By Peter Madigan
Javelin's CEO, James Cawley, comments on recent CFTC rulings to promote open access to cleared swaps markets with regard to industry documentation and real time trade acceptance. A proposal prohibiting an ISDA-FIA clearing document highlights rift within CFTC, with Republican appointees claiming they were kept in the dark.
A contentious draft rule from the Commodity Futures Trading Commission (CFTC) has revealed partisan divisions within the agency. The CFTC's two Republican-appointed commissioners argue the proposal - which shuts the door on a documentation project run by the Futures Industry Association (FIA) and the International Swaps and Derivatives Association (ISDA) - was unnecessary, and claim they were kept in the dark ahead of the agency's rule-making meeting on July 17.
The FIA-ISDA document, published on June 16, attracted fierce criticism from two other industry groups, the Managed Funds Association (MFA) and the Swaps and Derivatives Market Association (SDMA). At its meeting a month later, the CFTC proposed to ban key elements of the document.
CFTC commissioner Jill Sommers, one of the Republicans, claims there was a rush to judgement. "A rule-making concerning this FIA-ISDA agreement is completely unnecessary. I think the industry was trying to solve an issue itself before it became an issue for the commission and we rejected it, basically telling the industry it is prohibited from using its own solution," she says.
"We have a packed agenda, with more than 100 different issues on our plate right now, but we took time out because of two comment letters we received to an earlier rule-making to come up with this language. In my opinion, that is a huge waste of resources - we do not have time for extraneous, non-mandatory rule-makings," she adds.
Calls to the three Democrat-appointed commissioners, including CFTC chairman Gary Gensler's office, were not returned. Commissioner Bart Chilton's staff provided an emailed statement. "This is only a proposal. It is a response to reasonable comments made by interested, knowledgeable parties," it reads.
The FIA-ISDA document sets out the responsibilities of counterparties to over-the-counter derivatives transactions that are destined for clearing, including the length of time allowed for the confirmation of trade details following execution. It also includes an annex designed to tackle dealer concerns that counterparties without direct access to a clearing house may discover - after execution - that they have breached the credit limit set by their clearing member, potentially leaving the trade outside the clearing system and forcing it to be terminated.
Without the annex selected, any termination fee would have to be paid by one or other of the counterparties. Under the annex, the clearing member would also become liable - a risk to the member that is mitigated by making it party to the contract, in a three-way arrangement that allows the clearing member to see the identity of its client's dealer and allocate a credit limit for trades with that dealer.
The concerns of the SDMA and MFA focus on what they see as an overly long window for trade confirmations and the loss of anonymity firms would suffer if they signed up to the trilateral arrangement - the fear being that a clearing member would be able to dole out favourable credit limits for trades with its own executing desks.
"The CFTC rightfully concluded that the FIA-ISDA documentation introduced many elements contrary to the Dodd-Frank Act. The extended settlement latency - from trade execution to trade acceptance into clearing - that the documentation espoused actually increased settlement risk and ran contrary to standard practice in all other cleared markets," says James Cawley, Chief Executive at electronic trading platform Javelin Capital Markets in New York and co-founder of the SDMA.
The proposed rule was passed by three votes to two, with both Republicans voting against it. Both say they only became aware of the rule-making a short time before the July 17 commission meeting and had not heard about the FIA-ISDA documentation until they saw the agency's proposal to prohibit it.
"Why we are proposing a rule to prohibit an optional agreement from being made available in the market is a good question. I can't tell you when the rule-making was drafted, but there were two comment letters expressing concerns about the potential negative impact this documentation might have on the market. The staff drafted a rule-making and that rule then came up to us commissioners - that's really all I can tell you," says the second Republican commissioner, Scott O'Malia.