The comment period for one the CFTC’s most contentious proposed rules in recent memory concluded on March 15, 2019. The proposed Swap Executions Facilities and Trade Execution Requirement rule garnered 55 comment letters from a vast array of stakeholders including financial institutions, commercial end users, industry and trade organizations, an SRO, public interest group, as well as members of the public. At the same time, the CFTC also sought public comment regarding the practice of "post-trade name give-up" on SEFs.
Controversies from the get-go. Disagreements prevailed from the onset when Commissioner Dan Berkovitz dissented on the rule’s introduction in early November 2018. The controversial proposed amendments included requiring SEF registration requirements for additional entities, replacing the “made available to trade” determination process with a new approach to the trade execution requirement, and amending the method of trade execution provisions. The amendments also contained provisions relating to SEF trading specialists; impartial access; straight-through processing; financial resources, as well as SEF regulatory oversight. At the time, the CFTC issued a Fact Sheet on rulemaking and requests for comment.
Initially, and over the objections of Commissioners Berkovitz and Behnam, the comment period ran for just 75 days rather than 90 days, which is commonplace. Subsequently, the comment period was extended another 60 days. Below are some highlights of comments, which reflect the diverse views of three significant stakeholders— the FIA, the National Futures Association, and Better Markets, a non-profit organization founded in the wake of 2008 financial crisis that seeks to promote the public interest.
FIA seeks legal clarity and recognition of consequential costs for its members. The following three major themes ran through the FIA’s comment letter:
- Any final SEF rules should clarify the risk management obligations of FCMs that clear swaps that are block traded on SEFs. The FIA noted it has been in dialogue with CFTC for a number of years on this point yet a lack of clarity on this point persists;
- The CFTC should address the operational challenges and costs that the SEF notice of proposed rulemaking (NPRM) would impose on all market participants. FIA noted that amendments proposed in the SEF NPRM would effect a fundamental reconstruction of the “SEF ecosystem” and, thus, stand to change many of the ways in which market participants interact with, and trade on, SEFs, including the imposition of substantial costs on all market participants; and,
- The CFTC should revisit the proposed “Made Available to Trade” process and blanket prohibition on pre-execution communications on behalf of FIA’s commodities members and, further, should adopt a practical approach to trade execution mandate determinations. The letter noted that the MAT process is an unworkable approach to implementing the CEA’s trade execution mandate, and that SEFs have an inherent conflict of interest in issuing MAT determinations under the current framework.
- NFA is troubled by the Commission's proposal to move swaps activity from NFA member introducing brokers (IBs) to SEFs, and at the same time permitting unregistered SEF employees to arrange and negotiate these transactions;
- It would be contrary to congressional intent, and the CEA, to no longer require persons (including interdealer brokers) that arrange, negotiate, and accept orders for swaps transactions to register as IBs and the natural persons associated with them to register as associated persons; and,
- NFA believes the CFTC's proposal creates several internal anomalies and opportunities for regulatory arbitrage. Specifically, the CEA, as amended by the Dodd-Frank Act, explicitly allows swaps to be executed on either a SEF or DCM. To the extent the CFTC creates a flexible trading and regulatory structure for swaps traded on a SEF but not a DCM, the CFTC may, by regulation, have created a two-tiered market that favors swaps trading at SEFs over DCMs.
Specifically, the letter argues that the SEF proposal would dangerously dismantle many of the critical pillars of the multilateral swap execution framework adopted in the aftermath of the 2008 financial crisis and improperly codify statutory interpretations that are inconsistent with the plain language and intent of the Dodd-Frank Act. According to Better Markets, “this time is not different. The music will stop, inevitably exposing undetected, misunderstood, or ignored imbalances and risks within the financial system. The CFTC’s primary responsibility must be to anticipate that inevitability and limit the damage that will be inflicted on those participating in and depending on the derivatives markets when it does…”.
The commissioners continue to weigh in. A number of the current commissioner have continued to vigorously advocate for respective positions since the proposed rule was introduced. At the recent DerivCon 2019 conference sponsored by ISDA and TABB, three commissioners further expressed their differing views on potential changes to the SEF related rules.
Commissioner Brian Quintenz noted that market places are not one-size-fits-all and asserted the proposed rules will stop trying to squeeze the swaps market into a regulatory model designed for another asset class.
Meanwhile, Commissioner Dan Berkovitz noted that the current swap rules have led to an increase in competition, more electronic trading, and better price transparency. He argued that “We should not make fundamental changes to our regulations to our regulations where the data indicates that the regulations and markets are functioning well and achieving their intended purposes.”
In his remarks, Chairman Christopher Giancarlo noted that in the feedback he had received on the rule proposal, “almost all agreed that the current framework is flawed and would benefit from substantial revision.” He also pointed to the broad acceptance of making SEF execution methods more flexible, as well as addressing the most burdensome and unworkable aspects of SEF compliance.