Designated Contract Market Regulation - Comment Letters

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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

The Commodity Futures Trading Commission (CFTC) approved a proposal for new and revised rules, guidance and acceptable practices governing the designation and operation of designated contract markets (DCMs) at its December 1, 2010 meeting.[1]

On the last day of the comment period, February 22, the commission received comment letters from eleven exchanges, fund managers, and market participants' groups, most in opposition to the DCM proposal, specifically its proposal of on-exchange volume minimums, the so-called "85 percent rule."[2] The comment letters and summaries can be found below.

CME Group - February 22, 2011

Core Principles and Other Requirements of Designated Contract Markets
February 22, 2011

CME Group strongly disagreed with several provisions in the rule including:

  • "Its proposed rule under Core Principle 9 for DCMs – Execution of Transactions, which states that a DCM ―shall provide a competitive, open and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the centralized market."
  • "The 85 percent centralized market trading requirement is completely arbitrary. The Commission justifies the requirement only with its observations as to percentages of various contracts traded on various exchanges it provides no support for a position that the 85 percent Requirement provides or is necessary to provide a ―competitive, open, and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the centralized market of the board of trade."
  • "Further, imposition of the proposed 85 percent exchange trading requirement will have extremely negative effects on the industry. The 85 percent requirement will significantly deter the development of new products by existing exchanges like CME Group, and likewise deter any new futures exchanges from being established."
  • "Given the scope and highly prescriptive nature of the proposed new regulations and their impact on existing DCMs, CME Group believes that 60 days is a patently unreasonable timeframe in which to expect that DCMs will have implemented the necessary strategic, operational, system and rule changes that would be required in order for such a certification to be made to the Commission - assuming such certification could be made at all given the sweeping and absolute language contained in certain of the new prescriptive regulations."
  • "These proposed rules greatly and unnecessarily increase the documentation burden associated with this submission process, and it seems inevitable that they will greatly slow the process of new rule and product introduction."
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Green Exchange - February 22, 2011

Core Principles and Other Requirements of Designated Contract Markets
February 22, 2011

From the comment letter:

"GreenX generally supports the Commission’s efforts to 'codify certain requirements and practices,' but in many instances, what may be a best practice for one DCM, 'may not necessarily be a best practice for all DCMs, particularly for newly formed DCMs that have fewer resources, and operate in new markets, with less trading volume than long-established DCMs.'

"GreenX is concerned that the Commission’s departure from principles-based regulation to a 'one size fits all' approach to regulation will stifle innovation and competition. Potential entrants will be discouraged from entering the market as DCMs because the initial start-up costs will be tremendous, the ability to continue with anticipated products uncertain, and competing in the market as a DCM, with a slim chance of success in the best of circumstances, will be too difficult."

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Black Rock - February 22, 2011

Core Principles and Other Requirements of Designated Contract Markets
February 22, 2011

While Black Rock supports the objectives of the Dodd-Frank Act, it does not support Core Principle 9 (CP9), which imposes restrictions on trades conducted outside the centralized market, including block trades. Black Rock's concerns are threefold:

  • Buy-side participants often rely on block trades as the "best means to execute transactions," And CP9 amounts to an "artificial restriction."
  • CP9, as written, is ambiguously written, as it is uncertain whether the limits are based upon number of transactions, number of contracts, or the notional value of contracts.
  • Black Rock suggests lowering the "85% Regulation" threshold should be lowered to 75%.
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ELX Futures - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

From the comment letter:

"As a recently formed exchange, and one competing directly with the dominant CME Group, ELX is concerned that the proposed board composition standards will adversely affect ELX by making open access, third party clearinghouses (DCOs) reluctant to offer these necessary services to independent DCMs like ELX.

"Open access DCOs should be given strong consideration in the waiver process to avoid unnecessary intrusions into their governance structure, which is already well-regulated."

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OneChicago - February 22, 2011

Core Principles and Other Requirements of Designated Contract Markets
February 22, 2011

From the comment letter:

"None of the provisions regarding SFP have been amended, renumbered or repealed by Dodd-Frank, yet the CFTC has apparently decided unilaterally to adjust certain important regulations that impact security futures products. We believe that only Congress, and not the CFTC, has that authority."

Regarding Core Principle 9 (CP9), OneChicago argues that security futures products (SFPs)should be treated in a different manner than other future products, because "price discovery does not happen in the security futures price market, price discovery happens in the deep, liquid organized cash market for the underlying equity." Furthermore, SFP margins and deliveries differ significantly from other futures products.

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Minneapolis Grain Exchange - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

From the comment letter:

"...it appears the CFTC has liberally exercised the discretion it has been given under the Dodd-Frank Act to undertake a comprehensive evaluation of its existing regulations, guidance and acceptable practices associated with each of the core principles in order to update those provisions and to determine which core principles would benefit from new or revised regulations and new or revised guidance or accepted practices.

"In a time where budget constraints run across the board – from the public sector such as the CFTC to the private sector, additional burdens and costs such as many of the provisions of this proposed rulemaking may cause are premature at best."

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Intercontinental Exchange - February 22, 2011

Core Principles and Other Requirements of Designated Contract Markets
February 22, 2011

In the letter, Intercontinental Exchange, Inc. offers specific recommendations to the CFTC regarding the DCMs:

  • Adopt a less restrictive approach to implementing Core Principle 9’s centralized trading requirements;
  • Have different centralized trading requirements for liquid front months versus less liquid distant months;
  • Clarify that Requests for Cross meet the centralized trading requirement;
  • Adopt a less prescriptive approach to the pricing of block trades between affiliated parties and the timing of reporting block trades; Not adopt requirements on the pricing and time of reporting for exchanges of derivatives for related positions;
  • Allow the execution methods for swaps listed on a DCM to be similar to those available on a swaps execution facility (“SEF”);
  • Not require the real-time monitoring of intraday position limit rules by DCMs until the technology is readily available;
  • Allow DCMs to rely on clearing member guarantees when complying with financial integrity standards; and
  • Allow DCMs to distinguish between traders with intermediated access and direct access when adopting rules to comply with Core Principle 2.
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Eris Exchange - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

Eris exchange has raised "serious concerns" regarding the rigidity of certain CFTC proposals. Eris is especially critical of the 85 percent Centralized Market Requirement, calling it "crude," "misguided," and "not flexible," and suggests it will stifle innovation.

Eris is also critical of the block trade restrictions in Core Principle 9 (CP9), suggesting that it will impede price discovery.

Finally, Eris proposes implementation of three principles in order to strike a balance between transparency and anonymity:

  • publishing real-time intraday trade prices for par swaps at standard maturities;
  • publishing open-interest grouped in maturity buckets; and
  • publishing a transparent settlement curve from the clearing house, as well as specific settlement values applied to each cleared swap.
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Better Markets - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

In this comment letter, Better Markets, Inc. criticizes high frequency traders, and highlights some of their abusive tactics, such as "poking," "pinging," "jumping the queue," "rebate harvesting," and "price spraying." It suggests requirements such as risk controls, publication of market data, automated trade surveillance, and real-time market monitoring, in order to maintain fairness and transparency in the market.

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Kansas City Board of Trade - February 22, 2011

Core Principles and Other Requirements of Designated Contract Markets
February 22, 2011

From the comment letter:

"We are concerned and disappointed that the CFTC is apparently using the Dodd-Frank legislation to not only implement a regulatory regime for previously unregulated OTC trading, but as an opportunity to propose unnecessary and extremely prescriptive regulations on already regulated derivative markets. The regulated markets were not the cause of the 2008 financial crisis. In fact, these regulated markets operated exemplary under extreme market volatility and pressures. We are left wondering why, with all of the regulatory initiatives required to implement the provisions of Dodd-Frank, does the CFTC find it necessary to impose prescriptive regulations on an already well-functioning regulated marketplace. This abrupt shift away from principles-based to prescriptive regulation will not serve the industry in competing globally for market share and liquidity and could impact jobs and growth going forward."

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CBOE Futures Exchange - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

CBOE Futures Exchange (CFE) offers its own set of principles in the letter:

  • DCMs should be permitted to offer trading in swaps in the same manner that SEFs may do so.
  • The CFTC should define the term "market participant" as a non-member with the ability to enter orders directly into a DCMs trade matching system.
  • A DCM should be permitted to have fee differentiation based on factors other than cost.
  • DCMs should be allowed to determine which risk controls are appropriate depending upon the nature of the particular product.
  • If a minimum centralized market trading requirement is retained, it should be based on number of trades instead of volume and average order size in comparison to average block trade size.
  • The CFTC should lengthen the timeframe for DCM compliance to more than the proposed 60 days.
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Nodal Exchange - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

From the comment letter:

"Nodal Exchange notes that Commission staff recognizes that certain newly-listed contracts may fail to meet the minimum on-exchange threshold; however, the proposed rules specifically require such contracts to have achieved an average of at least 50% trading volume over the previous 12months with the likelihood of attaining the 85% minimum on-exchange trading threshold within the following 12months. The purpose of these blunt thresholds is unproven and does not accommodate for the unique qualities of commodity markets like power that have been evolving over the past decade, not just 12 months. Setting any threshold discourages the formation of new DCMs."

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NYSE Liffe - February 22, 2011

Core Principles and Other Requirements for Designated Contract Markets
February 22, 2011

From the comment letter:

"In proposing regulations for Core Principle 9, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act ('Dodd-Frank'), the Commission proposes to require the delisting of a contract that fails to maintain an average trading volume through the centralized market of at least 85%. The Commission indicates that this requirement is necessary to protect the price discovery function in the centralized market, but fails to explain how the requirement accomplishes this. As we will discuss in detail below, it is the Exchange’s contention that a one-size-fits-all approach to the protection of price discovery is unworkable and ignores the reality that the price discovery function of a market is but one of many factors that bear consideration, all of which should be appropriately balanced against each other on a market-by-market basis to ensure a beneficial and healthy market. Only in cases where a particular market is deemed to serve a primary price discovery function should such market be subject to a more stringent standard under Core Principle 9, but such standard should be based on a sliding scale that considers its relative dominance as measured by several factors, including trading volume and open interest. In addition, we do not find persuasive the analysis offered by the Commission in support of its numerical threshold approach and we have a number of concerns regarding the severe adverse affects any numerical threshold could have on competition and innovation."

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References

  1. Open Meeting on Sixth Series of Proposed Rules under the Dodd-Frank Act. CFTC. Retrieved on February 16, 2011.
  2. U.S. exchanges cry foul over "arbitrary" CFTC rule. Reuters. Retrieved on February 23, 2011.

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