SEC and CFTC unveil clear path to swaps migration

More clarity has been provided on when US market participants should expect to onboard various OTC derivatives to newly-created swap execution facilities (SEFs) and meet central clearing requirements.

This week, the Securities and Exchange Commission (SEC) revealed its roadmap for the phase-in of Dodd-Frank Act derivatives regulation, while last week, Commodity Futures Trading Commission (CFTC) commissioner Gary Gensler intimated a phased approach to bringing instruments onto SEFs.

The SEC’s new roadmap for moving swap trading onto regulated exchanges or SEFs provides greater clarity on the sequence in which the rules will take effect without providing firm dates for rule finalisation.

Concerning the sequencing of compliance dates for rules on security-based swaps, the agency believes “rules further defining the terms ‘security-based swap’, ‘security-based swap agreement’, and ‘mixed swap’, and the rules further defining ‘security-based swap dealer’ and ‘major security-based swap participant’, should be the earliest of the final rules” adopted.

The SEC then expects to propose its cross-border rules as a single release, addressing the application of Dodd-Frank to cross-border securities-based swap transactions and non-US persons acting in capacities regulated under the act.

Attempting to put the market at ease, the SEC said it did not expect to require compliance by participants in the US securities-based swap market with final rules arising “before addressing the cross-border aspects of such rules”.

Following the definitional rules and the cross-border rules, the agency said it wanted to next implement rules requiring swap data repositories (SDRs) to register and comply with applicable duties so that market participants can have an appropriate amount of time to analyse and understand the final rules and develop and test new policies and systems required as a result.

The SEC said procedural rules related to mandatory clearing determinations will need to be adopted before the rules further defining swaps, securities-based swaps, security-based swap agreements, and mixed swaps and before the cross-border rules. But, given the dependency of the securities-based swap mandatory clearing regime on other Dodd-Frank rules yet to be adopted, the agency said in its roadmap that securities-based swaps should not be required to be cleared until after clearing agency standards were in place, end-user clearing exceptions were established, and the SEC had determined whether to propose amendments to existing net capital and customer protection requirements applicable to broker-dealers, as well as whether to address portfolio margining with swaps, subject to consultation.

Clarity from CFTC 

Speaking at a conference last week, Gensler said beginning in the summer, interest rate and credit default swaps (CDS) transaction data will begin to be reported in real time to the public and regulators, followed by other swaps later in the year.

Also “later this summer”, Gensler said the CFTC was hoping to complete its rule for SEFs and block trading.

The CFTC has already completed reforms on SDRs, real-time reporting and designated contract markets. SDRs will now receive data on all swaps transactions, and Gensler said so far four entities had sent applications to become SDRs.

Gensler last week also provided more clarity on the increased use of central clearing for swaps. While clearing in the swaps market is presently on a voluntary, dealer-to-dealer basis, reforms will expand to include transactions between dealers and financial entities.

“CFTC staff is preparing recommendations for the commission and for public comment on clearing requirement determinations,” said Gensler. “The first determinations will be put out for public comment this summer and hopefully completed this fall. They are likely to begin with standard interest rate swaps, as well as a number of CDS indices.”

The commissioner said the CFTC was recommending a requirement for fixed-to-floating interest rate swaps, basis swaps, forward rate agreements, and overnight index swaps in four currencies: US dollars, euros, British pounds and Japanese yen.

“For CDS indices, the requirement likely will cover certain North American investment grade and high yield CDX indices, as well as certain European iTraxx, high volatility, and crossover iTraxx indices,” Gensler said. “For market participants trying to plan for the first clearing determinations, though I don’t have a specific date, if we’re able to put a proposal out next month, the determinations could be as early as October.”

The buy-side has become increasingly concerned that they will not be able to trade swaps in an unclear regulatory environment.

Consultancy Tabb Group contends buy-side firms, frustrated with the fees that dealers are charging for client clearing and unsure of where they’ll raise the estimated nearly $2 trillion in margin or collateral needed, will stop trading swaps if the economics don’t add up, threatening a liquidity crisis across the US$600 trillion marketplace.

“With a dip in liquidity a near certainty, waiting to see who blinks first is never comfortable,” said Will Rhode, a TABB principal, director of fixed income research and author of ‘US buy-side swaps trading 2012: I can see clearing now', the research firm’s first annual study on buy-side swaps. “Everyone knows clearing’s coming but there’s been little movement, even as the deadlines bear down. These are high-stakes games. For now, many on the buy side are taking a wait-and-see approach come implementation day, happier to stay on the side-lines, avoiding potential disruptions in pricing, clearing and perhaps the swaps trading system as a whole.”

Market participants have also expressed support for a petition circulated by Peter Barsoom, COO at Intercontinental Exchange's Clear Credit clearing house for credit-default swaps, demanding the SEC allow buy-side firms to use a single account to cross-margin between single name and index derivatives.

“Cleared derivatives must be at least as competitive as OTC derivatives,” he said. “It would be a bizarre outcome if trading and clearing a swap was disadvantageous relative to keeping it as a bilateral OTC contract. The same margin methodology needs to apply to all customers, and the buy-side needs to be able to hold single name and index derivatives in the same account for margining efficiencies.”