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From Securities Regulation Daily, May 16, 2013

CFTC Adopts Rules on Pre-Trade Transparency for Swaps

By Lene Powell, J.D.

The CFTC held a public rulemaking hearing to consider rules concerning pre-trade transparency for swap transactions. All were approved by the Commission.

Block trades. The Commission voted 3-2 to approve a final rule that groups swaps into categories, establishes methodologies for setting appropriate minimum block sizes for block trades and large notional off-facility swaps in each category, and prevents disclosure of the identities of swap counterparties in connection with the real-time public reporting of swap transaction and pricing data.

The final rule sets forth specific swap categories within the five asset classes previously established by the real-time reporting final rule: interest rate, credit, equity, foreign exchange, and other commodity. Swaps within each asset class are grouped based on common risk and liquidity profiles.

The rule provides that the Commission will set appropriate minimum block sizes for the swap categories within each asset class, using a two-period, phased-in approach. The Commission prescribes appropriate minimum block sizes during an initial period, which will last until registered swap data repositories have collected at least one year of reliable data for each asset class. The Commission will then use this data to establish post-initial appropriate minimum block sizes for each swap category using a 67-percent notional amount calculation. The Commission will update these post-initial appropriate minimum block sizes at least once a year.

The rule includes measures to protect the identities of counterparties and maintain the anonymity of their transactions. Cap sizes are established that mask the total size of a swap transaction. In addition, limits are imposed on the public dissemination of certain publicly reportable swap transactions in the "other commodity" asset class, which have specific delivery or pricing points.

Commissioners Jill Sommers and Scott O'Malia voted against the rule, noting that it was not based on recent data.

Made available to trade. The Commission voted 3-2 to approve a final rule establishing a process for designated contract markets (DCMs) and swap execution facilities (SEFs) to make a swap "available to trade" under section 723 of the Dodd-Frank Act.

Under the trade execution requirement, swap transactions subject to the clearing requirement must be traded on either a DCM or a SEF unless no DCM “makes the swap available to trade” or the transaction is not subject to the clearing requirement under section 2(h)(7) of the CEA. The Commission established a schedule to phase in market participants’ compliance with the trade execution requirement.

Under the new process, DCMs and SEFs may submit to the Commission a determination that a swap is available to trade, either for approval or under self-certification procedures, under CFTC Rule 40.5 or 40.6. The determination must consider the following factors: (1) whether there are ready and willing buyers and sellers; (2) the frequency or size of transactions; (3) the trading volume; (4) the number and types of market participants; (5) the bid/ask spread; and (6) the usual number of resting firm or indicative bids and offers.

After a swap is determined to be available to trade, the swap is subject to the trade execution requirement under Part 37 (SEF) or Part 38 (DCM).

Market participants must comply with the trade execution requirement upon the later of (1) the applicable deadline established under the compliance schedule for the clearing requirement for a swap under Rule 50.25 of the Commission’s regulations or (2) 30 days after a swap is deemed available to trade upon being approved under Rule 40.5 or allowed to become effective under Rule 40.6.

The Commission will post "made available to trade" determinations on its website. Market participants will be able to identify which swaps have been determined to be available to trade and therefore are subject to the trade execution requirement, including the SEFs and DCMs that list or offer those swaps for trading.

Commissioners Sommers and O'Malia voted against the rule, citing a lack of objective criteria in the "made available to trade" determination.

SEF rules. The Commission voted 4-1 on a rule that imposes many requirements for SEFs, including registration, financial resource requirements, and impartial access. The final regulations implement the SEF registration requirement in CEA Section 5h(a)(1) by requiring facilities that meet the SEF definition in CEA Section 1a(50) to register as SEFs. The final rulemaking also clarifies that swap transactions that are not subject to the CEA Section 2(h)(8) trade execution requirement may be executed on either a registered SEF or an alternative entity that is not required to register as a SEF.

The rule establishes procedures for the registration of SEF applicants, including a temporary registration process.

A facility that must register as a SEF is required to provide a minimum trading functionality, which is defined as an “Order Book.” Order Book means an electronic trading facility as defined in CEA Section 1a(16), a trading facility as defined in CEA Section 1a(51), or a trading system or platform in which all market participants in the trading system or platform have the ability to enter multiple bids and offers, observe or receive bids and offers entered by other market participants, and transact on such bids and offers.

The final regulations define Required Transaction as any transaction involving a swap that is subject to the trade execution requirement in CEA Section 2(h)(8) and Permitted Transaction as any transaction not involving a swap that is subject to the trade execution requirement in CEA Section 2(h)(8).

Each Required Transaction that is not a block transaction must be executed on a SEF in accordance with one of the following execution methods: (i) an Order Book or (ii) a Request for Quote System that operates in conjunction with an Order Book. In providing either one of these execution methods, a SEF may use “any means of interstate commerce,” provided that the chosen execution method satisfies the requirements in the rules. For Permitted Transactions, a SEF may offer any method of execution.

Commissioner Sommers voted against the rule, observing that it went beyond what the statute required and might pose problems for U.S. competitiveness.

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