Bloomberg v. CFTC on Margin Levels
Commentary by Bob Zwirb and Steven Lofchie
On April 16, 2013, Bloomberg L.P. filed a lawsuit against the CFTC in the federal district court for the District of Columbia asking the court to set aside CFTC Rule 39. 13(g)(2)(ii) [Risk Management], which indirectly mandates higher margin requirements for financial swaps than it does for economically equivalent futures and non-financial swaps. Bloomberg argues that the rule's disparate treatment of futures and commodity-based swaps, on the one hand, and financial swaps, on the other, improperly creates an opportunity for arbitrage between financial swaps and interchangeable "swap futures" contracts, and that the arbitrage threatens the viability of SEFs, including one that Bloomberg intends to operate. The CFTC rule establishes a minimum liquidation time of one day for futures and options, swaps on agricultural commodities, energy commodities, and metals, but five days for all other swaps.
The complaint argues that the CFTC imposed its own heightened across-the-board minimum liquidation times for financial swaps "without citing any evidence that more time is needed to liquidate positions in swaps than in futures contracts, let alone functionally interchangeable 'swaps futures' contracts, and that the margin requirements for the clearing of derivatives simply differ based on whether the derivative is labeled a 'swap' or a 'future.'"
View Complaint in full here (Cabinet link).
See also: Chairman Gensler and Commissioner Chilton Speak at the CFTC Roundtable on Futurization (with Zwirb Comment).
Commentary
We have previously highlighted and commented on the "futurization of swaps" trend: the conversion of swaps into economically equivalent futures. In this regard, we had observed that CFTC rules were fostering "regulatory arbitrage." Most regulatory arbitrage takes place where businesses shift activities between different regulators or jurisdictions; oddly, this arbitrage was "taking place within the CFTC's own regulatory space, with regulated firms converting their CFTC-regulated swaps into CFTC-regulated futures in an effort to avoid Dodd-Frank." At the time, we noted that, while such a move improves the situation for some (existing DCOs at the expense of to-be-created swap trading platforms), it also sends a signal that the regulatory scheme is arbitrarily favoring one product over another. The more economically sound manner of regulation would be to implement the swaps regulations so that commercial entities are not forced into doing futures when swaps would be more efficient and safer. While the regulators may describe this shift from contracts called "swaps" to those called "futures" as a "normal realignment," market participants who are prejudiced by a rule design that is not based on economic substance may take a different view. Here, Bloomberg is taking a "different view," and complains the regulatory scheme injures Bloomberg's swaps product as compared to futures products.
One more aspect of this rulemaking is also worth commenting on. The complaint joins Commissioners Sommers and O'Malia in criticizing the CFTC's rationale for imposing its own minimum liquidation standard here (rather than allowing DCOs to set it themselves) - that a uniform standard is necessary in an effort to prevent a potential race to the bottom by competing clearinghouses. The "race to the bottom" thesis which the CFTC endorses here is widely discredited in modern antitrust economic circles, as we noted more than a year ago when we first commented on this rule in a commentary entitled, "All Eyes on Cost-Benefit Analysis" that appeared on page 20-21 in the Energy Metro Desk (see PDF) (with the discussion on the race to the bottom appearing on p. 21) discussing the flawed economic analysis that the CFTC employs in its rulemakings. Rather than engaging in a "race to the bottom," economic studies suggest that actors in a competitive marketplace are involved in a race to find an equilibrium, one that takes into account a number of factors, including the quality of regulation. We also noted that the CFTC's concern with competition among DCOs on this matter directly conflicts with its statutory duty under CEA Section 15 to take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means in issuing its rules.
Commentary
Over the last several days, we have run a number of news stories concerning the CFTC's self-evaluation and budget requests. As we noted, while the CFTC has requested a substantial budget increase for next year, including for new hires, it also has proposed to actually decrease the number of individuals involved in the economic analysis of its rule proposals. See, e.g. Chairman Gensler's Statement on CFTC Budget (with Dissenting Commissioners' Comments) Given the degree of criticism that the CFTC has sustained in connection with its conduct of economic analyses (or failure to conduct them), and the ongoing position limits litigation, cutting back on the CFTC's abilities in this area seems a false economy. After all, there is simply no reason to believe the Bloomberg litigation is going to simply fade away; Bloomberg simply has too much to lose by virtue of a CFTC Rule that cannot be easily explained, and which has been the subject of overt dissent within the CFTC itself. So it seems that a significant portion of the CFTC's limited resources may now be diverted from issuing necessary no-action letters into a difficult litigation.