At an Open Commission Meeting, the CFTC approved a final rule updating the swap execution facility ("SEF") regulatory regime, approved new exemptions from the trade execution requirement, and withdrew an unadopted proposal due to marketplace concern over anticipated operational challenges and high compliance costs.

The adopting releases stem from a 2018 proposal. (A Cadwalader Memorandum relating to that proposal is available here.) In the third action, the CFTC withdrew the portions of the proposal that were not adopted.

Audit Trail, Financial Resources and CCO Requirements

The CFTC approved a final rule to resolve operational issues faced by SEFs and their market participants in relation to audit trail data, financial resources and chief compliance officer ("CCO") requirements.

The final rule updates the SEF regulatory framework in a number of ways, including:

  • Audit Trail Data. The final rule removes the requirement for an SEF to record and maintain post-execution allocation information in its audit trail data.
  • Financial Resources. The final rule imposes existing requirements outlined in Core Principle 13 under Section 5h of the CEA in a less stringent manner by, among other things, (i) amending the six-month liquidity requirement and (ii) adding new practices that provide further guidance for SEFs regarding reasonable calculations of projected operating costs.
  • CCOs. The final rule (i) centralizes CCO position requirements, (ii) enables SEF management to exercise its own judgment with regard to CCO oversight and (iii) simplifies annual compliance report preparation and submission requirements.

The final rule will go into effect 30 days after its publication in the Federal Register.

CFTC Commissioner Rostin Behnam said the final rule provided "precise and targeted" updates to the SEF regulatory regime that promote liquidity, "pre-trade price transparency and competition" in the derivatives markets in a manner consistent with the CFTC's core principles. CFTC Commissioner Dawn Stump called the amendments "common-sense" and based on experience in SEF regulation implementation rather than "drawing assumptions based on unknowns." CFTC Commissioner Dan Berkovitz expressed his view that despite the SEF CCO requirements diverging from those imposed on futures commission merchants and swap dealers, standardization may not always be "necessary or appropriate," given that SEFs play a different role in the swaps markets.

Exemptions from Swap Trade Execution Requirement

The CFTC also approved two new exemptions from the trade execution requirement. The first exemption pertains to swaps that both qualify for and meet the related requirements of any Part 50 exemption or exception. The second exemption codifies previously provided no-action relief under CFTC Letters 17-67, 16-80, 15-62, 14-136 and 14-26, and is applicable to cleared swaps that are entered into by certain eligible affiliate counterparties, irrespective of the affiliates' eligibility for the CFTC Rule 50.52 inter-affiliate clearing exemption.

The final rule goes into effect 30 days after its publication in the Federal Register.

Mr. Behnam praised the adoption of the final rule as being the result of careful evaluation and the consideration of concerns of overbreadth in the rule's original proposal. Ms. Stump stated that the final rule's exemptions are (i) consistent with the Congressional intent of Dodd-Frank's trade execution and clearing provisions, and (ii) advance Dodd-Frank's objective of promoting the central clearing of swaps. Mr. Berkovitz stated that the exemptions are (i) "consistent with the relevant sections of the CEA," and prudent, given that "neither market transparency nor price discovery would be enhanced by including [exempted transactions] within the trade execution mandate."

Withdrawal of Unadopted Proposals in 2018 SEF Proposed Rule

The CFTC voted to withdraw the unadopted portions of its November 2018 Swap Execution Facilities and Trade Execution Requirement proposal (the "2018 proposal"). In the withdrawal, the CFTC stated that it determined the withdrawal of the unadopted portions of the 2018 proposal to be necessary as a result of the "overwhelming" concern expressed by commenters regarding the operational challenges and compliance costs the unadopted portions would impose on market participants.

The unadopted provisions of the 2018 proposal include, among other things:

  • an SEF registration requirement for interdealer brokers and aggregators of single-dealer platforms;
  • an increased scope of the trade execution requirement, subject to certain exceptions;
  • disclosure-based trading and execution rules that would apply to all SEF execution methods; and
  • a limitation on the breadth of trading-related communications allowed for SEF participants while they are away from the trading system or platform.

The withdrawal is effective on the date of its publication in the Federal Register.

CFTC Chair Heath Tarbert stated that public comments on the original 2018 proposal indicated that it is appropriate to put significantly more work into a re-proposal of the rules before moving forward on the unadopted portions of the proposal. Ms. Stump also supported the withdrawal. Mr. Berkovitz said the withdrawal, in conjunction with targeted adjustments to the CFTC's SEF rules, enables the CFTC to retain the progress it has made in "moving standardized swaps onto electronic trading platforms, which has enhanced the stability, transparency, and competitiveness of our swaps markets."

Mr. Behnam supported the action because the CFTC approved several provisions of the original proposal. He said the "withdrawal" was an "affirmation of the success of the existing SEF framework and the careful process to markedly improve the SEF framework in a measured and thoughtful way."

Commentary

The CFTC actions are a bit of a rebuke to what was a key priority for former Chair J. Christopher Giancarlo. Mr. Giancarlo made SEF reform a priority even before he led the agency in 2017. (He issued a thoughtful white paper in 2015 on reform of swaps trading rules.) The 2018 proposal was a somewhat dramatic rethinking of the existing SEF trading scheme and inspired a great deal of industry comment. In the withdrawal notice, the CFTC indicated that its preference is to take "targeted rulemakings that address distinct issues" rather than to impose a broader rethink of the trading regime as originally implemented. As Mr. Behnam and Mr. Quintenz indicate (though from different perspectives), the withdrawal is a somewhat dramatic step, and perhaps underscores the depth of industry concerns with the proposal. Nevertheless, as Mr. Quintenz points out, it is unfortunate that many good ideas found in the 2018 proposal have been left on the cutting room floor.

Primary Sources

  1. CFTC Voting Draft: Swap Execution Facilities ("Audit Trail, Financial Resources and CCO Requirements")
  2. CFTC Voting Draft: Final Rule - Exemptions from Swap Trade Execution Requirement
  3. CFTC Voting Draft: Withdrawal of Unadopted Proposals in the 2018 SEF Proposed Rule - Swap Execution Facilities and Trade Execution Requirement
  4. CFTC Press Release: CFTC Unanimously Approves Final Rules Related to SEFs and Withdraws Unadopted Proposals
  5. CFTC Statement, Rostin Behnam: Concurring Statement regarding Swap Execution Facilities and Trade Execution Requirement
  6. CFTC Statement, Dawn D. Stump: Statement in Support of Final Rules Related to SEFs and Trade Execution Requirement
  7. CFTC Statement, Dan M. Berkovitz: Statement on Targeted Changes to Swap Execution Facility Requirements and Withdrawal of Remaining SEF Proposed Rules
  8. CFTC Statement, Brian D. Quintenz: Statement regarding Withdrawal of Unadopted Provisions of the 2018 SEF Proposal
  9. CFTC Statement, Heath P. Tarbert: Statement in Support of the Withdrawal of the Remaining Portions of the November 2018 SEF Proposal

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