CFTC Issues Trade Execution Mandate for Certain Interest Rate Swaps
Commentary by Steven Lofchie
The CFTC Division of Market Oversight ("DMO") certified Javelin SEF LLC's ("Javelin") self-certification of certain interest rate swap contracts has been made available-to-trade ("MAT Determinations").The CFTC stated that swaps subject to MAT Determinations, whether offered by Javelin or any other swap execution facility ("SEF") or designated contract market ("DCM"), will become subject to the trade execution requirement under Section 2(h)(8) of the CEA 30 days after certification. In the case of these interest rate swap contract MAT Determinations, the requirement will be effective as of February 15, 2014. The CFTC noted that all transactions involving swaps that are subject to the trade execution requirement must be executed through a DCM or a SEF, including swaps that are part of so-called "package transactions," or groups of transactions that are executed together for price coordination or other reasons.
CFTC Commissioner Scott D. O'Malia issued a statement of concern regarding the MAT Determination process, stating that it was "hard to imagine a federal regulatory agency process that is more flawed," and noting that the legally limited review process permitted under the MAT Determinations rulemaking was little more than a rubber stamp. He noted that although he is in support of mandatory trading determinations for individual benchmark swaps, the Commission's process creates significant market uncertainty. He highlighted in particular the issues created for "package transactions" (which Javelin itself had indicated it wished to exclude), stating "by accepting Javelin's determination and then immediately contemplating further action with respect to half of the MAT transactions, the Commission creates uncertainty in the market and sets a dangerous precedent for future MAT Determinations." He called on the CFTC to carefully review all possible package transactions for legal compliance and technical readiness, seek public comment, and hold roundtables in order to develop well-thought-out solutions to each type of complex transaction.
The CFTC noted that Acting Chairman Mark Wetjen has ordered a public roundtable discussion to address execution issues related to package transactions and whether and under what conditions to grant limited relief for such transactions to ensure proper implementation of the execution mandate.
See: Javelin MAT Approval (and Fixed-to-Floating Interest Rate Swap Table); Commissioner O'Malia's Statement.
Related news: Javelin SEF Submits More Limited MAT Determination to CFTC (with SIFMA AMG Comment Letter and Lofchie Comment) (December 3, 2013); MFA Comment Letter to CFTC on SEF Trading Rules and Onboarding Documentation (with Lofchie Comment) (January 9, 2014) MFA Supports More Limited Made-Available-to-Trade Submissions (December 6, 2013); MFA Submits Suggestions to CFTC on MAT Submissions (with Lofchie Comment) (November 25, 2013); SIFMA and ISDA Criticize SEFs' Made-Available-to-Trade Submissions (with Lofchie Comment) (November 21, 2013); CFTC Extends Comment Period on Certification from Javelin SEF to Implement Available-to-Trade Determinations (with Lofchie Comment) (November 1, 2013); SEF Seeks Determination of Mandatory Exchange Trading of Swaps (with Lofchie Comment) (October 18, 2013).
See generally: Cabinet Links to All SEFs, SEF Rule Sets and MAT Submissions.
Commentary
As noted by Commissioner O'Malia, the CFTC's prior rulemaking under Chairman Gensler all but preordained that MAT Determinations would be certified. Nevertheless, this action seems unduly risky. To begin with, while the Commodity Exchange Act permits registered SEFs to make MAT Determinations, the SEFs were provisionally registered based on mere submission of an application that was facially complete, and without review by the CFTC. According to the CFTC's own website, none of the SEFs have been advanced to permanent registration. It is questionable whether certification of MAT Determinations prior to completing review of the SEFs for compliance with "core principles" that are legally required for registration is compliant with Dodd-Frank or consistent with prudent risk management by the regulator. And given all of the well-publicized failures of trading technology in the past year, does it really make sense to force tremendous volumes of rates trading onto exchanges that have not been formally reviewed and approved for operation?
Further, the CFTC staff has imposed a significant amount of regulation though staff "guidance" and instructions to SEFs that was not the subject of a rulemaking in accordance with the Administrative Procedures Act. In particular, the SEF registration and rulemaking process was used to impose pre-trade credit screening on trades executed for clearing, requirements that such trades be deemed "void ab initio" when they fail to clear, and prohibitions on so-called "breakage" agreements, effectively adopting rules without notice and comment. While the CFTC may believe that these new requirements will facilitate rapid processing of SEF trades for clearing, they also limit the ability of market participants to manage credit risk associated with SEF trades and create dependence on new systems being built to fulfill the CFTC's vision of "straight-through processing." At a minimum it would be prudent to solicit feedback on the new guidance and provide time for those new systems to be fully tested prior to requiring SEF execution.
Finally, the MAT Determinations themselves leave open a number of questions as indicated by Commissioner O'Malia. In addition to the treatment of "package trades," the extraterritorial application of the SEF registration and trade execution requirements remains unclear, as does the application of the requirements to after-hours trading.
Commentary
The new certifications are another challenge facing Chairman Wetjen. Either he can go full-speed ahead with these rules risking trading problems that are disruptive to the market; or he can risk criticism by throttling back regulation (in the interest of market safety) by taking market comment on the guidance.
Even if one believes that mandatory SEF trading is of some value in price discovery, it almost certainly does nothing to make the economy safer (see, commentary by New York Times-featured economist, Craig Pirrong). Accordingly, there is certainly reason for Chairman Wetjen and the CFTC to take some delaying measures before the February 15 "deadline".