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CFTC Amends De Minimis Threshold, Proposes Changes to Swaps Trading Rules

nihal.patel@cwt.com's picture
Commentary by Nihal Patel

The CFTC voted to adopt final rules to amend the swap dealer de minimis threshold and to propose changes to swaps trading rules.

Swap Dealer De Minimis Amendments. The final rules amend the definition of "swap dealer" in CFTC Rule 1.3 in order to set the de minimis aggregate gross notional amount threshold level at $8 billion in swap dealing activity entered into by a person over the preceding 12-month period. The current rule provides for a threshold of $3 billion, subject to a "phase-in" amount of $8 billion.

Swap Trading Proposals. The CFTC voted 4-1 (with CFTC Commissioner Dan M. Berkovitz dissenting) to propose a number of changes to its swaps trading rules. These include, among other things:

  • SEF Registration. The CFTC indicated that the proposals would require swap execution facility ("SEF") registration by certain brokerage entities, including interdealer brokers and the aggregators of single-dealer platforms. Domestic broking entities would receive a six-month delay before registration is required and foreign entities would receive two years. In addition, the proposal would codify "footnote 88," and make clear that SEF registration is required regardless of whether swaps on platform have been made "available to trade."

  • Process for Making Swaps Subject to Mandatory Trading. The process for making a swap "available to trade" would change to eliminate the existing determination process and, instead, subject to exceptions, would require trading for swaps subject to a clearing requirement and listed by an SEF or designated contract market.

  • Methods of Execution. The proposal would eliminate the requirement: (i) that an SEF offer a central order book for all listed swaps and (ii) for swaps made "available to trade," that an SEF offer a central order book or "request for quote" system to at least three participants.

  • Impartial Access. The proposal would make SEF participation criteria and trading practices more flexible to allow SEFs to have rules "that align[] with the swaps market practices."

  • Straight-through Processing. The proposal would require SEFs and derivatives clearing organizations to facilitate processing in a "prompt, efficient, and accurate manner," and establish specified timeframes for the current "as quickly as technologically practicable" standard. In addition, the proposals would codify staff guidance that requires SEFs to facilitate pre-execution credit checks.

  • SEF Personnel Requirements. The proposal would establish "proficiency requirements and conduct standards" for SEF personnel who exercise discretion.

  • Post-Trade Name Give-up. The CFTC also will publish a request for public comment as to the utility of post-trade name give-up practices where swaps are anonymously executed and intended to be cleared.

CFTC Chair J. Christopher Giancarlo stressed that the final de minimis rule is "without prejudice to all other items" in the initial proposal, and that he would direct CFTC staff to continue to analyze issues raised therein. Mr. Giancarlo gave a lengthier discussion of, and expressed support for, the swaps trading rules. In particular, he cited his own 2015 white paper making suggestions for reforms of the swaps trading rules.

As he has done before, CFTC Commissioner Brian Quintenz expressed hope that the final de minimis rule is "just the first of many necessary steps toward correcting . . . a flawed swap dealer registration policy." Similarly, Commissioner Dawn D. Stump noted "unresolved questions" to be answered regarding the de minimis threshold. Commissioners Dan Berkovitz and Rostin Behnam both supported the de minimis final rule, but expressed concerns about broader rulemaking to change the de minimis threshold. Specifically, both commissioners voiced process concerns, suggesting that the CFTC needs to further consider its statutory authority and whether it must act in concert with the SEC.

Mr. Berkovitz issued a lengthy dissent from the swaps trading proposal. He said that the proposals "would reduce competition and diminish price transparency in the swaps market." Mr. Behnam expressed a number of similar and related concerns, but voted to support the proposal in order to hear from market participants as to how to improve the CFTC SEF framework. Mr. Quintenz and Ms. Stump offered more telescoped support for the SEF proposals, with Mr. Quintenz praising Mr. Giancarlo's "thought leadership and transparency in consistently and fully articulating his vision for swaps trading rules that would create a more cohesive, liquid swap marketplace."

Commentary

The de minimis proposal is, as Chairman Giancarlo indicated, a stopgap measure. By all accounts from the open meeting, the CFTC has punted on more ambitious changes to the rules. However, Mr. Giancarlo indicated that the CFTC staff would consider no-action relief that would address the exception for swaps entered into by insured depositary institutions in connection with loans. The proposal would have effectively expanded that exception.

The swaps trading proposals appear to be a lot of things at once. As always, the details will matter (the CFTC has not posted the text of the proposals at the time of writing). Preliminary indications from the Commissioners' discussions suggest that the proposals are a mixed bag for market participants. Mr. Giancarlo expressed concern that the strawest of straw men will not like the proposal: "[The] proposal will invariably be slammed by opponents of change as a 'rollback' of Dodd-Frank. Any such characterization would be disingenuous." Hyperbole aside, Mr. Giancarlo's core point is correct - this is no "rollback," and it appears in a handful of ways the CFTC is doing things that market participants may not like.

In fact, certain aspects of the proposal seem to codify things that market participants specifically do not like about the rules. For example, "footnote 88" has never been especially popular. An ISDA research note characterized the footnote as a cause of market fragmentation. A post on the Financial Times' Alphaville blog was more blunt and suggested "Maybe Footnote 88 really is evil." Of course, problems with footnote 88 were further compounded by the CFTC's approach to cross-border matters, but it does not appear the CFTC is addressing those issues with these proposals.

Requiring SEF registration for brokers also potentially could be problematic. Again, the details will matter, but applying what is essentially an "exchange" framework to brokers does not seem to be an obvious fit. Finally, the swap "made available to trade" ("MAT") process changes seem to put a strong finger on the scale in favor of more SEF trading. (Another area where an ISDA research note suggested the existing CFTC process caused market fragmentation.) The CFTC itself said the proposal would result in "a number of new interest rate swaps and credit default swaps" becoming subject to the trade execution requirement. The indicated changes double down on the power of a single trading platform to dictate requirements applicable to the entire market by listing a swap for trading. Based on the discussion in his white paper (from p. 29), Mr. Giancarlo seems to take the view that providing markets with greater flexibility for execution methods on SEFs will address concerns relating to the MAT process. 

Commissioner Berkovitz's dissent on the SEF rules is worth noting. Mr. Berkovitz seems to be stepping in as a foil to Mr. Giancarlo (including with some hyperbole of his own - "The proposal would abandon the commitments the United States made at the G20 Summit in Pittsburgh in 2009 . . . "). His dissenting statement and his lengthy discussion with staff during the open meeting indicate that he cares a great deal about how these rules come out. This is good. Mr. Berkovitz knows the rules well. (He was CFTC general counsel as Dodd-Frank was being implemented.) Hopefully, the substantive debate between he and Mr. Giancarlo will lead to better results for the CFTC.

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