Futures Exchange Applauds CFTC Block Trading Rule

Terry Flanagan

A futures exchange is in favor of rules that would require over-the-counter swaps to be subject to the same requirements as exchange-traded instruments.

In particular, the exchange is applauding a proposed rule by the U.S. Commodity Futures Trading Commission (CFTC) that would prohibit the aggregation of orders for different trading accounts in order to satisfy minimum block size or cap size requirements, unless such aggregation was performed on an exchange or swap execution facility (SEF) by a CFTC-registered commodity trading advisor (CTA).

“We are acutely concerned that OTC swaps, mandated to move to a SEF or exchange, be subject to the same regulatory requirements as single stock futures,” said David Downey, chief executive of OneChicago (OCX), a security futures exchange which provides a marketplace for trading over 2,800 futures in more than 1,500 individual equities and exchange-traded funds.

“Consequently, we encourage the CFTC to continue building a like regulatory environment for swaps. In that vein, we offer the OCX rulebook as a model.”

OCX’s Exchange Future for Physical is the economic equivalent of OTC equity swaps, specifically stock lending and equity repo transactions.

Securities lending and equity repos, which are secured lending of stock for cash or the lending of cash for collateral, are covered by a binding agreement (ISDA agreement), which provides for the terms of the loan.

“It’s critical that equivalent products be treated in an equivalent manner,” said Downey.

If too many trades were permitted to be aggregated and thus executable as blocks, the Dodd-Frank objectives of increased transparency and price discovery for swaps trading could be undermined, according to the CFTC.

By prohibiting aggregation of orders for different accounts to meet the minimum block size requirement, the proposed rule would prevent circumvention of exchange trading and of the real-time reporting obligations associated with non-block transactions.

In the futures market, all block rules approved by the CFTC have included an aggregation prohibition, with the exception of block trades done through CTAs.

In the futures market, where market participants have engaged in block transactions for years, exchanges that permit block trading have rules that prohibit the aggregation of orders for different trading accounts.

New capital requirements under the Basel III accord, a set of global regulatory standards aimed at toughening up bank capital adequacy rules that kick in from the start of next year, have made it more difficult for banks to execute transactions in large blocks because the amount of liquidity that must be maintained to meet regulatory demands has gone up.

“Basel III has resulted in a significant ratcheting up of capital requirements for risk weighted assets, including credit,” said Rick McVey, chief executive of MarketAxess, an electronic bond trading platforms operator, at Markets Media’s recent Summer Trading Network conference in New York. “Block trades as a proportion of total Trace volumes are steadily declining, as dealers trim balance sheets and manage inventory much more actively.”

The concept of aggregation also figured prominently in the CFTC’s final rule on position limits, which requires dealers to aggregate positions in commodities derivatives contracts for the purpose of calculating position limits.

The rule establishes account aggregation standards for positions in reference contracts, i.e., futures and swaps which are economically-equivalent to futures.

For decades, futures commission merchants (FCMs) and FCM affiliates engaging in dealer trading activities on behalf of a common parent have been disaggregated from their “walled off” commonly-owned asset management affiliates for purposes of determining compliance with speculative position limits and reporting requirements.

Dealers say that the rule goes against the grain of historic aggregation policy, and the consequences would be “drastic, severe, and far-reaching”, according to the Futures Industry Association, a trade body, in a comment letter.

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