Swap Execution Facilities Regulation
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FINAL RULES: On May 16, 2013, the CFTC approved several final rules affecting SEFs: |
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Final Rule Issue | Effective Date | Compliance Date |
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June 4, 2013 | August 5, 2013 | October 2, 2013 (one-year phase-in of RFQ minimum); Also see No-action relief note |
Proposal Date | Final Rule Issue | Effective Date |
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February 23, 2012 | May 31, 2013 | July 20, 2013 |
Final Rule Issue | First MAT Determination | First Compliance Date |
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June 4, 2013 | January 16, 2014 | February 15, 2014 |
Proposal Date | Final Rule Issue - Clearing | Final Rule Issue - Execution | Effective Date - Execution |
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September 20, 2011 | July 30, 2012 | June 4, 2013 | September 28, 2012 |
Proposal Date | Comment Deadline | Final Rule Issue |
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January 6, 2011 | June 3, 2011 | TBA |
Proposal Date | Comment Deadline | Reopened Comment Period Deadline |
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February 28, 2011 | April 4, 2011 | July 22, 2013 |
Swap execution facilities (SEFs) were given life by the Dodd-Frank Act, which requires over-the counter (OTC) swaps to be cleared and traded on this new type of regulated platform. Any swap that is "made available to trade" must trade on designated contract market or a SEF. The CFTC has been given the responsibility to monitor swap execution facilities; the SEC has jurisdiction over security-based SEFs.
The CFTC finalized several execution rules at its May 16, 2013 open meeting, including SEF Core Principles, the "made available to trade" provision and block trade rules.
Click to View All "Made Available to Trade" Determinations | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Swaps Made Available to Trade
The CFTC made its first determinations on January 16, 2014, making February 15, 2014 the date at which the first swaps will be subject to the execution requirements. Subsequent determinations were made on January 26 and 28. For more information on rulemakings related to swap execution facilities, click here.
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Contents
No-Action/Guidance/Update[edit]
On November 14, 2013, the CFTC issued guidance addressing "impartial access" requirements and swaps intended to be cleared ("ITBC") swaps. View Letter. Also on November 14, the commission issued an advisory on the applicability of transaction-level requirements for non-U.S. persons. View Letter On January 8, 2014, the commission put out a request for public comment on this staff advisory. The deadline for public comment was March 10, 2014.
On February 10, 2014, the commission issued no-action relief from the mandatory execution requirement for swaps that are part of a "package transaction" - transactions involving more than one swap or financial instrument (often referred to as “component legs”) and at least one swap subject to the trade execution requirement. The letter offers relief until May 15, 2014. View Letter.
Also on February 10, 2014, the commission issued guidance clarifying and easing the process by which parties trading on a SEF consent to its jurisdiction. Such consent need not be affirmed in writing. View Guidance. Finally, the commission issued an interim final rule clarifying that swap transaction entered into anonymously will remain anonymous to the other counterparty, and may not be accessed through the swap data repository.<ref>CFTC Announces Measures to Promote Trading on Swap Execution Facilities and Support an Orderly Transition to Mandatory Trading. CFTC. Retrieved on February 11, 2014.</ref>
On May 1, 2014, the commission further implemented the trade execution mandate by publishing a phased implementation timeline for swaps that are part of a "package transaction." View Letter
On August 19, 2014, the CFTC issued no-action relief until September 30, 2015, from data reporting and recordkeeping requirements in relation to confirmations required for uncleared swap transactions executed on a SEF.<ref>Swap Execution Facilities. Federal Register. Retrieved on January 18, 2011.</ref>
On November 2, 2015, the CFTC issued no-action relief for SEFs from certain block trade requirements. The relief is extended until November 15, 2016. Vie Letter.
Package Transactions Update[edit]
In November 2014, the CFTC updated its compliance dates for a number of package transactions. At issue are three requirements related to the execution rules:
- Trade execution: Any swap that is made available to trade must trade on a designated contract market (DCM) or a swap execution facility (SEF)
- Method of execution: A DCM or SEF is permitted to offer any method of execution for the swap components
- Order book minimum functionality: a trading system or platform in which all market participants can enter multiple bids and offers, observe bids and offers entered by other market participants, and transact on such bids and offers.
Click to View Implementation Timeline for Package Transactions | |||
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Package Transaction Components | Date of Relief Expiration' | ||
All components MAT | May 15, 2014 | ||
At least one leg MAT; others subject to mandatory clearing | June 1, 2014 | ||
Swap components MAT; other components are U.S. Treasury securities | June 15, 2014 | ||
Swap components MAT; other components are agency mortgage-backed securities | May 15, 2015 for trade execution requirement and method of execution | ||
At least one leg is MAT and at least one leg is not subject to mandatory clearing
(such as a MAT swap vs. a swaption or uncleared CDS) |
Feb 15, 2015 for trade execution requirement and Feb 12, 2016 for method of execution and order book trading functionality requirements | ||
At least one leg is MAT and at least one leg is "not a swap" OR at least one leg is not under CFTC jurisdiction
(such as a MAT swap vs. a single name CDS or cash bond on the secondary market) |
Feb 15, 2015 for trade execution requirement and Feb 12, 2016 for method of execution and order book trading functionality requirements | ||
At least one leg is MAT and at least one leg is not under exclusive CFTC jurisdiction (such as a "mixed swap")
(such as a MAT swap vs. a single name CDS or cash bond on the secondary market) |
Feb 15, 2015 for trade execution requirement and Feb 12, 2016 for method of execution and order book trading functionality requirements | ||
At least one leg is MAT and at least one leg is a bond issued in the primary market ("newly issued")
(such as a MAT swap vs. a single name CDS or cash bond on the secondary market) |
Feb 15, 2015 and Feb 12, 2016 for trade execution, method of execution and order book trading functionality requirements | ||
At least one leg is MAT and all other legs are futures contracts
(such as a MAT swap vs. a single name CDS or cash bond on the secondary market) |
November 14, 2015 for trade execution, method of execution and order book trading functionality requirements |
Background[edit]
The CFTC has proposed, and in many cases finalized, new rules, guidance and acceptable practices to implement the new Section 5h to the Commodity Exchange Act (CEA) concerning the registration and operation of SEFs, as well as new Section 2(h)(8) to the CEA concerning the listing, trading and execution of swaps on SEFs. These regulations will require, among other things, that swaps subject to the clearing requirement of Section 2(h)(1) be executed on either designated contract market (DCM) or a Swap Execution Facility, unless no DCM or SEF "made the swap available for trading."<ref>CFTC Staff Issues Time-Limited, Conditional No-Action Relief Regarding Documentation of Confirmations of Uncleared Swap Transactions. CFTC. Retrieved on August 20, 2014.</ref>
Swap Execution Facilities' (SEF) proposed regulation, released on January 7, 2011, was criticized by some in the industry, when the CFTC called for series of responsibilities that essentially would regulate SEFs more tightly than exchanges. Among the proposed rules are items such as: limiting the SEF's ability to outsource trade oversight responsibilities. SEFs are allowed to use a third-party firm to assist with compliance, but it would be held responsible for enforcing trading rules.<ref>CFTC Swap-Trading Rules May Limit Market Entrants, Moody’s Says. Bloomberg. Retrieved on February 3, 2011.</ref>
Rules Pertaining to Multiple Swap Entities[edit]
Additional rules and proposed rulemakings cover multiple swap entities - derivatives clearing organizations (DCOs), SEFs, and designated contract markets (DCMs). These rules can be found here.
John Lothian News Interviews[edit]
At SEFCON IV, held in November 2013, John Lothian News interviewed several participants and put together a three-part series on the state of SEFs.
Open for Business: SEFs Navigate the New Regulatory Environment
Though the final rules are out, the industry is still working on a few lingering issues such as new staff guidance and no-action letters on certain aspects of the rules. Also, as the CFTC begins making classes of swaps “available to trade” and subjecting them to mandatory execution on SEFs, the industry is expected to quickly adjust and comply.
Part two looks at the changes to the overall market structure brought about by new regulation. Though the swap execution facility is a new entity as defined by Dodd-Frank, an ecosystem of platforms and processes for the trading OTC derivatives has been in place for decades. The introduction of new requirements for quoting, clearing and data transmission significantly altered the competitive landscape among inter-dealer brokerage firms (IDBs) and dealer-to-client platforms. Click to view Part II
Part three of the series explores the importance of technology in the rapidly changing SEF landscape. Mandatory execution on SEFs, along with clearing and data mandates, have necessitated a technology transformation in financial markets. While most of the pieces are in place, several questions remain. Click to view Part III
CFTC Rulemakings[edit]
Core Principles and Other Requirements for Swap Execution Facilities
On January 7, 2011, the CFTC offered its proposed rules regarding Swap Execution Facilities. The open period for comment letters ran from from January 7 to March 8, 2011.
At a May 16, 2013 open meeting the CFTC approved a final rule that sets out core principles and other requirements for swap execution facilities. The rule entered the Federal Register on June 4, 2013; its effective date is August 5, 2013. Compliance will be required beginning October 2, 2013, although the rules on requests-for-quotes (RFQs) will be phased in over a one-year period.
Among the provisions of the final rules are 15 core principles covering areas such as:
- Trading and product requirements
- Compliance obligations;
- Surveillance obligations;
- Operational capabilities; and
- Financial information and resource requirements.
Process for a DCM or SEF to Make a Swap Available to Trade
At its December 5, 2011 open meeting, the CFTC approved a proposed rulemaking that would further define the process by which a swap execution facility or designated contract market shall make a swap "available for trade" under Section 2(h)(8) of the Commodity Exchange Act.
On May 16, 2013, the CFTC approved a final rule that sets the process by which a designated contract market or swap execution facility shall make a swap "available to trade." The rule entered the Federal Register on June 4, 2013; its effective date is August 5, 2013.
Under the final rule, a DCM or SEF may submit to the commission a determination that a swap is available to trade, either for approval or under self-certification procedures. The determination should have considered at least one of the following criteria:
- whether there are ready and willing buyers and sellers;
- the frequency or size of transactions;
- the trading volume;
- the number and types of market participants;
- the bid/ask spread; and
- the usual number of resting firm or indicative bids and offers.
Governance Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities
In the Federal Register, Volume 76, No. 5 (Friday, January 7, 2011, the CFTC offered its proposed rules regarding Swap Execution Facilities. The open period for comment letters is from January 6 to March 7, 2011. Specifically, the CFTC requests comments on the following reporting, transparency in decision making, and limitations on use or disclosure of non-public information:
- Each DCO, DCM, or SEF must implement a regulatory program to identify potential conflicts of interest,prescribe limits on the use or disclosure of non-public information,and make certain information on governance arrangements available to the public and relevant authorities, including summaries of significant decisions.
- Each publicly-traded DCM must evaluate the breadth and cultural diversity of its Board of Directors;
- Each DCM must design and institute a process for considering the range of opinions that market participants hold with respect to the functioning of an existing market and new rules or rule amendments.
- Each DCO must have 10 percent customer representation on its Board of Directors, in lieu of having such representation on the RMC (or the RMC Subcommittee). Alternatively, each DCO must have 10 percent customer representation on the RMC (or the RMC Subcommittee), in lieu of having such representation on the DCO Board of Directors.
SEC Rule Proposals[edit]
On Feb. 2, 2011, the Securities and Exchange Commission voted unanimously to propose rules defining security-based swap execution facilities (SEFs) and establishing their registration requirements, as well as their duties and core principles.<ref>SEC Proposes Rules for Security-Based Swap Execution Facilities. U.S. Securities and Exchange Commission. Retrieved on February 4, 2011.</ref>
The Commission's proposed rules:
- Interpret the definition of "security-based SEFs" as set forth in Dodd-Frank.
- Set out the registration requirements for security-based SEFs.
- Implement the 14 core principles for security-based SEFs that the legislation outlined.
- Establish the process for security-based SEFs to file rule changes and new products with the SEC.
- Exempt security-based SEFs from the definition of "exchange" and from most regulation as a broker.
Highlights of the Proposal
- Definition of a security-based swap execution facility (SB-SEF): a system or platform that allows more than one participant to interact with the trading interest of more than one other participant on the system or platform.
- Attributes of a SB-SEF: A limit-order book system; a request-for-quote (RFQ) system; creation and dissemination of composite indicative quotes
- SEF registration requirements:
- File with the Commission proposed changes to its rules as well as the security-based swaps that it intends to trade.
- Have rules to ensure compliance with the core principles outlined in the Dodd-Frank Act.
- Have rules regarding access to, and the financial integrity of transactions on, the security-based SEF.
- Put in place rules governing the procedures for trading on the security-based SEF.
- Ensure the integrity of security-based SEF systems by having policies and procedures reasonably designed to ensure that its systems have adequate levels of capacity, resiliency, and security.
- Make and keep certain books and records.
- Have adequate resources to operate as a security-based SEF.
For a comparison of the SEC and CFTC rule proposals, click HERE.
References[edit]
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