Relief (Conditional and Time-Limited) for Swaps Prime Brokerage (CFTC Letter 13-11) (with Lofchie Comments)

The CFTC issued a much anticipated letter providing relief from the business conduct rules in connection with "prime brokerage" arrangements; i.e., arrangements where one swap dealer executes the trade and another (the "prime broker") becomes the eventual counterparty. The letter describes prime brokerage arrangements. It then says that the executing broker and the prime broker must (i) agree in writing as to how each aspect of the business conduct rules will be allocated between them; (ii) provide that neither is responsible for the obligations of the other; (iii) require that customers be given 30 days' notice of the expiration of the agreement between the two brokers; and (iv) each keep records of all of this.

Lofchie Comment 1: Query: Does the CFTC really believe that market participants need only thirty days' notice to adjust to a change in the allocation of the business conduct rules?

Lofchie Comment 2: Here is a key excerpt from the no-action letter:"In sum, counterparties . . . fear that the implementation of the External Business Conduct Standards will eliminate or severely curtail their ability to seek prices from a wide range of executing dealers. . . . Indeed, the Division understands that some counterparties have already been contacted by executing dealers informing them that the executing dealer will not trade with the counterparty following the compliance date. . . .[This] may lead to higher prices for the counterparty. In addition, the implementation of the External Business Conduct Standards may cause a large number of executing dealers to be eliminated from the [market] or to have their ability to transact with a wide range of counterparties significantly curtailed. Market participants argue that as a result of the foregoing, the market will suffer reduced liquidity through a sudden drop in the number of participants in the markets."This is an explicit acknowledgment by the CFTC that it is possible for regulation to damage the market by driving up costs and driving out market participants. The CFTC has to start recognizing that this is a real problem, and it is not going to be solved by one no-action letter; certainly not by a no-action letter which itself exemplifies the burdensome and expensive conditionality of every rule, and every exemption therefrom adopted by the CFTC. That said, this recognition of the costs of regulation is a move in the right direction.

View Letter 13-11 here (link to CFTC web page; link to letter on top right of the page).