Blog News Events Publications Directory Community Industry Voices Media

CFTC rules on swaps trading put demands on compliance oversight

By Nick Paraskeva, for Compliance Complete

NEW YORK, May 29 (Thomson Reuters Accelus) – New U.S. rules requiring many over-the-counter derivatives to be traded on swap execution facilities and exchanges will have a major impact on the compliance and risk processes of market participants. Price quotation, execution and trade reporting requirements adopted last week by the Commodity Futures Trading Commission aim to bring transparency to the previously unregulated swaps markets.

The rules contain some concessions in response to industry lobbying against earlier proposals, but they did not squelch the opposition.

AdvertisingION Commodities
AdvertisingAmphora CTRM

The regulation of swap execution facilities, known as SEFs, makes the U.S. the first country to implement this major plank of the Group of 20 major economies’ commitments on derivatives made after the crisis. The other planks are mandatory clearing of standardized swaps, reporting all transactions to swaps data repositories and higher capital requirements for firms undertaking contracts that remain non-centrally cleared.

“These rules taken together will provide the public with the price and volume of every [swap] transaction in real time – and I mean in real time”, CFTC Chairman Gary Gensler said at a meeting last Thursday when the rules were adopted. “With these three rules, no longer will this be a closed, dark market,” he said. The regulation takes effect 60 days after publication.

The rules will give multiple participants the ability to trade in swaps by accepting bids and offers made by other participants, similar to other public markets. The aim is to provide transparency by the public display of prices and orders, and by the real-time volume display of those swap trades smaller than block size. All such trades are required to be reported “as soon as technologically practicable” after their execution.

Execution on SEFs or designated contract markets (DCMs) is only required for swaps between financial institutions. End-user companies benefit by being able to access information on the platforms, but are not required to use them. For example, end users can see prices of available bids and offers prior to making trading decisions. Companies can continue to rely on customized transactions that are not required to be cleared.

“CFTC’s decision to impose a minimum bid requirement for certain swap transactions executed on SEFs will impair market liquidity at the expense of all market participants,” said Ken Bentsen, acting SIFMA CEO and president. “The methodology for determining block sizes is flawed and results in arbitrary outcomes that are not based on observable market data,” he added.

The requirement for asset managers to request at least two quotes for a trade removes the discretion to decide what number of providers to go out to. In an industry survey submitted to the CFTC in March by the Managed Funds Association (MFA) and buy-side firms, 76 percent of fund managers expected higher costs to arise from the quote rule, including the need for new legal arrangements with their clients.

“SIFMA strongly believes that professional investment managers, not the government, should determine appropriate trading strategy,” said Timothy Cameron, head of SIFMA’s Asset Management Group.

Asset managers have stated concerns that requesting swap quotes from a wider number of sell-side banks and broker dealers, will risk exposing their investment strategies to the market. Other participants could then use the information to trade against the manager or to the disadvantage of their underlying clients.

Sell-side firms need to separately treat their swap trades with financial-institution counterparties from those with end-user customers who are not required to trade on market. Classification of swaps into the CFTC asset-type categories would allow matching with those deemed made available for trading. If one SEF or designated contract market (DCM) makes them available, all trading of swaps in that class will also covered.

Block transactions

The rules include procedures for CFTC to establish minimum block sizes for different classes of swap. Larger trades above the block size do not need to be immediately reported, and are eligible for a delay. The block threshold applies to all publicly reportable swap trades in all asset classes, whether cleared or uncleared, and whether it is traded bilaterally or through an execution facility such as a SEF.

Block sizes are tailored by asset class and underlying reference product. There are 27 interest-rate swap categories, 18 for credit swaps, and foreign exchange is based on unique currency combinations. Equity swaps do not qualify as block trades, and have no time delay before public dissemination. Parties to a trade notify the SEF or DCM if they elect to have the trade treated as a block trade, and SEFs notify trade depositories.

Phased-in implementation of minimum block sizes apply for a one-year period. The threshold for interest rate and credit swaps will be set to cover 50 percent of traded notional in an asset class. Block size in forex and commodity swaps is based on that set by exchanges for related contracts in traded futures. After one year, the CTFC will set the size based on data collected by swap repositories to obtain 67 percent coverage.

SEF trade execution

Swap trades are required to be conducted on na SEF or DCM if clearing in the swap is mandatory, and the product has been made available to trade. SEFs and DCMs determine which swaps to make available for trading on their platforms. They will submit these determinations to CFTC, either on a self-certified basis or for approval. CFTC will publish such certifications.

A 30 day phase-in period applies after the SEF or DCM finalize their made-available-to-trade status for a product, before trade execution is mandated to other markets. After this period, all other DCMs and SEFs that list the same swap must also meet trade execution rules.

SEFs are required to provide a matched order book to all market participants. Participants are required to trade on a SEF through the SEF order book, and also provided flexibility to seek requests for quotes. The public is able to access the market and have their bids or offers communicated to the rest of the market.

SEFs will also have flexibility to offer trading through “requests for quotes” rather than orders. Requests have to go out to a minimum of two unaffiliated market participants before trade can be executed. After a one year phase-in period, the number of firms that must be approached for a quote increases to three. Such requests can be made through any means, including on the Web and by telephone.

New core principles require SEFs to provide all market participants with impartial access to their trading platforms. They are also required to comply with obligations on market surveillance, operational capability and level of financial resource. Other conditions are trade control mechanisms, including pauses, halts to trading, and safeguards on system integrity.

A SEF may contract with a regulatory service provider to perform tasks assigned to a SEF’s compliance staff. However, the CFTC stated that the SEF must have sufficient internal compliance staff to oversee the quality and effectiveness of the services provided.

Disruptive trading

CFTC guidance cited practices on a SEF and DCM that it views as disruptive of fair and equitable trading. These would prohibit a person from buying a swaps contract on a SEF or DCM at a price which is higher than the lowest available price offered for that contract, or selling at a price below the highest bid. For a SEF, this prohibition only applies when a person is using their order book, rather than requesting quotes.

A violation may occur when a firm accumulates a large position before the close with intent or reckless disregard to disrupt orderly trading. Also cited is where a trader intends to cancel a bid or offer before it is executed. A spoofing prohibition covers firms making or canceling bids or offers to delay another person’s trade, or making multiple bids to create an appearance of a false market depth or create artificial prices.

CFTC rules adopted:

– Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-
Facility Swaps and Block Trades; Final Rules: May 17, 2013

– Core Principles and Other Requirements for Swap Execution Facilities; Final Rules

– Process for a Designated Contract Market or Swap Execution Facility to Make a Swap Available to Trade: Swap Transaction Compliance and Implementation Schedule; Trade Execution Requirement. Final Rules.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

(Nick Paraskeva is principal of Reg-Room LLC (, which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and Follow Nick on Twitter@regroom.)