Markets Assess Swap Trading Rules

Terry Flanagan

CFTC would assign responsibility to SEFs and DCMs for determining if swap is available to trade.

Market participants are weighing a proposed rule by the Commodity Futures Trading Commission that delegates to swap execution facilities and designated contract markets the responsibility for determining whether a particular swap is deemed as “available to trade.”

The proposal provides that DCMs and SEFs, rather than the CFTC, will make the determination of when a swap has been made available to trade by considering seven enumerated factors, or any other factor that the DCM or SEF may view as relevant. The DCM or SEF may base its determination on any combination of the factors, or on a single factor.

Once such a determination is final, all other DCMs and SEFs are obligated to determine whether they list or offer the same, or an economically equivalent swap, and if so, they must treat the swap or economically equivalent swap as having been made available to trade.

There is a fundamental split among the commenters, with some preferring a determination by the Commission itself, and others preferring that the regulated execution facilities make this determination.

Commenters who support a Commission determination have suggested that the regulated facility could have incentives to prematurely make certain swaps available to trade in order to mandate trading in these instruments on their platforms.

The theoretical concerns that have been raised about the incentives that this might create for a SEF or DCM could be addressed through modification by the CFTC of its Part 40 procedures to allow for special timeframes concerning these categories of filings.

For example, an SEF or DCM could be required to have listed a particular swap for a minimum of three to six months before designating it as available to trade.

Many in the derivatives industry have recommended that the process for determining when a swap is available to trade should include greater CFTC involvement, because once the Commission mandates that a swap must be cleared, then that swap can only be traded on an exchange or an SEF.

“It’s up to the CFTC to determine that a two-year interest-rate swap is available to trade,” an executive at a major inter-dealer broker told Markets Media.

All over-the-counter (OTC) participants would have to determine whether a swap they trade or would like to trade is the same or economically equivalent because, if the Commission has determined that the swap must be cleared, OTC trading must cease, said Commissioner Jill Sommers, in a dissenting statement.

The definition of “economically equivalent” set forth in the proposal is also problematic. It directs DCMs and SEFs to determine whether a swap is economically equivalent with another swap after considering each swap’s “material pricing terms.”

The proposal, in effect, would delegate implementation of the trade execution requirement of the Dodd-Frank Act to DCMs and SEFs.

The CFTC views the proposed procedure as a balanced approach, whereby a DCM or SEF—the facilities that may be most familiar with the trading of these swaps—has responsibility to make a swap available to trade, and that the procedure is responsive to comments that the CFTC be involved in the process.

Under the proposed rule, an SEF or DCM would take the following factors into account in determining whether to make a swap available for trading: whether there are ready and willing buyers and sellers; the frequency or size of transactions; trading volume; number and types of market participants; bid/ask spread; number of resting bids and offers; and whether a SEF’s or DCM’s trading platform will support trading in the swap.

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