Designated Contract Market Regulation

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Gavel.png FINAL RULE: Designated Contract Market Core Principles approved at CFTC Open Meeting, May 10, 2012.
Dodd-Frank Timeline, Core Principles and Other Requirements for Designated Contract Markets
Final Rule Issue Effective Date Compliance Date
June 19, 2012 August 20, 2012 October 17, 2012
Timeline, Made Available to Trade Provisions
Final Rule Issue First MAT Determination First Compliance Date
June 4, 2013 January 16, 2014 February 15, 2014

At an open meeting on May 10, 2012, the CFTC finalized rules, guidance and acceptable practices under Dodd-Frank Act that, among other things, amend Section 5 of the Commodity Exchange Act ("CEA") concerning designation and operation of contract markets, and add a new CEA Section 2(h)(8) to include the listing, trading and execution of swaps on designated contract markets. The rules were originally proposed on December 1, 2010. [1]

DCM Core Principles

The final rules incorporate the new and amended rules, guidance, acceptable practices, and 23 core principles. They also incorporate the trading and execution of swaps on DCMs. The core principles fall under five general guidelines:

  • Financial information and resource requirements;
  • Compliance obligations;
  • Operational capabilities;
  • Surveillance obligations; and
  • Trading and products requirements.[2]

A DCM may also elect to become a swap execution facility, a new type of entity created in the aftermath of the Dodd-Frank Act, for the "listing, trading, and processing of swaps." If a DCM operates as an SEF, it must register separately as an SEF, and, if the same platform will be shared by both the DCM and SEF, it must notify customers which entity (the DCM or SEF) is clearing the swap. The DCM is expected to monitor its markets in real-time, enact and enforce rules to support compliance, as well as enforce additional rules and regulations pursuant to the Dodd-Frank Act.[3] At subsequent open meetings, the CFTC introduced additional rule proposals regarding all "swap entities" - designated contract markets (DCMs), swap execution facilities (SEFs), and derivatives clearing organizations (DCOs).

The final rules also included several new requirements for DCMs (released in Q&A format by the CFTC on May 10, 2012):

  • "The rules eliminate the ninety-day accelerated approval procedures for DCM applications and require that all applications for designation as a contract market be reviewed within 180 days, as required under the CEA.
  • To streamline the application process, the rulemaking includes, under Part 38, a new DCM application form with a comprehensive list of instructions and documents that must accompany applications for designation as a contract market.
  • To prevent market disruption, the rules require that DCMs implement trade risk control mechanisms, including pauses and halts to trading, under certain conditions.
  • The rules require DCMs to meet specified financial resource requirements.
  • The rules require DCMs to establish operational and system safeguard requirements.
  • The rules describe specific requirements for DCMs that list swaps, including reporting and recordkeeping requirements."[4]

Core Principle Nine

The final rule does not yet finalize a proposed provision that would require either the delisting or "reclassification" of any contract in which less than 85 percent of its volume occurs on a central order book. According to the commission, the rule is designed to "protect the price discovery process." On the last day of the comment period, Feb. 22, 2011 the commission received comment letters from 11 exchanges, fund managers, and market participants' groups, most in opposition to the DCM proposal, specifically its proposal of on-exchange volume minimums, or so-called "85 percent Rule." [5]

The proposed rule became more controversial on Oct. 18, 2011, when the commission approved its final rules on derivatives clearing organizations. In the DCO rules, margin collateralization requirements will be higher than those for futures contracts. Since, according to DCM Core Principle Nine, contracts not meeting the 85/15 percent threshold would need to delist or reclassify as swaps, the rule carries "hidden costs."[6]

CFTC Roundtable on Core Principle 9

On June 5, 2012, the CFTC held a public roundtable to discuss the implementation of Core Principle 9.[7] The roundtable consisted of three panels covering these issues:

  • Proposed minimum centralized market trading requirement;
  • Proposed requirements for exchange of derivatives for related position transactions; and
  • Proposed requirements for reporting block transactions (futures contracts).

To view the press release click HERE.

At the June 5, 2012 roundtable, several exchange representatives expressed concerns over the 85% Rule. There was concern that implementation of the rule would discourage innovation and prohibit the launch of certain types of futures contracts. Also, it was noted that differing margin requirements, tax treatment, and documentation requirements for swaps versus futures would be present further challenges if the rule were implemented.

The CFTC will consider a final rule on Core Principle 9 on December 10, 2013.

Swaps "Made Available to Trade"

Among the provisions of the Dodd-Frank Act is a requirement that any swap "made available for trading" must trade on a DCM or swap execution facility (SEF). Subsequent to the proposal, market participants have requested a clarification of the requirements of SEFs and DCMs. On December 5, 2011 open meeting, the commission submitted a proposed rulemaking regarding the definition of "made available to trade (MATT)." Details of this proposal can be found HERE. Comment letters on this proposal can be found HERE.

References

  1. Open Meeting on Sixth Series of Proposed Rules under the Dodd-Frank Act. CFTC. Retrieved on February 16, 2011.
  2. Fact Sheet: Final Rulemaking Regarding Core Principles and Other Requirements for Designated Contract Markets (PDF). CFTC. Retrieved on May 10, 2012.
  3. SEC Proposes Rules for Security-Based Swap Execution Facilities. U.S. Securities and Exchange Commission. Retrieved on February 4, 2011.
  4. Q & A – Core Principles and Other Requirements for Designated Contract Markets (PDF). CFTC. Retrieved on May 10, 2012.
  5. U.S. exchanges cry foul over "arbitrary" CFTC rule. Reuters. Retrieved on February 23, 2011.
  6. Statement of Dissent, Final Rulemaking On Derivatives Clearing Organizations, Commissioner Scott D. O'Malia. CFTC. Retrieved on October 18, 2011.
  7. US CFTC to hold roundtables on Volcker, 85/15 rules. Platts. Retrieved on May 30, 2012.

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