On Nov 5, the U.S. Commodity Futures Trading Commission held a public meeting to discuss two rules and a request for comment related to swap markets. This was the agency's first open meeting since the appointment of its two newest commissioners and the first time since May 16, 2013 that the CFTC held a public meeting with a full five-member complement of commissioners.
During the meeting, the five commissioners voted unanimously to change a rule that would lower the de minimis threshold for swap dealer registration from $8 billion in notional value to $3 billion. The action brought to an end a long-running debate about this issue and will eliminate an important source of uncertainty for swap market participants. In addition, commissioners voted 4-1 to issue a proposal amending the CFTC's rules for swap execution facilities and trade execution requirements and 5-0 to issue a request for comments on the practice of post-trade name give-up on SEFs. Both Democratic commissioners challenged the legal justification for the SEF proposal and warned that it would reduce competition among dealers.
De minimis Exception
The CFTC action makes permanent the current $8 billion de minimis threshold for requiring market participants to register as swap dealers. Under the previous rule, the threshold was scheduled to drop to $3 billion at the end of 2019. Click here for a CFTC fact sheet on the proposal.
CFTC staff noted that the current threshold captures 98% of swap transactional activity, and said lowering it to $3 billion would bring relatively little benefit in terms of market supervision but considerable cost for market participants forced to register as dealers. CFTC Chairman Chris Giancarlo commented the final rule will provide "needed clarity and certainty" and will prevent burdensome requirements on small and mid-sized swap dealers that would have resulted in fewer service providers for small and medium firms.
Several commissioners noted, however, that the CFTC was able to reach a consensus on this rule only because it had been narrowed from the proposed version of the rule, which was issued in June. Giancarlo announced that CFTC staff will conduct a study on alternative ways to measure the threshold, as discussed in the June proposal, and then use the study as the basis for further discussion.. These alternative methods include excluding cleared swaps from the calculation, "haircutting" the value of swaps, and a "bifurcated" calculation that would rely on initial margin for cleared swaps and "entity-netted notional" for uncleared swaps. CFTC Commission Brian Quintenz, a Republican, said the current approach, which relies on measuring the notional value of swaps, is "incredibly deficient" and should be replaced by a risk-based metric.
But the two Democratic commissioners, Rostin Behnam and Dan Berkowitz, cautioned that changes to the calculation methodology would affect the definition of a swap dealer and therefore would require joint rulemaking with the Securities and Exchange Commission. Commissioner Dawn Stump, a Republican, agreed that "difficult issues remain" and suggested that the CFTC go back to basics and consider the purpose of the registration rule. For example, if the purpose is to protect clients, then what about firms that do not face clients, she asked.
Proposed Changes to SEF Regulations
A proposed rulemaking to expand permitted execution methods on swap execution facilities advanced by a vote of 4-1. Giancarlo, Behnam, Quintenz and Stump voted for the proposed rule change; Berkovitz voted against.
The SEF proposal would allow for more flexible methods of executions beyond the two currently allowed: order book and request-for-quote via a minimum of three dealers. The proposal also would eliminate the "made available for trade" determination process, expand the range of entities required to register as SEFs by adding swap brokers and aggregators, and create certain requirements for "SEF trading specialists" such as proficiency training and a code of conduct. Click here for a CFTC fact sheet on the proposal.
Giancarlo noted that since the Dodd-Frank requirements, there have been "virtually no innovation and few new entrants" into the SEF marketplace. Furthermore, "we see most liquidity and price execution taking place in introducing brokers, while SEFs have just become booking engines and price discovery has already taken place," he noted. Quintenz agreed, noting that the law allows for SEFs to conduct business by "any means of interstate commerce" and the CFTC should embrace that flexibility.
Berkovitz, who helped draft these rules when he was serving as the agency's general counsel under former Chairman Gary Gensler, expressed strong opposition to the proposal and spent a considerable amount of time challenging many of its provisions. He cited several academic studies showing that the existing rules promoted competition among dealers and reduced transaction costs to the benefits of customers, and he expressed concerns that the proposal would allow SEFs to discriminate against certain types of market participants, roll back gains in market transparency, and stand in opposition to G20 requirements for swap trading.
"The wide latitude that would be granted to SEFs as to how swaps may be traded, who may trade them, the oversight of the marketplace, and the conduct of the brokers looks very much like the 'light-touch' approach to regulation that was discredited by the financial crisis," Berkovitz said.
Behnam agreed to vote for the proposal, but expressed similar concerns and said he would vote no if the current proposal had been a final rule. "While I believe targeted reforms could bring more products onto SEFs … today's proposed reforms are far from targeted," he said. However, Behnam acknowledged that the current framework for SEFs is "far from perfect" and explained that he vote for the proposal to allow the process to move forward.
Giancarlo responded with a lengthy statement explaining the rationale for the rulemaking, which is based on the ideas he put forward in a pair of white papers issued in 2015 and in April 2018. He emphasized that the proposal is designed to allow SEFs to innovate to meet customer demand and adapt their trading methods to the "more episodic nature" of liquidity in the swaps markets. And he stressed that the proposal would bring more swaps trading onto SEFs and expand the range of swaps covered by SEF regulations, in line with the intentions of Congress as expressed in Dodd-Frank.
The deadline for comment on the proposed rulemaking will be 75 days after notice for the proposed rulemaking is published in Federal Register.
Post-Trade Name Give-Up
The commissioners also voted 5-0 to issue a request for comment on the practice of post-trade name give-up. This refers to trades that are matched anonymously, but then after the trade is executed, the names of the counterparties are disclosed to the trade participants. This is not a specific rule proposal, but the CFTC is asking for industry feedback on the issue.
The CFTC staff explained that the practice was developed when swaps were not cleared and counterparties needed to know the entity on the other side of the trade in order to manage their counterparty credit risk. The commission did not put forth a point of view on the practice, either for or against, and instead asked for comments as the first step in developing a recommendation.
"I have an open mind as to the advisability of restrictions on the practice, and what form a rule would take, if at all," Giancarlo said.