CFTC Open Meeting

Commodity Futures Trading Commission

Open Meeting

Monday, November 5, 2018

Key Topics & Takeaways

• Final Rule: Amending the De Minimis Exception to the Swap Dealer Definition
  • Vote: The final rule was unanimously approved by all Commissioners.
• Proposed Rule: Amendments to Regulations on Swap Execution Facilities and the Trade Execution Requirement
  • Vote: The final vote was approved 4-1, with Commissioner Berkovitz dissenting.
• Request for Comment Regarding the Practice of “Post-Trade Name Give-Up” on Swap Execution Facilities
  • Vote: The request for comment was unanimously approved by all Commissioners.

Opening Remarks

Chairman J. Christopher Giancarlo

In his opening remarks, Giancarlo noted that the Commodity Futures Trading Commission (CFTC) has not has a full Commission member meeting since May 2013, then introduced the topics being discussed at today’s meeting: 1) a final rule amending the de minimis exception to the swap dealer definition; 2) a proposed rule for amendments to regulations on swap execution facilities (SEFs) and the trade execution requirement (TER); and 3) a request for comment regarding the practice of “post-trade name give-up” on SEFs.

Commissioners Brian Quintenz, Rostin Behnam, Dawn Stump, and Dan Berkovitz

Quintenz stressed that the matters before the Commission are of “critical importance,” and Behnam added that the de minimis exception to the swap dealer definition will “put an end to uncertainty” in the swaps market. Stump discussed how regulators should assess regulatory implementation regularly to ensure they are sufficient in mitigating risk and protecting the market, adding the importance of addressing work product “based on experience and current data available.” Berkovitz stated that the final de minimis exception and proposed SEF rule are “significant for market participants.”

First Staff Presentation

Final Rule: Amending the De Minimis Exception to the Swap Dealer Definition 

Matt Kulkin, Director, Division of Swap Dealer and Intermediary Oversight (DSIO), explained that in addition to the de minimis threshold itself, the June 2018 notice of proposed rulemaking (NPRM) solicited comments for four additional proposals and feedback on three other topics, and that there may be additional de minimis exception-related amendments in the future.

Rajal Patel, Associate Director, DSIO, explained that the final rule makes permanent the aggregate gross notional amount (AGNA) of $8 billion in swap dealing activities over the previous 12-month period for the de minimis exception to the swap dealer definition. He gave an overview of the history of the establishment of the definition of a swap dealer and de minimis exception, stating that while the original threshold was set at $8 billion in AGNA, it would have fallen to $3 billion in 2017 without commission action.

Jeffrey Hasterok, Data and Risk Analyst, DSIO, explained the data-driven and cooperative analysis that led to the final rule, evaluating likely swap dealer market coverage at different de minimis thresholds: reducing to $3 billion, maintaining at $8 billion, or increasing to $20/50/100 billion. He noted that the $8 billion threshold is an appropriate threshold, as only a small percentage of swap activity is not covered, and that having thresholds at $3/20/50/100 billion would only have small changes in AGNA subject to swap dealer regulation compared to the $8 billion threshold.

Questions

Stump noted the continuing obligation of a 12-month lookback and asked if the DSIO or institutions will have to proactively review who should and should not be registered as swap dealers. Kulkin replied that entities will still have to monitor their own activity for registration purposes, but that DSIO will also keep an eye on swap activity via swap data repository (SDR) data for swap activity.

Berkovitz asked what would happen if the threshold was lowered to $3 billion, to which Hasterok explained that only a very small amount (0.01 percent) of swap transactions would be added, and that some participants may lower their swap dealing activities to whatever the threshold is set at, leading to a reduction in competition.

Statements

Quintenz voiced his support for the final rule, giving an overview of the different analyses conducted since 2015, adding that this is the first of “many necessary steps toward correcting flawed swap dealer registration policy.” He criticized using notional value, calling it a “poor measure of activity” and “meaningless measurement of risk,” adding that one-size fits-all approaches to swap dealer registration captures smaller, low-risk entities and places them in the same regulation regime as high-risk large banks. Quintenz explained that even the $8 billion threshold may still force smaller players to curtail their swap dealing business, reducing competition and concentrating activity in the larger competitors. He stated that the August 2018 no-action letter regarding counting loan-related swaps shows the deficiencies to the de minimis exception and how it strains the ability to serve clients.

Behnam voiced his support for the final rule, noting that he previously did not support the proposal. He explained that he initially was concerned that the CFTC was using the rulemaking to change the definition of swap dealing activity without consulting with the Securities and Exchange Commission (SEC) and that the Commission was not focusing on areas it needed to: providing regulatory certainty for market participants. Behnam noted that while he is pleased with how narrow the final rule is when it comes to setting the AGNA threshold, he is still concerned with the insured depository institution (IDI) loan-related swap exclusion, and how the final rule is vague regarding whether the CFTC will work with the SEC in considering issues raised by commenters, consistent with Dodd-Frank, or whether there will be a separate exception, stressing the need to work with the SEC on these issues.

Stump voiced her support for the final rule and how it gives regulatory certainty to the markets. She explained that placing regulations and burdens on low-risk institutions does not further the objectives of the G-20 standards and how Congress tried to avoid this in instructing a de minimis exception. Stump continued that after reviewing the data in studies and rules, she disagrees with arguments in favor of lowering the AGNA threshold, which would subject smaller institutions to swap dealer registration and its associated obligations and costs. She noted that narrowing the rule from its proposed form to final rule shows that “difficult and critical questions remain unsolved,” questions that need to be answered in the future.

Berkovitz voiced his support for the final rule and the extensive data analysis conducted over the past few years. He gave an overview of the history of the swap dealer definition and de minimis threshold, as well as the reports released and comments received from the public. Berkovitz noted that data was collected from all four SDRs and that it was analyzed for years, showing that decreasing the threshold would only add dealer coverage to less than one tenth of one percent but imposing costs on market participants. He discussed the non-financial commodity swap market and how their cost of registering for many smaller swap dealers exceed the anticipated benefits and called on the Commission to continue focusing on improving data collection and analysis for swaps, as more robust data helps balance the benefits of de minimis swap dealing and swap dealer registration.

Giancarlo voiced his support for the final rule, stressing that it is “truly data-driven” and will provide the markets with the certainty that the AGNA threshold will not fall from $8 billion. He noted the other rule amendments and topics in the June 2018 NPRM and the comment received, adding that they are still under staff consideration pending further CFTC action. Giancarlo stated that staff will study possible alternative metrics for calculating the swap dealer de minimis threshold, drawing from proposals in the NPRM, including the feasibility of: 1) removing cleared swaps from the current de minimis calculation; 2) haircutting cleared swaps included in the current de minimis calculation; 3) adopting a new, bifurcated de minimis calculation that uses initial margin amounts for cleared swaps and entity-netted notional amounts for uncleared swaps; and 4) applying other risk-based approaches that the staff may recommend. He concluded that he and SEC Chairman Jay Clayton are committed to working together on harmonization where appropriate, and that should CFTC staff receive a meritorious request, they will consider no-action relief for IDIs pending formal Commission action.

Vote

The final rule was unanimously approved by all Commissioners.

Second Staff Presentation

Proposed Rule: Amendments to Regulations on Swap Execution Facilities and the Trade Execution Requirement

Nhan Nguyn, Division of Market Oversight (DMO), led the presentation of the Commission’s proposal to amend regulations on SEFs and the TER. The key aspects of the proposal are as follows:

1. Amendments to the SEF Registration Requirement: The proposal seeks to apply the statutory SEF registration requirement to certain swaps broking entities, including interdealer brokers, and aggregators of single-dealer platforms. Delays of six months, and two years will be granted to domestic swaps broking entities and foreign swaps broking entities, respectively, from the SEF registration requirement. Further, the proposal seeks to codify the “Footnote 88 issue” by amending the SEF registration requirement to clarify that entities that meet the SEF definition would be required to register as a SEF, regardless of whether the swaps that they list for trading are subject to the trade execution requirement.[1]
2. Elimination of the “Made Available to Trade” (MAT) Requirement: The proposal seeks to eliminate the MAT determination process for SEFs and DCMs and establish a new approach based on a revised interpretation of the trade execution requirement in the Commodity Exchange Act. The new approach will be phased in over a period of up to 270 days, and the new trade execution requirement would be subject to certain exemptions.

3. Amending Restrictions on Methods of Execution: A SEF will no longer be required to offer an Order Book for all swaps it lists for trading. For swaps that are subject to the proposed trade execution requirement, a SEF would no longer be limited to offering an Order Book or a “Request for Quote” system that requires transmission of requests to a minimum of three other market participants (“RFQ-to-3 System”). A SEF would instead be able to offer flexible methods of execution for all listed swaps, including swaps subject to the proposed trade execution requirement. Additionally, a SEF would be required to establish general, disclosure-based trading and execution rules for any execution method that it offers. However, nothing in the proposal prevents a RFQ or order book system.

4. Prohibition of away from SEF Pre-Execution Communications: The proposal would also prohibit pre-execution communication that market participants conduct away from a SEF’s trading system or platform, with some exceptions.

5. Revisions to the Impartial Access Requirement: The proposal also revises the impartial access requirement by allowing a SEF to structure participation criteria and trading practices in a manner that aligns with the swaps market practices. Specifically a SEF will be able to establish trading criteria that is transparent, fair, and non-discriminatory and applied to all or “similarly situated” market participants in a “fair and non-discriminatory” manner.

6. Clarification Under the Straight-Through Processing Requirements and Codification of Existing Staff Guidance: In addition to proposals to clarify relationships between Derivatives Clearing Organizations (DCOs) and SEFs, and the “as quickly as technologically practicable” (AQATP) standard, the proposal codifies existing staff guidance that requires SEFs to facilitate pre-execution credit screening for swaps intended to be cleared.

7. Amending the Financial Resources rules, and Increasing Qualifications and Ethics Training for ‘SEF Trading Specialists’: Finally, the proposal seeks to “professionalize” those SEF employees who perform core functions that facilitate swaps trading and execution for a SEF by requiring sufficient qualifications and ethics training. Separately, seeks to amend the financial resources requirements to clarify that a SEF would only need to maintain adequate financial resources to cover the operating costs needed to comply with the SEF core principles and Commission regulations for a one-year period, as calculated on an ongoing basis.

In addition to these key highlights, more information on the CFTC’s proposal can be found here.

Questions

Quintenz began by noting that Dodd-Frank allowed for SEFs to conduct their activities through “any means of interstate commerce,” and the proposed rulemaking at issue, was meant to address the current limitations to two methods of execution. Quintenz then asked whether the staff had any other examples of execution methods. Roger Smith, DMO, answered that there were others including (but not limited to) auctions, and risk mitigation sessions. Additionally, Smith noted the proposal will allow SEFs to implement and employ other trading policies as intended by congress, increasing efficiencies. Moreover, Quintenz asked staff to describe particular nuances of the proposed rulemaking, including the proposed financial resources rules. Nguyn responded that the proposed rulemaking sets forth operating costs that a SEF will not need to include in its financial resources calculations, such as marketing, and developmental costs.

Behnam questioned the length of the 75-day comment period for the proposed rulemaking on SEFs and the Trade Execution Requirement. Amir Zaidi, Director, DMO, responded that the proposal includes  issues that have been telegraphed through Giancarlo’s Swaps 2.0 Whitepaper, and the 75-day comment period seems right because of past conversations. Behnam responded that market participants will likely need more time, stating a 90-day comment period should be imposed. Behnam then asked how many additional SEF registrations would exist, as a result of the new rule proposal. Smith responded that the proposal suggests there could be 40-60 additional registrations, but many could be affiliated with already registered SEFs. Behnam asked whether a SEF could have a request for quote system that requires transmission of a request to one market participant (RFQ-to-1 System). A staff member responded that SEF execution methods have to meet the SEF definition which require multiple participants, stated differently, if the market participant had a system that was solely RFQ-to-1, they’d have to send multiple RFQs to multiple participants.

Further, Benham asked staff to discuss the logic behind their interpretation of impartial access, and how the proposed rules would increase liquidity. Nguyn responded that implementing the existing rules has been a balancing act between types of discretion that SEFs currently have, and how to enhance participation on their platforms. He continued stating that, under the proposal, SEFs have to continue to offer impartial criteria for participation and trading, that is fair and applied in a non-discriminatory manner, and the underlying philosophy of the new rule proposal remains the same, and only reflects the Commission’s experience in maintaining the current landscape. Finally, Behnam asked what role the Commission would play in SEFs establishing this new criteria. Nguyn responded that the proposed rulemaking would not change current process for evaluating a SEF’s criteria for participation and trading.

Stump asked whether the proposed designation of certain individuals as “SEF Trading Specialists” would limit their ability to operate outside of the SEF as an introducing broker, and if not, which regulatory body or bodies would conduct oversight over these individuals. Nguyn responded that the SEF Trading Specialist definition is meant to identify those type of SEF employees, who are introducing brokers, and designate them to be compliant. Further, he stated the proposed rule would not preclude outside operation as an introducing broker, but that individual would be subject to the SEFs oversight and the SEF will implement its own requirements. Stump then asked how non-domiciled US brokers can operate on the SEF without registering as SEF trading specialists. Smith responded that there will be a two-year delay that will allow them to operate as they do today while the CFTC evaluates its jurisdiction over foreign trading entities, and its own cross-border jurisdiction, generally. Stump then asked how the prohibition on pre-execution communications would affect technological communications like chats. A staff member responded that the proposal asks questions to figure out whether a SEF can handle monitoring these pre-trading communications, and that staff anticipates the SEFs to possibly build out chat functions, to bring those chats to the SEF.

Berkovitz began by asking whether the proposal was consistent with G-20 standards, and whether staff would classify a SEF as an exchange. Zaidi responded that staff looked to both G-20 commitments and Dodd-Frank and stated he believes the proposal is consistent with both. On the question of whether a SEF is an exchange, Zaidi responded that it is, and Berkovitz disagreed. On “Impartial Access,” Berkovitz asked whether a SEF could determine which market participants are “similarly situated,” create a dealer only market, and whether a SEF could create criteria for dealer only markets. Nguyn responded that a SEF, based on their business objectives and knowledge, could create a market for a particular type of market participant, and that the proposal talks about the reasons why these markets exist, and continue to exist under the current rules.

Berkovitz then criticized the proposal stating that the proposal was not based on data, like the de minimis rule. [2]\. ( Mr. Zaidi responded that each study was considered, and staff was not denying the current framework has brought the market into a good position, but the proposal’s goal is to bring liquidity and trading to SEFs. Further, Berkovitz continued to be critical of the staff’s proposal, specifically stating that RFQ-to-3 isn’t appropriate for everything, but is appropriate for things that are already being traded RFQ-to-3 based on the studies, and that, getting rid of these requirements would dismantle what is working. Berkovitz expanded on this concern by stating that he thinks you need to look at the removal of the request methods of execution in conjunction with access, and right now RFQ-to-3 is working for the transactions it is required for because buy side firms have to go to three different dealers. Further, he stated that RFQ-to-3 is far superior than three consecutive RFQ-to-1s.

Statements

Giancarlo supported the proposal. The Chairman stated that Congress, through Dodd-Frank, permitted SEFs to conduct their activities through “any means of interstate commerce,” and by setting forth SEF rules that constrain swaps trading to two methods of execution, the CFTC did not listen to Congress. Giancarlo stated that by making the “made available for trading” determination synonymous with the clearing determination to include all swaps subject to the clearing requirement and listed by a SEF or DCM, it will bring the full range of liquidity formation, price discovery and trade execution on SEFs for a broader range of swaps products. On “impartial access” Giancarlo stated “impartial” does not mean that SEFs must serve every type of market participant in an all-to-all environment, and the proposal would establish what is meant by “impartial access” by defining “impartial” as transparent, fair and non-discriminatory as applied to all similarly situated market participants in a fair and non-discriminatory manner. Finally, Giancarlo stated that the new proposal is consistent with regulatory systems of other G-20 jurisdictions.

Quintenz supported the proposal, stating that he looks forward to hearing from market participants about how these reforms will impact SEF trading dynamics and liquidity formation.

Behnam concurred with the proposal, but voiced serious concerns with the proposal to amend regulations on SEFs and the TER. Behnam began by stating the he believes the NPRM violates the clear language of the Commodity Exchange Act (CEA) by not promoting pre-trade transparency in the swaps market. Additionally, Behnam stated the proposal both increases limitations on access to SEFs, and that the new registration scheme may add significant costs for market participants. Behnam also voiced concern that a 75-day comment period, as currently proposed, may not be sufficient for such a complex rulemaking that impacts a wide range of market participants in fundamental ways.

Stump supported  the proposal, stating that she looks forward to learning from those who comment as to whether a change in course is warranted for both the execution mandate application and the operational structure of SEFs.

Berkovitz dissented on the proposal. Berkovitz stated that the proposal would reduce competition and diminish price transparency in the swaps market, which will lead to higher costs for end users and increase systemic risks. Further, Berkovitz stated that the proposal abandons the commitments the United States made at the G-20. Berkovitz stated that by eliminating the requirement that swaps are subject to the trade execution mandate, the proposal would undermine the Congressional directive in Dodd-Frank. Berkovitz stated that the new impartial access requirement would deny market participants (other than dealers) access to the most favorable prices in the dealer-to-dealer market, resulting in the elimination of competition and higher prices for customers. Berkovitz stated that the proposal does not consider the available data and market studies that demonstrate the current RFQ-to-3 system is working. In addition to major flaws, Berkovitz discussed reforms that should be considered and other specific concerns with the proposal.

Vote

The final vote was approved 4-1, with Commissioner Berkovitz dissenting.

Request for Comment Regarding the Practice of “Post-Trade Name Give-Up” on Swap Execution Facilities

Nguyn stated that the Commission is requesting comment on the necessity or utility of Post-Trade Name Give-Up practices in facilitating swaps trading where swap transactions are anonymously executed and intended to be cleared. Further, Nguyn stated that the Commission intends to use market participants’ comments to make recommendations to the Commission.

Questions

Behnam asked whether there was an expectation that there may be a supplemental proposal for Post-Trade Name Give-Up. Zaidi responded that it will be evaluated whether a supplemental proposal was needed based on comments received, and staff could potentially offer up that proposal to be finalized at the same time as the proposal to amend SEF rulemaking.

Berkovitz stated that given the current state of the Name-Give up request for comment, there’s a lot of analysis and work that needs to be done, and a proposal on Name-Give up will either need to be sped up, or the SEF rulemaking will need to be held up for this proposal to be finalized. Zaidi responded that staff will wait and see what the comments will say, and that it is possible to finalize both proposals at the same time.

Statements

Behnam concurred with the request for comments on name give up, but voiced his concern that if the proposal does not take a view on name give up practices, it may serve as an endorsement of the status quo. Further, Behnam stated that he is concerned with how far behind a proposal on name give up may be relative to the SEF rules.

Stump supported the request for comments on name give up, but stated that she prefers the Commission be able to opine on a final SEF rule and a final rule on name give-up at the same time.

Giancarlo supported the request for comment on the practice of name give up in swaps market. He is looking forward to comments on the advisability of restrictions on the practice and what form a rule would take, if at all.

Vote

The request for comment was unanimously approved by all Commissioners.For additional information on this meeting, click here.

[1] This issue refers a footnote within the Core Principles and other Requirements for Swap Execution, published in June of 2013 (“Footnote 88”).  Footnote 88 expanded the scope of who needs to register as a SEF, even if they are executing swaps that are not required to be executed.

[2] Berkovitz cited conclusions from three studies, including: 1) a CFTC economist study (2018); (2) a Bank of England Staff Working Paper (2018); and (3) a study of “Market Structure and Transaction Costs of Index CDSs” (2017).