The Commodity Futures Trading Commission (CFTC or Commission) at year-end issued one final and two proposed rulemakings. The proposed rules are potentially significant for all swap market participants, and the final rules are applicable specifically to derivatives clearing organizations (DCOs).
By unanimous vote, the Commission proposed a rule prohibiting the practice of “post-trade name give-up”1 for swaps that are executed anonymously on a swap execution facility (SEF) and intended to be cleared. If adopted, this rulemaking will likely be the most significant of the actions taken by the Commission at its December 18, 2019 open meeting.
What are the proposed rule’s key aspects and the likely implications for market participants?
The rule would prohibit a SEF from disclosing directly or indirectly the identity of counterparties to a transaction that is executed anonymously and intended to be cleared. The prohibition would also apply to third-party trade processing services used to route transaction information from a SEF to a DCO. The rule would not apply to name-disclosed methods of execution on a SEF, such as requests for quotes, or to uncleared transactions.
The Commission believes that this rule, if adopted, will lead to greater participation by a more diverse group of market participants and promote increased liquidity, and greater competition and interaction between market participants, thereby enabling SEFs to act as more efficient venues for price discovery.2 If adopted, the rule may well constitute the most significant change in market structure since the adoption of the SEF trading rules in 2013.
Comments on the proposal must be received by March 2, 2020.
The Commission, by a 3-2 vote, proposed to codify its Guidance4 regarding the cross-border application of registration and other requirements to swap dealers (SDs) and major swap participants (MSPs)5. As proposed, the rule would codify the current no-action treatment relating to US-based personnel who arrange, negotiate or execute swaps on behalf of a non-US SD and would amend the definition of “US person.”
What are the key aspects of the rule proposal?
- The proposal harmonizes the CFTC’s rules with those of the Securities and Exchange Commission (SEC) by adopting a uniform definition of US persons across the two agencies’ cross-border swap activities rules.6
- However, the CFTC, unlike the SEC, is proposing to treat all foreign-based swaps entered into between a non-US swap entity and a non-US person the same regardless of whether the swap is “arranged, negotiated, or executed” by US-based personnel or agents. The CFTC’s “comity” approach with respect to transactions between two non-US persons that are booked to entities outside the United States but arranged, negotiated or executed by US-located personnel (ANE Transactions)7 would diverge from the “territorial” approach of the SEC. Although CFTC rules will not apply to ANE Transactions, such transactions remain subject to the Commodity Exchange Act’s anti-manipulation and anti-fraud provisions and the rules thereunder.
- The proposal also introduces the concept of significant risk subsidiary (SRS), a significant subsidiary of a US person that can impact its ultimate US parent entity and US commerce.8 The Commission proposes to apply certain regulations, including the SD and MSP registration threshold calculations, to an SRS in the same way as they are applied to a US person.
What are the major implications for market participants?
If adopted, the proposal will bring greater consistency with the definition of US person used by the SEC for security-based swaps. It will also provide greater legal certainty regarding the treatment of ANE Transactions. Finally, the proposed rules would more finely calibrate the available substituted compliance regime. If these proposed rules are adopted, market participants should be prepared to assess their businesses to determine whether they are affected by the modifications to the definitions of US person and SRS, respectively, and to assess whether these definitions will impact the swaps or swap positions that count toward their SD or MSP registration thresholds.
The comment period will be open for 60 days following publication in the Federal Register.
In a unanimous vote, the Commission approved final rules which primarily clarify or codify existing interpretation, guidance or no-actions. New rule amendments are largely administrative in nature.
What are the key aspects of this final rule?
- Governance Fitness Standards, Conflicts of Interest and Composition of Governing Boards: DCOs will be required to include market participants and individuals who are not executives, officers, or employees or affiliates of the DCO on the DCO’s governing board or board-level committee.
- Chief Compliance Officers (CCOs): CCOs will have greater flexibility in the submission and content of their annual reports and will be required to describe the process by which the reports are furnished to the board of directors. CCOs are permitted to report to the senior officer responsible for the DCO’s clearing activities whether the DCO also engages in activities unrelated to clearing. The CCO annual report may incorporate by reference portions of its most recent report, particularly those sections describing the DCO’s written policies and procedures.
- Enterprise Risk Management: The rule requires that DCOs have an enterprise risk management program and to identify its enterprise risk officer. The enterprise risk officer, who may also be the chief risk officer, may report to the board of directors, a committee of the board or the senior officer responsible for the DCO, but should have access to the board of directors.
- Risk Management: When conducting back tests of initial margin requirements, DCOs are required to compare portfolio losses only with those components of initial margin that capture changes in market risk factors.
- Default Rules and Procedures: Although not included in the original proposal, for consistency with other exceptions for fully collateralized positions, the Commission is adopting a new Section 39.16(e) to provide that a DCO may satisfy the requirements of paragraphs (a), (b) and (c) of Section 39.16 (which relate to a DCO’s default management plan and procedures) by having rules that permit it to clear only fully collateralized positions.
- Default Committee Procedures: A proposed rule that was not adopted relates to default committees. Regulation 39.16(c) currently requires a DCO to adopt procedures that would permit the DCO to take timely action in the event of a default by one of its clearing members. The Commission had proposed to require DCOs to have a default committee consisting of clearing members and market participants to be convened to address instances of significant member defaults. However, the Commission declined to adopt the proposed rule in light of the strongly divergent comments it received.
- Reporting: DCOs are now required to report any of the following events: (i) a significant decrease in liquidity resources from the prior day or changes in liquidity funding arrangement, depositories for customer funds or independent accounting firm or (ii) significant events such as settlement bank issues, major decisions of the board of directors, margin model issues, recovery and wind-down plans, new products accepted for clearing, and decreases in liquidity resources.
What are the major implications for market participants?
The final rules are mainly administrative and technical in nature. However, the requirement with respect to the composition of the boards of directors of DCOs may in the longer term provide more open and inclusive governance of DCOs.
The final rules will become effective 30 days after publication in the Federal Register.