Derivatives Industry Associations Recommend Changes to CFTC Implementation Schedule to Minimize Market Disruption
Fanni Koszeg | Bloomberg Law
The International Swaps and Derivatives Association (ISDA), the Futures Industry Association (FIA), and the Securities Industry and Financial Markets Association (SIFMA, and collectively, Associations) submitted a joint comment letter to the Commodity Futures Trading Commission (CFTC) on its proposed compliance and implementation schedules for clearing and trade execution requirements and documentation and margining requirements (together, Proposals). The Associations believe that in order to facilitate a successful transition plan that is “comprehensive, transparent, and minimally disruptive to the continued operation of swap markets,” the CFTC should consider making certain changes to the Proposals. The Associations proposed a phase-in plan that sequences the requirements of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in three stages and, within these stages, by type of market participant.
Stage One: Swap Data Repositories and Regulatory Reporting
The Associations argued that functioning Swap Data Repositories (SDRs) and effective regulatory reporting of swap transactions are pre-requisites to an orderly transition because only by compiling sufficient market data will the CFTC be in a position to determine a number of questions necessary for implementing other crucial provisions. In particular, wide-ranging data on entities and transactions is essential for determining which transactions should be subject to mandatory clearing and in what order, as well as how to implement and monitor compliance with business conduct and other swap dealer rules. The Associations contended that industry standard identifiers should be finalized before reporting can begin and SDRs can finalize their systems and processes for data collection in parallel.
The Associations argue that since it is impossible to expect compliance with all of the Dodd-Frank reporting requirements as soon as SDRs start operating, it is important to phase in reporting requirements from more basic to more complex information and by product type. According to the Associations, the additional requirement that swap dealers and major swap participants maintain transaction records should be amended. In addition to core recordkeeping requirements (i.e., documentation that codifies a transaction and position records), the CFTC would also implement more extensive recordkeeping requirements in stage one. The Associations asserted that non-core recordkeeping requirements far exceed anything currently in place and, as a result, significant time, as well as technological and operational resources, will be needed, if possible at all given the short time-frame. Therefore, the Associations suggested, implementation of these more complex requirements should be completed in stage three, if necessary.
Stage Two: Registration and Clearing
The Associations proposed that the transition to compliance in the second stage should be as follows: (1) registration of swap dealers and major swap participants; (2) mandatory compliance with core business conduct requirements; (3) phasing in of mandatory clearing; and (4) mandatory compliance with margin and capital rules. This sequence of events should follow from the accomplishments of stage one logically, they argued; once sufficient data has been collected in stage one, the CFTC can better categorize market participants. After the definitions of “swap dealer” and “major swap participant” are finalized, market participants will be able to categorize themselves, as appropriate, as swap dealers, major swap participants, financial end users, and commercial end users. The Associations recommended that only core business standard requirements (e.g., conflicts and clearing disclosure) be rolled out in stage two and non-core requirements (e.g., provision of daily marks to counterparties) be deferred until stage three. As to mandatory clearing, the Associations recommended that the requirements should be phased in by type of market participant and by product category, beginning with interest rate and credit default swaps for which clearing already exists. After mandatory clearing has been implemented, margin and capital requirements for uncleared swaps can be phased in. According to the Associations, if these requirements were to be implemented before clearing, compliance would become mandatory for certain market participants as a practical matter before becoming mandatory as a regulatory matter.
The Associations believe that the 90-, 180-, and 270-day time frames for compliance in the Proposals should be significantly lengthened for this stage. In their assessment, compliance with the technological and operational requirements alone may take more than a year. Complying with certain required documentation changes will be particularly challenging given that no Dodd-Frank-compliant industry standards exist and tens of thousands of agreements will potentially have to be re-negotiated. The burden on buy-side participants with more limited resources may be overwhelming and one unintended consequence, according to the Associations, may be that asset managers will be forced to transact only with the largest dealers with standard documentation, thereby negatively affecting the competitive positions of smaller dealers.
Stage Three: Swap Execution Facilities and Public Reporting
The third and final stage would be sequenced as follows: (1) swap execution facility (SEF) and designated contract market (DCM) execution requirements; (2) non-core external business conduct standards; (3) real-time public reporting and transaction data; and (4) non-core recordkeeping requirements. The Associations pointed out that Title VII was clear that the execution requirement would automatically apply to transactions that are subject to mandatory clearing so long as a DCM or SEF has “made it available” for trading. They argued that the CFTC, rather than the SEFs, should determine when enough liquidity has developed that a swap qualifies as “made available for trading,” and that this determination should be subject to public notice, comment, and opportunity for a hearing. Non-core business conduct requirements could be implemented next and real-time reporting requirements should be implemented gradually, as a last step, according to the Associations.
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