Introduction
On Wednesday, July 15, 2015, the Commodity Futures Trading Commission’s (“CFTC”) Division of Market Oversight (“DMO”) hosted a public roundtable to discuss the process to determine whether a swap must be executed on an exchange. The roundtable assessed industry experience with the current process under the Commodity Exchange Act (“CEA”) and compared approaches to mandatory exchange trading in other jurisdictions.
Under CEA Section 2(h)(8), if a swap is required to be cleared, then the swap must be executed on a designated contract market (“DCM”) or swap execution facility (“SEF”) to the extent the swap is “made-available-to-trade” (“MAT”). In 2013, the CFTC promulgated a rule governing the MAT process, authorizing any one DCM or SEF to make a determination, subject to CFTC review, that a swap or class of swaps must be traded on a DCM or SEF.1 In the two years since the rule’s inception, the exchanges have made five MAT determinations, all in the credit default swap or interest rate swap asset classes.2
Commissioner Giancarlo, along with several other panelists, highlighted various shortcomings in the rule—chief among them that it unnecessarily restricts efficient trade execution. Commissioner Giancarlo encouraged roundtable participants to focus on the CFTC rule’s restricting the manner of executing a swap on an exchange, rather than on who makes the MAT determination. Noting that the current CFTC rule requires swaps subject to mandatory exchange trading to be executed via order book or request for quote, Commissioner Giancarlo argued that the process creates unnecessary barriers to market entry. Participants that intend to execute a swap subject to a MAT determination must shoehorn their swaps into one of two execution methods and find a counterparty willing to do the same. Instead, Commissioner Giancarlo asserted that the rule should provide exchanges with the flexibility to offer a wide array of trade execution methods that best serve the needs of each swap. “Flexible methods of execution would open U.S. swaps markets to promising technological advances and further Congress’ goals of promoting the trading of swaps on SEFs and pre-trade price transparency.”3
Industry Assessment of the MAT Process
Following Commissioner Giancarlo’s cue, industry participants—including SEFs, trade associations, liquidity providers, and buy-side firms—weighed in on the effectiveness of the MAT determination process. Although they agreed that the MAT process has been measured in pace and collaborative, they highlighted ongoing gaps and the need to change existing CFTC rules.
Factors to Consider to Make a Swap Available to Trade
Under Parts 37 and 38 of the CFTC rule, a DCM or SEF may base its decision on any of the following: (1) Whether there are ready and willing buyers and sellers; (2) the frequency or size of transactions; (3) the trading volume; (4) the number and types of market participants; (5) the bid/ask spread; or (6) the usual number of resting firm or indicative bids or offers. However, as several panelists pointed out, SEFs and DCMs consider more than one factor when making a MAT determination. Therefore, allowing a decision to be based on any one factor, as the rule currently provides, is not in line with industry practice.
Separately, panelists agreed that other factors should be considered before making a swap available to trade. For example, the CFTC, SEFs, and DCMs consider the technological readiness of all market participants. SEF panelists noted that they have limited their MAT submissions to date where dealers and buy-side participants may not have the requisite capabilities to trade on a facility. Similarly, representatives from asset management firms and swap dealers stressed that even if a SEF or DCM is technologically ready to make a swap available to trade, the rest of the market will require significant time and resources to ensure connectivity and compliance with the relevant platforms’ rules. Nonetheless, the technological readiness for the market to move to the required exchange trading methodologies (i.e., order book and request for quote) is not a factor in the CFTC’s current MAT process.
Finally, several panelists urged the CFTC to adopt quantitative factors to ensure that MAT determinations are made on an objective basis. One industry panelist proposed minimum thresholds, such as a requirement that at least two SEFs offer the swap and at least two liquidity providers deal in the swap. The panelists agreed that any quantitative thresholds should be predicated on a universally accepted set of market-wide swaps data.
Process for Making MAT Determinations
Several panelists emphasized the need for greater CFTC involvement. Representatives from two asset management firms took exception to the current self-certification process, which allows a DCM or SEF to make a MAT determination on an expedited basis. These panelists feared that the expedited process may be too quick for market participants to assess and prepare for compliance. Some participants suggested a process akin to the mandatory clearing determination, which allows a derivative clearing organization (“DCO”) or the CFTC to make a mandatory clearing determination.
Representatives from certain SEFs were amenable to expanding the MAT process to other parties, with one panelist supporting a CFTC-led process and another suggesting that other market participants, in addition to SEFs, be permitted to submit MAT applications. Another panelist recommended the use of advisory committees comprised of market professionals to help evaluate MAT submissions. One panelist further suggested amending the MAT rule to incorporate a formalized public comment process. Across the board, the panelists agreed that all relevant parties—including SEFs/DCMs, the CFTC, and market participants—should play a role in assessing whether a swap must be executed on an exchange.
Panelists also addressed the need to create a process to undo a MAT determination. For example, if the CFTC were to adopt quantitative factors for making MAT determinations, one panelist argued that the CFTC could easily determine that a swap should no longer be subject to the mandatory exchange trading requirement.
Conflicts of Interest in the MAT Process?
During the panel discussion, several academic panelists emphasized that exchanges face a conflict of interest under the CFTC’s MAT process because the exchanges benefit from a requirement to execute a swap on a DCM or SEF. To prevent this conflict of interest, the academic panelists supported the CFTC making MAT determinations. However, several speakers, including some industry panelists, expressed optimism about the exchanges’ use of the MAT process. These speakers believed the conflict of interest concerns may have been overstated.
Mandatory Trade Execution in Japan and the European Union
Representatives from Japan and the European Union (“EU”) discussed their efforts to adopt more flexible regulatory frameworks driven by market principles rather than artificial regulatory prescriptions. For example, the EU’s final trade execution regime will not impose arbitrary limits on execution methods by its exchanges. Moreover, both jurisdictions will implement a transparent process to prevent arbitrary or self-serving decisions and will seek market input to ensure that all issues are adequately considered. Several panelists urged the CFTC to develop a similarly flexible process to prevent a “liquidity flight” overseas.
Conclusion
The CFTC’s roundtable highlighted several gaps in the MAT process from the perspective of various market participants, including SEFs, swap dealers, and end-users. Accordingly, this roundtable may trigger further rulemaking from the CFTC to modify the agency’s implementation of the exchange trading requirement in the CEA. In connection with the roundtable, market participants may submit comments on the topics discussed during the roundtable by Friday, August 14, 2015.
1 See Process for a Designated Contract Market or Swap Execution Facility To Make a Swap Available to Trade, Swap Transaction Compliance and Implementation Schedule, and Trade Execution Requirement Under the Commodity Exchange Act, Final Rule, 78 Fed. Reg. 33606 (June 4, 2013).
2 CFTC, Swaps Made Available to Trade Determination, available at http://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination.
3 Statement of Commissioner J. Christopher Giancarlo on the DMO Made Available to Trade Process Roundtable (July 14, 2015).
