Section 723(a)(3) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (''Dodd-Frank") requires that swaps subject to mandatory clearing1 must be executed2 on a designated contract market ("DCM") or swap execution facility ("SEF"), unless no DCM or SEF "makes the swap available to trade."3 On December 5, 2011, in an effort to bring more transparency to the process, the US Commodity Futures Trading Commission ("CFTC") issued a further notice of proposed rulemaking ("Notice") establishing the procedure for a DCM or SEF to make a swap available to trade.4

The regulations proposed in the Notice ("Proposed Regulations") set forth eight factors that a DCM or SEF must consider in deciding to make a swap available to trade.5 The DCM or SEF must then submit its analysis to the CFTC under one of two procedures: pre-approval or self-certification. Under either procedure, the CFTC may deny "available to trade" status if the proposed determination conflicts with provisions of the Commodity Exchange Act or CFTC regulations.

Under the Proposed Regulations, once a DCM's or SEF's determination is final, all other DCMs and SEFs listing or offering for trading such swap and/or any economically equivalent swap must treat the swap or any economically equivalent swap as available to trade. A determination by one DCM or SEF would thus bind the entire market.6 Moreover, the "economically equivalent swap" rule creates a trap for the unwary. If this rule is finalized in its current form, any party seeking to enter into an over-the-counter (OTC) swap would have to confirm that the swap is not economically equivalent to a swap that has been made available to trade. If the CFTC has determined that the proposed OTC swap is subject to clearing, then the swap automatically would be subject to the trade execution requirement as well and could not be traded OTC.

The Notice requests comments by February 13, 2012, on nine topics relating to the Proposed Regulations, including such key questions as whether the CFTC should allow a DCM or SEF to submit an available to trade determination if that DCM or SEF does not itself list the subject swap for trading, and whether a DCM or SEF should be required to submit to the CFTC its reasoning for deciding that a certain swap is or is not economically equivalent to another swap.

Background

The Notice is the CFTC's second proposed rule addressing the "available to trade" issue. The CFTC's December 16, 2010 proposal on core principles for SEFs (the "SEF NPRM") included a brief proposal regarding "available to trade."7 There, the CFTC had proposed that each SEF would periodically determine which swaps that it offers are made available to trade, and annually report those determinations to the CFTC. The CFTC had not made a similar proposal for DCMs. Largely in response to comments on the SEF NPRM, the CFTC issued the Notice, refining the "available to trade" process and applying it to DCMs in addition to SEFs.

Filing Procedures

Under the Proposed Regulations, as noted above, a DCM or a SEF would first determine that a swap is available to trade and then submit that determination to the CFTC either for approval (pursuant to an approval procedure) or for certification (pursuant to a self-certification procedure).8 The approval procedure gives the CFTC a 45-day review period, which the CFTC may extend for an additional 45 days in specified circumstances.9 In the certification procedure, the CFTC would have 10 business days to review a determination after which it would be deemed certified, unless the CFTC issues a stay of the certification.10 The stay would operate for 90 days, during which time the CFTC must provide a 30-day public comment period.11

Under either approach, the DCM or SEF would be required to explain how it considered the factors enumerated in the Proposed Regulations with respect to the swap.12 As noted, in either procedure the CFTC may deny a determination only if the CFTC concludes it is inconsistent with the CEA or the CFTC's regulations.

If the CFTC either approves a DCM's or SEF's determination or permits a certified filing to become effective, then the related swap would be deemed available to trade. However, the trade execution requirement would not become effective immediately after the end of the CFTC's review period. Rather, there would be a waiting period to allow other DCMs or SEFs to prepare to compete, for example, by building required connectivity or making related technological and trading strategy amendments.13

In addition, the Notice states that as the CFTC gains experience with oversight of the swaps markets, it may decide, in its discretion, to determine that certain swaps are available to trade.

Factors to Consider in Making a Swap Available to Trade

A DCM or SEF must consider one or more of the following factors in making a swap available to trade: (1) whether there are ready and willing buyers and sellers; (2) the frequency or size of transactions on DCMs or SEFs, or of bilateral transactions; (3) the trading volume on DCMs or SEFs, or of bilateral transactions; (4) the number and types of market participants; (5) the bid/ask spread; (6) the usual number of resting firm or indicative bids and offers; (7) whether a DCM's trading facility or a SEF's trading system or platform will support trading in the swap; or (8) any other factor that the DCM or SEF may consider relevant.14 The Notice indicates that the CFTC may in the future consider setting objective standards based upon its analysis of swap trading data as the swaps markets evolve.

Economically Equivalent Swaps

As noted above, after one DCM or SEF has made a swap available to trade, all other DCMs and SEFs listing or offering for trading that swap or any economically equivalent swap must make those swaps available to trade as well.15 The Proposed Regulations define the term ''economically equivalent swap'' as a swap that a DCM or SEF determines to be economically equivalent with another swap after consideration of each swap's material pricing terms.16

Annual Review of "Available to Trade" Determinations

The Proposed Regulations require that each DCM and SEF annually review and assess its prior "available to trade" determinations.17 This review is to be based on the factors described above, and could result in a determination that a particular swap is no longer available to trade. The Notice also encourages DCMs and SEFs to evaluate their swaps that they have not determined to be available to trade and submit them to the CFTC for approval or certification as appropriate. Each DCM or SEF would be required to submit to the CFTC a report of its review and assessment no later than 30 days after the DCM's or SEF's fiscal year-end.

Key Questions on Which Comments are Requested

As noted, the CFTC invited public comments on several categories of questions. Among the key questions raised are:

  • Is the CFTC's approach in the Proposed Regulations regarding the determination that a swap is available to trade appropriate? If not, what approach is appropriate and why?
  • Should the CFTC allow a DCM or SEF to submit its available to trade determination with respect to a group, category, type, or class of swaps?
  • In evaluating the factors under Proposed Regulations sections 37.10(b) and 38.12(b), should the CFTC allow a DCM or SEF to consider the same swap or an economically equivalent swap on another DCM or SEF?
  • When a DCM or SEF makes a swap available to trade, should all other DCMs and SEFs listing or offering for trading such swap and/or any economically equivalent swap be required to make those swaps available to trade? What would be the economic impact on those DCMs and SEFs of imposing such a requirement?
  • Is the CFTC's proposed definition of the term ''economically equivalent swap'' appropriate? If not, how should the CFTC revise the definition as applicable to the Proposed Regulations and why?
  • If a DCM or SEF is required to make an economically equivalent swap available to trade, should that DCM or SEF be required to submit its reasoning for deciding that a certain swap is or is not economically equivalent to another swap?
  • Should the CFTC specify a process whereby a swap that has been determined to be available to trade may be determined to no longer be available to trade?
Footnotes

1. See section 2(h)(1) of the Commodity Exchange Act ("CEA").

2. See CEA section 2(h)(8).

3. Id. The mandatory clearing and trade execution requirements are also inapplicable to certain end users, as defined in CEA section 2(h)(7), as amended by section 723(a)(3) of Dodd-Frank.

4. Process for a Designated Contract Market or Swap Execution Facility To Make a Swap Available To Trade, 76 Fed. Reg. 77728 (published December 14, 2011), available here. If made final, the new regulations would appear at sections 37.10 (SEFs) and 38.12 (DCMs) of Title 17 of the Code of Federal Regulations.

5. No one factor would be dispositive, as the DCM or SEF may consider any one factor or several factors to make a swap available to trade.

6. Note, however, that if a DCM or SEF makes a swap available for trade, the Notice would not require other DCMs or SEFs to list or offer that swap, or an economically equivalent swap, for trading.

7. Core Principles and Other Requirements for Swap Execution Facilities, 76 FR 1214 (published Jan. 7, 2011).

8. Proposed Regulations sections 37.10(a) and 38.12(a). The approval and self-certification procedures are set forth in rules that the CFTC finalized in July 2011. See 17 C.F.R. sections 40.5 (approval) and 40.6 (self-certification), and Provisions Common to Registered Entities, 76 Fed. Reg. 44776 (published Jul. 27, 2011).

9. 17 C.F.R. sections 40.5(c), (d).

10. 17 C.F.R. sections 40.6(b), (c)(1).

11. 17 C.F.R. section 40.6(c)(2).

12. Proposed Regulations sections 37.10(a), (b) and 38.12(a), (b).

13. The CFTC established this waiting period in a notice of proposed rulemaking that it issued on September 8, 2011. Under the proposed rule, a swap would be subject to the trade execution requirement upon the later to occur of (1) the applicable deadline established for the clearing requirement or (2) 30 days after the swap is first made available to trade on either a DCM or a SEF. See Swap Transaction Compliance and Implementation Schedule: Clearing and Trade Execution Requirements under Section 2(h) of the CEA, 76 FR 58186 (published Sep. 20, 2011).

14. Proposed Regulations sections 37.10(b) and 38.12(b).

15. Proposed Regulations sections 37.10(c)(1) and 38.12(c)(1).

16. Proposed Regulations sections 37.10(c)(2) and 38.12(c)(2).

17. Proposed Regulations sections 37.10(d) and 38.12(d).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.