U.S. Commodity Futures Trading Commission Market Risk Advisory Committee Teleconference
U.S. Commodity Futures Trading Commission
Market Risk Advisory Committee Teleconference
Monday, September 9, 2019
Key Topics & Takeaways
- Plain-English Disclosures: Battle explained that these proposed plain-English disclosures are intended to serve as helpful examples of plain-English disclosures that market participants could use as they deem appropriate when referencing LIBOR and similar IBORs. She stated that these disclosures were drafted with the intent for them to be helpful to all market participants, even if they are not aware of benchmark reform, existing fallback provisions in derivatives and other instruments, or other efforts to implement additional fallback language. The proposal was approved 30-0 and will be submitted to the Commission for consideration
- CCP Adjustments to Discounting & Price Alignment Interest: McLaughlin noted that the LCH produced a report to outline its approach to the transition of rates, with a preference for the transition to occur in October 2020. He said the LCH’s approach is a combination of cash-only trading options and compensation for trading risk through swaps, with a focus on currency markets. Mirza stated that the goal of the CME’s plan is to achieve a single-day accounting mechanism with the transition to SOFR. He said CME’s proposed approach is built upon ensuring market stability and risk management, with a goal of phasing out of the old rates by July 2020. Wipf stated that the keys to both proposals are timing, pricing mechanisms and risk management.
- Clearing Treatment for Certain Physically Settled Swaptions: Wipf said the Subcommittee has been working on a proposal to address cleared swaps discounted at the federal funds rate, how to approach risk management of legacy swaps, cash options, and the transition to swaps contracted with SOFR. He stated that the Subcommittee believes it to be premature to endorse any one proposal and that the Subcommittee will have an update in November. Wipf stated that some of the concerns of the Subcommittee include targeted clearing and factoring calculations.
Opening Statements
Commissioner Rostin Behnam
In his opening statement, Behnam provided a brief overview of the topics to be discussed and praised the MRAC for its contributions to the work of the Alternative Reference Rates Committee (ARRC).
Chair Nadia Zakir, Executive Vice President and Deputy General Counsel, Pacific Investment Management Company LLC (PIMCO)
In her opening statement, Zakir expanded upon Behnam’s comments, focusing particularly on the work of the Interest Rate Benchmark Reform Subcommittee (Subcommittee) and relevant developments related to the London Interbank Offered Rate (LIBOR) transition. Zakir outlined the three main items on the Committee’s agenda: 1) a presentation and MRAC vote on the Subcommittee’s initial recommendation regarding the adoption of plain-English disclosures for new derivative contracts referencing LIBOR and other IBORs; 2) a discussion of proposals from central counterparties (CCP) regarding adjustments to discounting and price alignment interest; and 3) a discussion of the clearing treatments for certain physically settled swaptions.
Report from the Interest Rate Benchmark Reform Subcommittee
Panel Presentation
Thomas Wipf, Subcommittee Chairman and Vice Chairman, Institutional Securities, Morgan Stanley, delivered a report from the Subcommittee. Wipf provided an update on key developments regarding the transition to LIBOR, driven by both regulators and market participants. He outlined the plain-English disclosures draft, stating that the standard set of disclosures can be incorporated into market participants’ documents to better inform their clients and counterparties about the implications of using LIBOR and other IBORs. He added that market participants are also encouraged to amend these disclosures to best serve their organizations as long as such disclosures (or other internally developed disclosures that are substantively similar) are effectively distributed to both clients and counterparties.
Wipf then highlighted key areas of concern for the CCPs discounting and price adjustments proposals, which include timing of the adjustments, the pricing mechanism for cash compensation, and the methodology by which ongoing basis risk would be “compensated”. He expressed the desire of the Subcommittee for consistency across the clearinghouses in how they approach this important event. He also noted that the in the current construct of the single step transitions at both clearinghouses, valuation discrepancies may arise in these products. Wipf reported that Subcommittee thought it was premature to recommend that the MRAC propose CFTC relief for the CCPs regarding certain physical-settled swaptions. He outlined his desire to continue discussion to coordinate the clearinghouse proposals, as well as to ensure a timely resolution for the transition to the Secured Overnight Financing Rate (SOFR).
Plain English Disclosures
Panel Presentation
Ann Battle, leader of the Subcommittee’s Disclosure Working Group and Assistant General Counsel, International Swaps and Derivatives Association (ISDA), opened the panel by presenting, in detail, the recommendation from the Subcommittee regarding the plain-English disclosures. She explained that these proposed disclosures are intended to serve as helpful examples of plain-English disclosures that market participants could use as they deem appropriate when referencing LIBOR and similar IBORs. Battle stated that it would be appropriate to use these disclosures if a market participant does not have its own disclosure or if it prefers to use something that is publicly available and standardized. She said it is worth noting that internally-developed disclosures that are substantively like these proposed disclosures would satisfy the intent of the Subcommittee if they are shared with all counterparties in an operationally feasible manner. Battle stated that these disclosures were drafted with the intent for them to be helpful to all market participants, even if they are not aware of benchmark reform, existing fallback provisions in derivatives and other instruments, or other efforts to implement additional fallback language.
Battle noted that the proposed disclosures contain four options based on whether the transaction references LIBOR or another IBOR and on whether the transaction was entered into before or after ISDA updates its standard definition for derivatives to include new fallbacks.
Battle reported that these proposed disclosures reflect feedback from the Subcommittee and MRAC. Specifically, she said they have been amended to: 1) note that counterparties should consider using an ISDA protocol to add the new fallbacks when they are final but clarify that they would not be required to do so; 2) clarify that counterparties could also seek to enter bilateral amendments to add the new fallbacks as an alternative to using a multilateral ISDA protocol; 3) note that counterparties should consider the tax, accounting and regulatory implications of continuing to enter transactions referencing LIBOR or other IBORs; 4) recognize that existing derivative transactions do include a process for attempting to determine a fallback rate if LIBOR or another IBOR is discontinued; and 5) note that spread adjustments are contemplated in connection with the new fallbacks to address the inherent differences between the IBORs and the risk-free fallback rates.
Battle emphasized that nothing in the proposed disclosures would amend or supersede the terms of any transaction or any related governing documentation, and that information in the disclosures would remain subject to the terms of the relevant transaction’s governing documentation.
Question and Answer
Frank Hayden, VP Trading Compliance, Calpine Corporation, asked whether these recommendations concerning fallback provision language are specific to a particular type of counterparty.
Battle responded that these disclosures are written for use by all market participants who continue to engage in transactions that reference LIBOR or other IBORs.
The proposal was approved 30-0 and will be submitted to the Commission for consideration.
CCP Adjustments to Discounting and Price Alignment Interest
Panel Presentation
Dennis McLaughlin, Chief Risk Officer, LCH Group, noted that the LCH produced a report to outline its approach to the transition of rates, with a preference for the transition to occur in October 2020. He said the LCH’s approach is a combination of cash-only trading options and compensation for trading risk through swaps, with a focus on currency markets. McLaughlin welcomed comments to improve the components of LCH’s bi-lateral trade coordination efforts, which will apply to the swaps. He said the main idea is to help facilitate and standardize swap trading as LIBOR is phased out.
Agha Mirza, Managing Director, Global Head of Interest Rates, CME Group, stated that the goal of the CME’s plan is to achieve a single-day accounting mechanism with the transition to SOFR. He said CME’s proposed approach is built upon ensuring market stability and risk management, with a goal of phasing out of the old rates by July 2020. Mirza said CME’s proposal would eliminate value transfer by making a cash adjustment at the individual swap level that is equal and opposite to each cleared swaps net present value specifically attributable to the discounting change. The proposal would also restore swaps at July 17th closing curve value to mitigate hedging costs. Further, he said that the proposal offers a standardized methodology for swap exercises, and bilateral compensation agreements could also be standardized in the proposal. Mirza added that the single-day accounting will help to provide further liquidity in the market.
Wipf stated that the keys to both proposals are timing, pricing mechanisms and risk management. He suggested that it would be beneficial for LCH and CME to be better align their proposed transition dates and plans to mitigate risk. Wipf said the Subcommittee has expressed the need for consistency through this transition, and to account for concerns of antitrust.
Question and Answer
Biswarup Chatterjee, Global Head of Electronic Trading & New Business Development, Credit Markets, Citigroup, suggested for both proposals to align their transition dates, and to address present values and compensation mechanisms. He said that overall, if there is conceptual alignment for the proposals, they would be beneficial for the marketplace.
Marnie Rosenberg, Managing Director and Global Head of Clearinghouse Risk & Strategy, JP Morgan, echoed the need to align the transition dates, and recommended the preferred date of October 2020. She also suggested for the proposals to improve compensation mechanisms to mitigate risks to benefit the market.
Stephen Berger, Managing Director and Global Head of Government & Regulatory Policy, Citadel, added that the risks and challenges to address one-way auction flow and counterparty trading should also be considered in the proposals.
Rana Yared, Managing Director, Principal Strategic Investments Team, Securities Division, Goldman Sachs, recommended the transition date be set to July 2020, and suggested for the organizations to consider the effects of any changes made to both sides involved in the options mechanism.
Clearing Treatment for Certain Physical-Settled Swaptions
Panel Presentation
Wipf said the Subcommittee has been working on a proposal to address cleared swaps discounted at the federal funds rate, how to approach risk management of legacy swaps, cash options, and the transition to swaps contracted with SOFR. He stated that the Subcommittee believes it to be premature to endorse any one proposal and that the Subcommittee will have an update in November. Wipf stated that some of the concerns of the Subcommittee include targeted clearing and factoring calculations.
Closing Remarks
Wipf recapped what was discussed, emphasizing the positive impact of the plain-English disclosures, the MRAC’s desire for consistency and coordination between the clearinghouses in terms of their single step plans, and that there is more work to be done on the clearing treatment for physical settled swaptions. He reiterated the need for the MRAC to determine the appropriate forum for the clearinghouses where they can work together to achieve the desired consistency in transitions.
Behnam reiterated Wipf’s remarks and thanked all Committee and Subcommittee participants. He stated that the work of the Committee and Subcommittee is critical to ensure a seamless process during the 2020 transition, and concluded that CFTC Chairman Heath Tarbert is examining LIBOR extensively and the Commission intends to respond to the regulatory relief that was requested last year.
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