in the industry, and that higher capital, in combination with clearing and regulatory costs, will drive further consolidation. He noted that “it is ironic that the rules meant to mitigate risk in our markets may have the unintended impact of concentrating risk and discouraging new entrants.”
5. Fixing the Trust Deficit: According to President Lukken, there is a trust deficit with the public that should be fixed. He stated that it is incumbent on trade associations like FIA and SIFMA to play a lead role in this effort.

Lofchie Comment: The need for the industry to reclaim public “trust” is an issue that is raised regularly. Unfortunately, it seems impossible for this to occur so long as the government and regulators find it beneficial to bash the financial industry as a means of engendering political support, and so long as the press finds that this story sells. While I have not yet read Mr. Lewis’s new book (and I do intend to buy it, demonstrating the profitability of industry bashing), the early reviews indicate that it is yet another demonstration of the upside in impugning the industry. This is not a battle that the industry shows any sign of being able to win. Perhaps after another few years of the employment rate’s failing to rise, it will become clear that this bashing of an entire industry is completely destructive (even if it is profitable for the bashers).

Regarding the issue of trust, it also seems that the regulators have their own issues. Now that Chairman Gensler has departed from the CFTC, there is a greater willingness to confront the fact that central clearing is fraught with risks, and there are reasonable arguments that the risks created by central clearing in the swaps market are just as significant as those that central clearing eliminated. Yet for years, Chairman Gensler touted the view (largely unchallenged by other government regulators who knew better) that central clearing was an inherently safe process, as if it were a magical solution to financial risk. Here, for example, is a typical quote from the former Chairman: “For over a century, through good times and bad, central clearing in the futures market has lowered risk to the broader public. Dodd-Frank brings this effective model to the swaps market. Standard swaps between financial firms will move into central clearing, which will significantly lower the risks of the highly interconnected financial system.” Now, the events in Korea make clear what was already known to those who work in financial regulation: that central clearing by increasing interconnectivity may increase risk to the system. So how does the government now address the risks that come with its forced imposition of central clearing without first admitting that the product was oversold?

See: President Lukken’s Speech.

CFTC Acting Chair Mark Wetjen and Commissioner Scott O’Malia issued statements at the public roundtable concerning end users and Dodd-Frank. Acting Chair Wetjen and Commissioner O’Malia both stated that they are pleased to see the CFTC hold a meeting to address issues concerning end users.

Acting Chair Wetjen stated that the CFTC will publish a Notice of Proposed Rulemaking that would amend the de minimis exception from swap dealer registration to address an issue as to government-owned electric utilities and special entities.  He explained that, going forward, the CFTC “must continue to remain open to revisiting certain rules and making adjustments as necessary.”

Commissioner O’Malia stated that he has advocated consistently for the protection of end users from Dodd-Frank’s expansive regulatory reach.  He noted that “end-users are getting caught up in the CFTC’s rules or are spending too much time and resources to get the necessary reassurance from the Commission that they are entitled to the protection that Congress afforded them in Dodd-Frank.”  Commissioner O’Malia stated that he is pleased the CFTC will be reviewing CFTC Rule 1.35 (“Records of Commodity, Interest and Related Cash or Forward Transactions”) and the de minimis threshold for swap dealing to government-owned electric utilities.

See: Chair Wetjen’s Statement; Commissioner O’Malia’s Statement.
Related news: CFTC No-Action Letter (14-34) Raises De Minimis Threshold for Swaps with Utility Special Entities (March 24, 2014); CFTC Commissioner O’Malia Remarks on the Impact of Dodd-Frank on Commodity Futures and Swaps Markets (March 24, 2014).

The CFTC published in the Federal Register its request for comment regarding swap data recordkeeping and reporting requirements.  The request for comment was developed by the newly created CFTC interdivisional staff working group, which is reviewing CFTC swap data reporting rules to make recommendations, resolve reporting challenges and consider data field standardization and consistency in reporting by market participants. 

The interdivisional working group – which includes staff from the Division of Market Oversight, the Division of Clearing and Risk, the Division of Swap Dealer and Intermediary Oversight, the Division of Enforcement, the Office of the Chief Economist, the Office of Data and Technology, and the Office of General Counsel – is seeking comments to help determine how swap data reporting and recordkeeping rules are being applied and to determine what clarifications, enhancements or guidance may be appropriate.

The request for comment is limited to Part 45 (“Swap Data Recordkeeping and Reporting Requirements”) and related provisions. Comments must be submitted by May 27, 2014. 

See:  79 FR 16689.
Related news:  CFTC Announces It Is Requesting Public Comment on Swap Data Reporting Rules (Pre-Fed. Reg.) (March 20, 2014); CFTC Announces Formation of Interdivisional Working Group to Review Regulatory Reporting (January 22, 2014).

The CFTC published in the Federal Register its interim final rule and request for comment regarding access to swap data repository (“SDR”) data by market participants. 

The interim final rule clarifies that, for a swap which is executed anonymously on a swap execution facility or designated contract market, and which is then cleared in accordance with the CFTC’s straight-through processing requirements, the data and information maintained by a registered SDR that may be accessed by either counterparty to the swap does not include information as to the other counterparty or the other counterparty’s clearing firm.

The interim final rule is effective March 26, 2014.  Comments must be submitted by April 25, 2014. 

See:  79 FR 16672.
Related news:  CFTC Publishes Guidance, No-Action Letter and Interim Final Rule to Promote Trading on SEFs and Support an Orderly Transition to Mandatory Trading (CFTC Letter 14-12) (February 11, 2014).