Responding to the CFTC’s reproposal of its
block trade regulations under Title VII of the Dodd-Frank Act, the hedge fund
industry strongly believes that the
granularity of the swap categories in the interest rate and credit asset
classes can be improved by taking into account the different product types
within each asset class. In a letter to the CFTC, the Managed Funds Association
said that improved granularity is important to avoid “mixing apples and
oranges”, both when selecting the appropriate data to calculate minimum block
sizes for a given category of swaps, and when applying such minimum block sizes
to specific categories of swaps within each asset class.
The reproposed regulations would define the
criteria for grouping swaps into separate swap categories based on common risk
and liquidity profiles; establish methodologies for setting appropriate minimum
block sizes for each such swap category; and provide protective measures to
prevent the disclosure of the identities, business transactions and market
positions of swap market participants.
In the view of
the MFA, the granularity of the swap categories can be improved by taking into
account different product types within each asset class, such as in the
interest rate asset class, distinguishing between plain vanilla interest rate
swaps and swaptions. Otherwise, the MFA said that the Commission’s proposed
groupings by spread and tenor for credit and currency and tenor for rates is
sufficient.
The MFA also
suggested that the proposed initial minimum block sizes should be calibrated
against current market conditions, rather than based exclusively on a limited,
three-month data set from 2010. Selected adjustments to initial minimum block
sizes may be warranted due to a combination of the noted granularity concerns
in swap categories and limitations related to the size, composition, and
timeliness of the data set that the Commission used to set its proposed initial
minimum block sizes for swap categories in the interest rate and credit asset
classes.
The MFA is also concerned that the proposed use of a
rolling three-year window of data for calculating post-initial minimum block
sizes would unnecessarily constrain the Commission’s ability to shorten that
look-back period if material changes in market conditions were to warrant
looking at a smaller set of more recent data. Thus,
the hedge fund association urged the Commission to retain the flexibility and
discretion to update the post-initial minimum block sizes on a case-by-case basis
where appropriate, for example, by narrowing the look-back window if needed due
to material changes in the trading activity in a given swap category.
The group also believes that the cap sizes
for public reporting purposes should mirror the minimum block sizes for each
swap category. The MFA does not want the CFTC to burden itself with extra calculations, ongoing maintenance
responsibility of separate cap size data on its website, and other
administrative work that will likely result from market participants seeking
exemptive relief or interpretive guidance based on any anomalies between
post-initial cap sizes and post-initial minimum block sizes.
More broadly, the MFA noted that, if swap
categories are properly distinguished in the final regulations, the
Commission’s proposed 67 percent notional amount calculation provides a viable
methodology to calculate post-initial minimum block sizes. However, if swap
categories are not properly distinguished, and the Commission cannot ensure a
calibration of the initial minimum block sizes to current market conditions, the
MFA would be hesitant to endorse the 67 percent notional amount calculation in
the final regulations, preferring instead that the CFTC use a 50 percent notional
amount calculation, particularly in the initial period, with a phase-in to a 67
percent notional amount calculation over time.
Returning to the granularity issue, the
MFA emphasized that further granularity
of swap categories is warranted since, as proposed, swaps with materially
different trading profiles involving number and frequency of trades and the
number of counterparties would be grouped together in a single swap category.
If swap categories are set too broadly and capture dissimilar product types,
warned the MFA, the resulting blended data set, when subjected to the notional
amount calculation, would yield a minimum block size that is theoretically too
low for certain swaps in the category and too high for others.
While the MFA appreciates that the Commission has
taken care to address such results by proposing groupings that sufficiently
address this issue along some differentiating factors, the CFTC should also
consider the fact that there are a limited, though materially important, number
of distinct product types within each asset class that could be used to further
distinguish categories for setting minimum block sizes.
By introducing this additional granularity by product
type within an asset class, the MFA believes that the Commission would obtain
better tailored initial and post-initial minimum block sizes, irrespective of
whether the notional amount calculation is based on a 67 percent or 50 percent
figure. In fact, with this refinement, the Commission may well obtain an
appropriately higher minimum block size for more standardized, liquid, or
on-the-run swap categories, and similarly, an appropriately lower minimum block
size for less standardized, liquid, or off-the-run swap categories.
Thus, the MFA strongly
recommended that the Commission establish separate swap categories for each
product type, in addition to the existing groupings by currency and tenor. In
the hedge fund association’s view, this change will result in better tailored minimum
block sizes. If distinguishing among five to ten product types appears too
complex, the Commission should consider distinguishing between those products
that are cleared today by LCH and CME or become clearing-eligible, and those
that are not, which, at a minimum, provides a more viable delineation among
products.