CME v. CFTC – A Regulator’s Conundrum
By Neal L. Wolkoff, Richardson & Patel LLP
Neal Wolkoff is Of Counsel at New York law firm Richardson & Patel LLP, where he specializes in Dodd-Frank preparedness and other regulatory issues affecting the financial sector. He is a veteran exchange executive, having previously served as CEO of ELX Futures and the American Stock Exchange (AMEX), and as chief operating officer of NYMEX. His commentary appears frequently in MarketsReformWiki and the John Lothian Newsletter.
|Neal L. Wolkoff
|| Of Counsel
|| Richardson & Patel, LLP
|| New York, NY
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Note: Subsequent to this article's publication, the CFTC approved CME Group's application for provisional registration as a swap data repository.
The Commodity Futures Trading Commission faces a conundrum that impedes its ability to create an efficient and cost effective solution to establish a comprehensive data-set of interest rate swaps. The lawsuit that CME has recently brought against the CFTC highlights the issues facing a regulator to implement an often poorly drafted statute. It also highlights the disruption to the existing futures industry as it seeks to enter and compete in the swap market. Before describing the Catch 22, a review of the issues in CME v. CFTC is useful.
The Commission has determined that CME, as a registered Derivatives Clearing Organization, or “DCO,” is obligated to report all swap data, including proprietary customer information, to a third party Swap Data Repository, or “SDR,” most likely the DTCC. Of all the parties to compel the CME to report to, DTCC is among the most sensitive competitive possibilities as DTCC currently competes directly with the CME on interest rate futures clearing.
The CFTC is preparing to oversee a newly regulated world of swap transactions for which it has little technical infrastructure already established. In theory, having all swap data aggregated through a single SDR could alleviate the cost, development effort, and “time to market” for the Commission to employ a system to aggregate data across many SDRs and DCOs in order to view the positions and exposures of swap entities in a single location and format.
Section 20a(c)(4)(a) of the Commodity Exchange Act (Act) , 7 USC § 24a (c)(4)(a) - Swap Data Repositories - explicitly allows the Commission the power to require SDRs to send swap data, including proprietary data, to a central SDR:
“A swap data repository shall—
(4) (A) provide direct electronic access to the Commission (or any designee of the Commission, including another registered entity);”
In governing the data requirements of SDRs, Section 20a of the Act broadly empowers the Commission to establish data standards for SDRs’ public price and transaction dissemination as well as for collection and retrieval of proprietary data.
CME is contesting the Commission’s authority to require it as a DCO to follow the Commission’s directives. The suit makes two main claims:
- the Commission’s regulation requiring CME to report non-public swap data to an SDR violates the Commodity Exchange Act by requiring a DCO to perform actions that are outside the statute’s allowable area of regulatory authority; and
- the Commission failed to perform a sufficient cost-benefit analysis even if the regulation is otherwise permissible.
The CME’s Complaint highlights the various and clear distinctions in the CEA governing the duties of a DCO with respect to sharing transaction data for cleared swaps with SDRs. Specifically, the CME draws a bright line between providing price and basic reporting information to an SDR for contemporaneous public reporting (a market data function) versus providing detailed information of proprietary client information, such as name, counterparty, clearing firm, account designation, etc. As paragraph 70 of the Complaint states,
“CEA Section 5b(k) unambiguously requires DCOs to make nonpublic regulatory reporting of cleared swap data available to the CFTC. Section 5b(k) does not mention SDRs.”
As the CME points out in its Complaint, it has outstanding with the Commission an application to be designated as an SDR. However, the Commission has not approved the CME’s application, and has so far indicated that without changes to the CME’s proposed operating rules as an SDR it is not inclined to give its approval.
It appears that the Commission’s most straightforward solution to the claims leveled in the lawsuit would be to grant the CME its application to be an SDR, and then use the powers given to the Commission under Section 20a a(c)(4)(a) of the Act to require the CME as an SDR, and not as a DCO, to report swap data to a designee. In the case of interest rate swaps presumably that designee would be the DTCC. Of course, even if CME were designated as an SDR it might still litigate to avoid sharing proprietary information with a competitor.
However, litigating as an SDR, and not as a DCO, would appear to considerably weaken the CME’s arguments. First, Dodd-Frank grants the Commission clear statutory authority to require “SDR to SDR” reporting, but does not grant the CFTC specific authority to require “DCO to SDR” reporting of proprietary swap data. The CME’s “cost-benefit” argument would also be weaker. Unlike the recent federal court ruling against the Commission (ISDA v. CFTC) on position limits - where the court found an unambiguous requirement in Dodd-Frank to justify the imposition of position limit regulations on hard data - in this instance, Dodd-Frank does not appear to make a similar fact-finding condition a prerequisite of regulation. In addition, the Commission presumably could make a clear showing of the heavy impact on its own costs, as well as causing delay to implement a core statutory purpose of Dodd-Frank, should it not designate interest rate swap reporting to a central depository.
The CME’s lawsuit describes a standoff between it and the CFTC over the issue of the Commission’s view of the competitive requirements of Dodd-Frank as they pertain to the CME’s application for designation. According to the CME’s Complaint:
“57. The FAQ also makes clear that a DCO cannot require, through agreement or otherwise, market participants to select the DCO’s SDR or an affiliated SDR: “Market participants may choose to use a...DCO’s SDR for reporting swap transactions, but a... DCO as part of its offering of trading or clearing services cannot require that market participants use its affiliated or ‘captive’ SDR for reporting.”
"58. CFTC staff has taken the position that CME must amend its SDR application to show compliance with the FAQ before staff will recommend approving the application."
This piece is not intending to pass judgment on the merits of the Commission’s position with respect to the CME’s application to be an SDR. However, while Dodd-Frank requires the Commission to take steps to not promote anti-competitive conduct, the statute also circumscribes the authority of the Commission to compel sharing of proprietary swap data other than between registered SDRs.
The Commission’s Catch 22, it appears, is to approve the CME’s SDR application, notwithstanding its competitiveness issues (which of course might prompt other lawsuits from other parties), or to limit its ability to create an efficient, cost-effective mechanism to centralize interest rate swap data – which is critical to the success of its Dodd-Frank mandate to understand, monitor and regulate swap exposure.
Will the CME amend its SDR application to satisfy the Commission’s concerns while its lawsuit is pending and likely to be successful? Will the CFTC justify approving an SDR application that it believes is problematic in order to quickly get the technology solution to implement a rational method of interest rate swap data collection?
As I said: a conundrum.
Also by Neal Wolkoff