Venues to Determine Swap Trading Availability

Terry Flanagan

Proposed rule makes SEFs and DCMs responsible for decision subject to CFTC approval.

Designated contract markets and swap execution facilities will determine where a swap is deemed available for trading, according to a rule proposed by the Commodity Futures Trading Commission.

By putting the onus on DCMs and SEFs to make such a determination, the CFTC is opening up a potential hornet’s nest of issues. In particular, a determination by one venue that a swap is available to trade may force the hands of other venues, setting in motion a rollercoaster effect.

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.

“This approach is deeply flawed and I cannot support putting it out for comment, even recognizing that it is just a proposal,” said CFTC commissioner Jill Sommers. “This proposal, if finalized, would allow a single DCM or SEF to bind the entire marketplace to a trade execution requirement through an ill-defined analysis that the Commission will be unable to reject.”

For example, the proposed rules would allow a DCM or SEF to declare a swap made available to trade based solely on a finding that there are ready and willing buyers and sellers.

“Will a swap that trades once or twice a year qualify under this test? Could the Commission find a determination based on one or two trades a year to be inconsistent with the rule?” said Sommers.

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.

In addition, said Sommers,” all over-the-counter (OTC) participants will also 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.”

The CFTC acknowledged that the derivatives industry has recommended that the process for determining when a swap is available to trade should include greater CFTC involvement.

For example, one commenter suggested that a SEF certify to the CFTC those swaps that qualify as available to trade, and that following a public notice and comment period, that the CFTC confirm or reject the SEF’s certification.

The CFTC view the propose procedure as a balanced approach whereby a DCM or SEF—the facilities that may be most familiar with the trading of these swaps—has reasonability to make a swap available to trade, and that the procedure is responsive to comments that the CFTC have involvement 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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