Chairman Giancarlo unveils ambitious new swaps reform agenda

By Lene Powell, J.D.

In a new white paper, CFTC Chairman J. Christopher Giancarlo laid out broad plans to revise CFTC rules on swaps clearing, execution, and reporting, as well as swap dealer capital requirements and an end user exception from clearing and margin requirements. Regarding timing, the chairman said he intends to pursue the revisions according to an “ambitious timetable,” but will use a “deliberative process” and proceed in regular order to “get it right.”

"This white paper is economy-focused," said Giancarlo. "And our role at the CFTC is to bring a market-focused approach.”

The paper, “Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps,” was co-authored by CFTC Chief Economist Bruce Tuckman. It was unveiled at the International Swaps and Derivatives Association (ISDA) annual meeting in an interview with former CFTC Commissioner and current ISDA CEO Scott O’Malia.

Swaps clearing. Since enactment of the Dodd-Frank Act in 2010, the rate of clearing has increased from about 40 percent to 80 percent for interest rate swaps and eight percent to 80 percent for credit default swaps. The goal for swaps clearing is to continue progress to enhance the safety and soundness of central counterparties (CCPs) that clear swaps. Challenges in extreme stress scenarios include liquidity of prefunded resources, correlated defaults and network effects, liquidation of defaulted swaps positions, and design of the “waterfall” or recovery mechanism. Regarding CCP resolution, the FDIC and CFTC established a dedicated joint working group in 2017 to establish protocols for coordinated action in the event of resolution of systemically important CCPs.

• Recommendation: the FDIC and CFTC should continue their work on CCP resolution planning. 

Swaps reporting. In building a swaps reporting regime from scratch, the CFTC followed a principles-based approach. Swap data repositories (SDRs) were allowed to apply their own data schema and develop unique templates for reporting. Given the need for efficiency and uniformity, however, swaps reporting calls for greater specificity.

• Recommendations: the CFTC should update reporting requirements for SDRs and market participants, including validation of incoming data, changes to Part 45 reporting, and public reporting of block trades. Also, the CFTC should collaborate with market participants on the potential development of distributed ledger technology (DLT) for swaps reporting. 

Swaps execution. According to the paper, current swaps execution rules have stunted trading on swap execution facilities (SEFs) by unnecessarily limiting swaps that must be traded on exchanges and unduly limiting trade execution methods. This has had adverse consequences, including a significant amount of price discovery and liquidity formation taking place off-SEF such as through registered Introducing Brokers; fragmentation of swaps trading into numerous artificial market segments; increased market liquidity risk; and hindering of technological innovation.

• Recommendations: The CFTC should allow SEFs to offer any means of interstate commerce and eliminate the requirement for SEFs to maintain an order book for swaps subject to the execution requirement. Also, the CFTC should make the trade execution requirement synonymous with the clearing requirement, i.e., eliminate the “made available to trade (MAT)” process and expand the category of swaps subject to the trade execution requirement to include all swaps subject to the CFTC clearing mandate, unless no SEF or designated contract market (DCM) lists the swap for trading. 

Swap dealer capital. 80 percent of swap dealers are either banks or bank holding companies, so capital rules for banks strongly affect swap dealers. According to the paper, bank capital requirements overestimate the amount of risk posed by swaps and therefore bias the system against swaps.

• Recommendations: Banking regulators should either continue to iterate—and most likely complicate—prescriptive, regulatory models of risk, or ascertain how to rely more heavily but confidently on the internal risk models used by banks and their swap dealer affiliates. 

End user exception. Although Dodd-Frank did not except small banks from the clearing requirement, it specifically invited the CFTC to do so. The CFTC adopted rules permitting certain depository institutions with less than $10 billion in assets to elect the end user exception, and also issued no-action relief to bank holding companies and savings and loan holding companies with consolidated assets under this threshold.

• Recommendations: The CFTC should codify existing no-action relief and consider incremental regulatory changes. Material swaps exposure thresholds should be established below which entities would be excepted from clearing and margin requirements. Also, rules on uncleared initial margin should be reworked to be less prescriptive and eliminate bias against uncleared swaps. 

Revisions timetable. The proposed changes are sweeping and will take time to carefully implement. In addition, some changes require coordination with other regulators, both domestically and internationally.

“We're not in the wake of a crisis right now—we need to take the time to get this right,” said Giancarlo. “We have an ambitious timetable, and we will get this done, but we will do this right. We will move forward in regular order and in good order—we will get this done."