European Union: Initial Swap Trading Requirements Come Into Effect—Limited Relief For Packaged Trades And Some EU Facilities

The Commodity Futures Trading Commission has imposed for the first time a requirement that certain swaps be traded on a regulated market. Beginning February 15, 2014, certain cleared interest rate swaps and index credit default swaps will have to be executed on a swap execution facility or designated contract market, or, in certain cases, on an EU multilateral trading facility.

Overview

As a result of a series of actions by the Commodity Futures Trading Commission (CFTC), certain cleared interest rate swaps and index credit default swaps will have to be executed through an order book or a request for quote system on a registered swap execution facility (SEF) or designated contract market (DCM), or, in certain cases, on a qualifying EU-regulated multilateral trading facility (MTF). In connection with this requirement, the CFTC has provided temporary no-action relief from the mandatory trading requirement for so-called "package transactions" that include a swap that would otherwise be subject to mandatory trading, and has clarified certain reporting issues with respect to swaps traded on a SEF or DCM.

These determinations have the potential to fundamentally change the way covered interest rate swaps and credit default swaps are traded, and mark a further step in the reforms imposed on the derivatives markets under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new mandatory trading requirements will apply to all market participants, other than non-financial end-users electing an exemption from the mandatory clearing requirement. Unlike its approach with the implementation of mandatory clearing, the CFTC has not provided phase-in periods for different categories of market participants.

Scope of Trading Requirement

As a technical matter, the CFTC's determinations, made on the basis of submissions of certain SEFs,1 certify that the relevant categories of cleared interest rate swaps (MAT IRS) and cleared index CDS (MAT CDS) have been "made available-to-trade" (so-called MAT Determinations) for purposes of Section 2(h)(8) of the Commodity Exchange Act (CEA) and are thus subject to the mandatory trade execution requirement. Often referred to as "Required Transactions," these MAT IRS and MAT CDS, unless of block size, must be executed through an order book or a request for quote system on either a SEF or DCM. By no-action letter, the CFTC has also permitted the mandatory trading requirement to be satisfied through use of a qualifying EU-regulated MTF.2

Market participants should note the following consequences of these MAT Determinations:

  • After the effective date of the relevant MAT Determination, it will be illegal for most market participants to execute such trades bilaterally (unless the end-user exception from clearing applies or the trade is of block size). The first effective date for the MAT Determinations is February 15, 2014, which falls on a Saturday. February 18, 2014 is the first business day afterwards.3
  • A MAT Determination is not exchange-specific. All swaps covered by a MAT Determination must be executed on a SEF or DCM (or qualifying MTF), but the CFTC does not require that a particular facility be used. In particular, it is not necessary for market participants to use the SEF or DCM that submitted the MAT Determination in the first place.
  • The specific kinds of swaps covered by the MAT Determinations to date are as follows:

The CFTC has created a website with a centralized list of swaps subject to the trade execution mandate.7

Packaged Trades and Other Relief

Previously, the CFTC stated that grouping component trades together into "package transactions" would not in itself relieve market participants of the obligation to trade such swap(s) through a DCM or SEF, if required under a MAT Determination. A "package transaction" is a trade that combines at least one swap that is subject to a MAT Determination and another swap or financial instrument, which may be a swap, futures contract or cash market transaction.8 However, in response to requested relief from market participants—who cited potential difficulties in the execution and processing of packaged transactions—the CFTC recently granted time-limited, no-action relief from the trade execution requirements for such trades until May 15, 2014.9 In addition, the CFTC's Division of Market Oversight (DMO) held a public meeting on February 12, 2014, to discuss potential difficulties surrounding the execution of package transactions through SEFs or DCMs. It is expected that during the no-action period the DMO will give further consideration to relief for package transactions.

In connection with the February 10, 2014 no-action letter, the CFTC also announced a number of other measures to promote trading on SEFs. One such measure was an interim final rule clarifying that a party to an anonymous trade executed on a SEF or DCM cannot access information in swap data repositories in order to obtain the identity of its counterparty.

Relief for EU-regulated MTFs

The mandatory trading requirements are being imposed at a time of some uncertainty as to the cross-border application of the mandatory trading and SEF requirements. In guidance released late last year, the DMO expressed its view that a multilateral swap trading platform located outside of the United States that provides US persons or persons located in the United States with the ability to trade or execute swaps on or pursuant to the rules of the platform, either directly or indirectly through an intermediary, would have to register as a SEF or DCM.10 Consequently, non-US platforms that have not registered as a SEF or DCM have had to reevaluate the extent to which they provide US persons, or non-US persons acting through US-located persons, with the ability to enter into swaps.11

However, by no-action relief announced on February 12, 2014,12 the CFTC is providing a procedure for EU-regulated MTFs to certify that they are subject to EU regulation that is comparable to US SEF regulation. Such MTFs would not be required to register as a SEF, subject to the satisfaction of certain conditions.13 In addition, trading on such qualifying MTFs would satisfy the CFTC's mandatory trading requirement.

Is the Market Ready?

Some market participants have expressed concern that the MAT Determination process, which relies on a submission by the SEF or DCM, rather than being initiated by the CFTC, could result in MAT Determinations for products that may not be appropriate for mandatory trading (e.g. due to liquidity or other commercial factors). In addition, a swap that has been deemed available to trade will remain subject to the trade execution requirement until all SEFs and DCMs that had listed or offered that swap for trading no longer list or offer the swap for trading. These concerns were brought to the attention of the CFTC by several commenters during the comment period following the release of the proposed DCM/SEF rules:

"SEFs and DCMs should not make the determination because they may have a financial incentive-based conflict of interest to maximize the number of swaps subject to mandatory trade execution. Commenters expressed a related concern that a SEF's or DCM's determination would be influenced by a desire to gain a "first-mover advantage," (i.e., acquiring market share in the trading of a particular swap before other venues can list and develop trading activity in that swap), which would lead to premature or ill-advised mandatory trading of illiquid swaps on a SEF or DCM."14

The CFTC noted, in response to these comments, that only swaps that it has determined are subject to mandatory clearing are eligible for a MAT Determination. The CFTC further noted that, in making a MAT submission, the SEF or DCM would have to address following factors with respect to the swap: (1) whether there are ready and willing buyers and sellers; (2) the frequency or size of transactions; (3) the trading volume; (4) the number and types of market participants; (5) the bid/ask spread; or (6) the usual number of resting firm or indicative bids and offers.

Others have questioned whether these new markets are ready for mandatory trading. SEFs have only been (provisionally) registered since October 2013, and many aspects of their rulebooks, trading functionalities and mode of operations have not necessarily been finalized. The CFTC itself continues to update its guidance as to the regulatory requirements applicable to SEFs. It is not yet clear for many market participants how they intend to access SEFs (either as direct participants, through some form of sponsored access or through another party acting as their agent) and which SEFs they intend to use. Not all SEFs will necessarily offer all products that are subject to a MAT Determination. Although the relief for EU-regulated MTFs is expected to provide useful flexibility for those platforms and market participants, it comes at a late hour and the effect on these markets, both in the short and long term, is unclear.

Whichever SEFs and access methods are chosen, users will need to have appropriate arrangements in place by the effective date of the mandatory trading requirements. According to some, there are also lead times—in some cases three to four weeks—associated with onboarding new customers onto particular SEFs, a factor that market participants may wish to incorporate into any internal compliance timeline.

Conclusion

The mandatory trading requirement is intended to create a significant change in derivatives market structure. Nonetheless, the market may remain in a state of uncertainty as some of the issues identified above are worked out. Market participants will want to watch for further refinements by the CFTC to the requirements applicable to SEFs, and also pay close attention to which contracts must be traded on a SEF or DCM, the markets (including qualifying MTFs) that are available for such products, and the rules, trading protocols and means of access to those markets.

Footnotes

1 Available-to-trade determinations for certain interest rate and credit default swaps were self-certified by Javelin SEF, LLC; trueEX LLC; TW SEF, LLC; and MarketAxess SEF Corporation. Those certifications became effective on January 16, 2014, January 22, 2014, January 27, 2014, and January 29, 2014, respectively. See the CFTC's site for the various MAT determinations/submissions: http://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination.

2 See CFTC No-Action Letters 14-15 and 14-16 (Feb. 12, 2014).

3 The Commission's final rules on the subject require market participants to comply with the trade execution requirement upon the later of (1) the applicable deadline established under the compliance schedule for the clearing requirement for a swap under § 50.25 of the Commission's regulations, or (2) 30 days after the available-to-trade determination for that swap is deemed available to trade upon being approved under § 40.5 or allowed to become effective under § 40.6. As a result, transactions involving swaps in the determinations described herein will be subject to the trade execution requirement, effective February 15, 2014, February 21, 2014, and February 26, 2014, as applicable.

4 Standard Coupon refers to the then-current fixed coupon rates for Market Agreed Coupon ("MAC") contracts

5 Par coupon swaps with a tenor of four or six years (in bold) become subject to the trade execution requirement on February 26, 2014 and are limited to the 3M USD LIBOR floating rate index; Quarterly Reset Frequency; and the following fixed leg conventions: (1) Semi-Annual and 30/360; or (2) Annual and Actual/360.

6 Euro (EUR)-denominated, par coupon swaps with a tenor of four or six years (in bold) become subject to the trade execution requirement on February 26, 2014 and are limited to the fixed leg conventions: Annual and 30/360.

7 http://www.cftc.gov/PressRoom/ssLINK/%20swapsmadeavailablechart

8 Technically, the CFTC's definition of a package transaction is a "transaction involving two or more instruments: (1) that is executed between two counterparties; (2) that is priced or quoted as one economic transaction with simultaneous execution of all components; (3) that has at least one component that is a swap that is made available to trade and therefore is subject to the CEA section 2(h)(8) trade execution requirement; and (4) where the execution of each component is contingent upon the execution of all other components." Some common types of interest rate swap package transactions may include, but are not limited to, transactions commonly known as swap curves (package of two swaps of differing tenors), swap butterflies (package of three swaps of differing tenors), swap spreads (government securities vs. swaps typically within similar tenors), invoice spreads (Treasury-note or Treasury-bond futures vs. swaps), cash/futures basis (Eurodollar futures bundles vs. swaps), offsets/unwinds, delta neutral option packages (caps, floors, or swaptions vs. swaps), and mortgage-backed security basis (to-be-announced swaps (agency MBS) vs. swap spreads). Common credit default swap package transactions may include, but are not limited to, transactions commonly known as index options vs. index, tranches vs. index, and index vs. single name CDS.

9 "No-Action Relief from the Commodity Exchange Act Sections 2(h)(8) and 5(d)(9) and from Commission Regulation § 37.9 for Swaps Executed as Part of a Package Transaction," CFTC Letter No. 14-12, February 10, 2014.

10 "Division of Market Oversight Guidance on Application of Certain Commission Regulations to Swap Execution Facilities," Nov. 15, 2013.

11 Many market participants have taken issue with both the form and substance of this guidance. Alleging that, among other things, the CFTC unlawfully circumvented the requirements of the Administrative Procedure Act and the CEA by characterizing its regulations as "guidance," on December 4, 2013, SIFMA, ISDA and the IIB filed a lawsuit in federal court in the district of DC seeking to block the CFTC's cross-border rules.

12 The no-action relief consists of (1) a temporary no-action letter (No. 12-14) that provides relief to an MTF from the SEF registration requirement and mandatory trading requirement until March 24, 2014, or, if earlier, the time the particular MTF receives permanent no-action relief, and (2) a conditional no-action letter (No. 12-15) that provides a procedure for demonstrating comparability and obtaining permanent relief. The letter contemplates that each relevant MTF will have to apply for relief under the letter and obtain acknowledgment of relief from DMO. The letter contemplates that the CFTC will adopt a more formal exemption process for non-US trading facilities, and leaves open the possibility that a non-US trading facility with a sufficiently high level of US participation might be required to register as a SEF.

13 Among other conditions, the MTF would have to provide the execution methods required under the SEF rules (i.e., an order book and if an RFQ methodology is provided, one that is compliant with the SEF rules), and trades would have to be reported to an SDR and submitted for clearing to a DCO (or a clearing organization with an exemption or relevant no-action relief).

14 "Process for a Designated Contract Market or Swap Execution Facility To Make a Swap Available to Trade, Swap Transaction Compliance and Implementation Schedule, and Trade Execution Requirement Under the Commodity Exchange Act," Federal Register/ Vol. 78, No. 107 / Tuesday, June 4, 2013 / Rules and Regulations, pp. 33608.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Barnabas W.B. Reynolds
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions