Dealers Assail CFTC Margin Rules

Terry Flanagan

The fungibility of over-the-counter swaps and exchange-traded financial futures is at the center of calls for parity with exchanges by operators of swap execution facilities (SEFs) and other market participants.

At a roundtable discussion on the ‘futurization’ of swaps held at the Commodity Futures Trading Commission last week, participants said that importing constructs from the exchange-traded world into the world of OTC swaps placed SEFs and others at an unfair disadvantage to futures exchanges.

In particular, it was pointed out that under new margin requirements adopted by the CFTC in order to implement provisions of the Dodd-Frank Act, a derivatives clearing organization (DCO) would be required to specify margin requirements to cover a liquidation period of five days in order to cover the DCO’s potential future exposures during the interval between the last collection of variation margin and the time within which the DCO could liquidate the defaulting clearing member’s position.

In the event that a futures contract is converted to a swap, this would result in the DCO margining such swap contracts using a minimum of five days instead of one day for futures.

Such a scenario could occur because under separate rules proposed by the CFTC for designated contract markets (DCMs), a DCM is prohibited from listing any contract for trading unless an average of at least 85% of the total volume of such contract is traded on the centralized market. This could result in DCMs having to delist hundreds of futures contracts.

“There is no question that there is significantly more liquidity in cleared financial swaps than in cleared financial swap futures,” said George Harrington, head of global fixed income trading at Bloomberg.

Subjecting cleared futures contracts and economically-equivalent cleared swaps to different margin regimes would result in either the swap executed on a SEF or a futures exchange being “over-margined” by a factor of five, or the futures contract executed on a futures exchange being “under-margined” by a factor of five, Harrington said.

Chris Ferreri, managing director of hybrid trading at interdealer broker ICAP, said that the rules should be rewritten so that margin is calculated based on actual trading liquidity and other market data, not on whether an instrument is labeled a swap or future.

“It is troubling that futures exchanges are touting the lower margin cost for swap futures over swaps as part of their printed sales pitch,” Ferreri said.

Even if futurization is inevitable because of a natural migration to order books as swaps become more liquid, he said, “it still begs the question why greater liquidity must move to order books operated by single-silo non-fungible exchanges?”

The buy side is dealing with a cornucopia of post-trade issues related to transparency and reporting with both their OTC and exchange-traded instruments.

“A lot of what’s driving the desire for transparency and accuracy in reporting are looming regulations,” Ian Danic, managing director at Electra Information Systems, told Markets Media.

Electra provides systems for trade settlement, reconciliation, data collection and aggregation to institutional investment management and hedge fund organizations.

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