Packaged Swaps Transactions Create Operational Hurdles

Terry Flanagan

Ahead of a public roundtable to be held on February 12 to discuss the application of the swap trade execution requirement to so-called package transactions, the Commodity Futures Trading Commission has issued a no-action letter providing relief until May 15, 2014 from mandatory trading of certain swaps executed as part of a “package transaction.”

The temporary relief is intended to enable participants to continue their efforts towards compliance with the trade execution requirement and to allow Commission staff to address the issues surrounding package transactions where at least one component is not subject to the trade execution requirement.

In announcing the trade execution requirement for certain interest rate swaps on January 16, 2014, the CFTC clarified that the inclusion of a swap subject to the trade execution requirement in a multi-legged transaction would not per se relieve market participants of the obligation to trade such swap through a DCM or SEF.

The swaps industry is concerned that the methods currently used by clearing members for the pre-trade screening of credit limits may not facilitate screening for package transactions, and further, that derivatives clearing organizations (DCOs) may lack the ability. Similarly, SEFs and DCMs may face particular difficulties in facilitating specific types of package transactions, such as those that involve a swap paired with a U.S. Treasury security.

“Market participants are executing package transactions (one economic transaction) that include multiple OTC interest rate derivatives,” said Sunil Hirani, CEO of trading platform TrueEx, in a presentation. “However, since there is no mechanism in the current market standard trade workflow to group individual trades into package transactions, each individual trade within a given package transaction is being individually submitted to the CCP/FCM for credit analysis/approval and registration.”

This individual trade submission to the FCM/CCP “creates the potential for temporarily incorrect changes in the portfolio risk at the FCM/CCP, and in turn leads the FCM to observe/calculate changes in client portfolio risk, that in many cases do not reflect the true intended risk of the client and could lead to incorrect breaches of credit limits due to trade flow ordering,” Hirani said.

The CFTC roundtable will discuss the definition of package transactions, whether such transactions pose challenges in clearing or execution that are distinct from those applicable to the clearing or execution of stand-alone swaps subject to the trade execution requirement, and potential solutions for trading package transactions on or pursuant to the rules of a DCM or SEF.

In a presentation, Citadel Investments recommended against breaking up the simultaneous pricing and execution of package transactions.

For multi-swap package transactions, Citadel recommended collaborative industry enhancements to the execution-to-clearing workflow that support these package transactions, and for swap vs. non-Swap package transaction, it recommended development of execution paradigms/protocols that are viable for these package transactions (including an “EFRP” style process for swaps).

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