CFTC Extends Temporary No-Action Relief for SEFs from ''Occurs-Away'' Requirement (CFTC Letter 15-60)
Commentary by Bob Zwirb
The CFTC Division of Market Oversight ("DMO") extended no-action relief, which was granted in CFTC Letter 14-118, to swap execution facilities ("SEFs") from the "occurs-away" requirement under CFTC Rule 43.2 ("Definitions"). Relief was granted in order to (i) give DMO staff sufficient time to continue to review and evaluate SEF trading practices and functionalities for pre-execution credit checks; and (ii) allow the DMO to consider, develop and evaluate best practices and permanent solutions to the issues involved in screening block trade orders for compliance with risk-based limits, including, if appropriate, amendments to CFTC regulations.
The DMO specified that the conditions for relief include the following:
- that the block trade is not executed on the SEF's Order Book functionality, as defined in CFTC Rule 37.3(a)(3) ("Requirements and Procedures for Registration");
- that the SEF adopts rules pertaining to cleared blocks that indicate the SEF's reliance on the relief in this no-action letter and require each cleared block trade execution on a non-Order Book trading system to comply with the requirements set forth in the block trade definition in CFTC Rule 43.2, which stipulate that a block trade must:
- involve a swap that is listed on a registered SEF;
- be executed pursuant to the SEF's rules and procedures;
- meet the notional or principal amount at or above the appropriate minimum block size applicable to the swap; and
- be reported to a swap data repository pursuant to the SEF's rules and procedures and the CFTC's rules and regulations.
- that the Futures Commission Merchant ("FCM") completes the pre-execution credit check pursuant to CFTC Rule 1.73 ("Clearing FCM Risk Management") at the time at which the order for a block trade enters the SEF's non-Order Book trading system or platform; and
- that the block trade is subject to void ab initio requirements where the swap is rejected on the basis of credit.
The DMO stated that the relief will expire on November 15, 2016.
Commentary
In this case, the CFTC's relief is necessitated by the incongruity of applying a regulatory model intended for futures traded by humans in trading pits to swaps traded through a variety of execution methods.
Those who are not familiar with this issue should refer to the words of CFTC Commissioner Christopher Giancarlo, who explained it well in a speech he gave last January:
"The CFTC block trade definition, specifically, the 'occurs away' requirement, is another example of artificial market segmentation. The CFTC defines a block trade as 'a publicly reportable swap transaction that: (1) involves a swap that is listed on a registered SEF or designated contract market ("DCM"); (2) "occurs away" from the registered SEF's or DCM's trading system or platform; and (3) has a notional or principal amount at or above the appropriate minimum block size applicable to such swap. . . .'
"The block trade definition is a holdover from the futures model. In the futures market, block trades occur away from the DCM's trading facility as an exception to the centralized market requirement given the price and liquidity risk of executing these large-sized trades.
"In today's global swaps market, however, there are no 'on-platform' and 'away-from-platform' execution distinctions. OTC swaps trade in very large sizes. These swaps are not constrained to trading facilities, but trade through one of a variety of execution methods appropriate for the product's trading liquidity.
"Again, Congress recognized these differences by not imposing on SEFs an open and competitive centralized market requirement. Rather, Congress expressly authorized delayed reporting for swap block transactions. Congress got it right.
"We at the CFTC have got the swaps block trade definition wrong. There is no statutory support for the 'occurs-away' requirement. The requirement creates an arbitrary and confusing segmentation between non-block trades 'on-SEF' and block trades 'off-SEF.' The 'off-SEF' requirement undermines the legislative goal of encouraging swaps trading on SEFs."