By Peter Madigan
The Commodity Futures Trading Commission (CFTC) may even-up block trade rules for swaps and swap futures, it announced today, as long-awaited requirements for swap execution facilities (Sefs) were approved at an open meeting in Washington, DC. As things stand, swaps are subject to CFTC-set block thresholds – which allow big trades to avoid real-time reporting requirements – but exchanges can set their own thresholds for futures contracts.
Critics have argued this disparity hands the exchanges – formally known as designated contract markets (DCMs) – an unfair advantage in cases where they are trading products that are economically equivalent to over-the-counter swaps. The CFTC appears to be listening.
"The staff as a team is looking at issues relating to the setting of block sizes on DCMs and is contemplating some sort of potential commission action, regulation or rule-making that would address issues related to the setting of block sizes on DCMs – in particular, with respect to the so-called futurisation of swaps that happened last year. That's something we're looking at," said Richard Shilts, acting director in the division of market oversight at the CFTC.
Economically equivalent instruments, whether traded on a DCM in the form of a swap future or over the counter as a swap contract, should have the same block standards
This was immediately welcomed by Lee Olesky, chief executive of New York-based electronic execution platform Tradeweb. "The different treatment between the ability of DCMs to set their own block sizes and the CFTC-mandated block sizes for Sefs is a serious inconsistency, especially as it relates to the goal of transparency. Our view has long been that economically equivalent instruments, whether traded on a DCM in the form of a swap future or over the counter as a swap contract, should have the same block standards. The fact that the commission mentioned the issue and its willingness to investigate it is a positive step in equalising these two types of provision."
The block rules for swaps were finalised during today's meeting, establishing a 67% notional size threshold. Any trades above this point in a given product's range of notional sizes can be executed bilaterally, away from a Sef, and will be subject to a reporting delay of at least 30 minutes – meant to give liquidity providers time to hedge themselves before the market is notified of a large transaction. The CFTC has calculated that roughly 6% of swaps will qualify as blocks under the final standard but, during the first year of the new regime, the block threshold will initially be set at 50%.
Under the final block rules, the threshold applies to all swaps, regardless of whether they are traded on a Sef or a DCM. Market participants could sidestep this rule, however, by electing to instead trade a swap futures contract that is economically equivalent to the swap – the fear of Tradeweb's Olesky and other critics – thereby becoming subject to the DCM's own block threshold rather than adhering to federal limits.
Beyond the CFTC staff's decision to review this disparity, trading platforms generally lauded the final form of both the block trade and Sef core principles. Proposals for both sets of rules had been hugely contentious.
"I think the commission has come up with a great rule, notwithstanding the arguments and delays that led up to it," says James Cawley, chief executive of Javelin Capital Markets, a New York-based Sef. "I think the block rule is the most significant measure passed, because requiring Sef execution for all trades larger than 67% of notional swaps size translates into 94% of all swaps traded, and that's a big win for transparency and for competition. Combine that with the made-available-to-trade rules, which give autonomy to Sefs to list products and self-certify, and this is a big step in getting this market rolling."
The final design of the Sef core principles provided little in the way of surprises. The proposal that requests for a quote would need to be sent to a minimum of five market-makers – potentially making it more difficult for these firms to manage their risks, critics claimed – has been watered down. During a one-year transition period, quote requests can go to two participants, and three thereafter.
As expected, voice broking is permitted to continue as an execution method and the 15-second crossing rule delay is also retained. The latter means a customer order has to be displayed for a minimum of 15 seconds and cannot be instantly filled, giving other participants a chance to provide a better price.
Sefs will be allowed to start operating as soon as they receive a temporary Sef registration from the CFTC, rather than being required to wait for a full registration. And in a departure from the normal 90-day waiting period, the Sef rules go into effect just 60 days after they are published in the Federal Register – a move some platforms have interpreted as an apology from the CFTC for the lengthy period of regulatory limbo that preceded today's vote.
"That 60-day approval could be interpreted as a tip of the hat by the CFTC to the long delay the market has endured and toward moving things along a little faster. What these rules have provided is clarity, and we can now get down to the business of submitting our applications and beginning to serve clients," says Christian Martin, chief executive at New Jersey-based DCM, TeraExchange.