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From Securities Regulation Daily, July 15, 2015

CFTC commissioners criticize process for swaps execution mandate

By Lene Powell, J.D.

At a CFTC roundtable today on trade execution in derivatives markets, Commissioners J. Christopher Giancarlo and Mark Wetjen criticized the process that determines whether swaps contracts must be executed on an organized exchange versus over-the-counter. Giancarlo warned of inconsistency with other jurisdictions and urged the CFTC to be more flexible in accepting methods of execution, saying this would promote the trading of swaps on exchanges. Taking a different tack, Wetjen recommended that the CFTC take a greater role in making the determinations, which are currently largely driven by market participants.

Trade execution mandate. The Dodd-Frank Act amended Section 2(h)(8) of the Commodity Exchange Act to require that swaps that are required to be cleared must be executed on a designated contract market (DCM) or swaps execution facility (SEF) unless the swap is not “available to trade” on any DCM or SEF. This is known as the “trade execution requirement.” The aim of the trade execution mandate was to drive more swaps to be executed on organized exchanges, with the hope that this would result in better risk management and transparency in the derivatives markets.

Whether or not a swap is “available to trade” on an exchange is determined by the “made available to trade” process (MAT). Using this process, DCMs and SEFs may submit a determination to the CFTC that a certain swap contract is available to trade, either by requesting the CFTC’s approval or by self-certifying. If the CFTC does not reject the submission, the swap is approved or deemed certified as available to trade. After that, the particular swap contract may no longer be offered over-the-counter and must be traded on an organized exchange in accordance with the trade execution requirement. It was generally anticipated that the market-driven MAT process would result in higher volumes of derivatives trades taking place on exchanges as SEFs competed to be the first to list particular swaps contracts.

Giancarlo: more flexibility needed. According to Commissioner Giancarlo, the MAT process is problematic for a number of reasons. It is not supported by the Dodd-Frank Act, which did not intend to limit swaps execution methods to Order Book or Request for Quote systems. Liquidity for swaps is generally more episodic than for futures, meaning a broader variety of execution methods are necessary. Also, more flexible methods of execution would allow for technological advances, promote pre-trade price transparency and trading on SEFs, and align more closely with other jurisdictions, which are not as restrictive as the U.S on trade execution methods.

Giancarlo noted that some market participants, concerned with the MAT process, have urged the CFTC to step in and make the determinations of which swaps are required to trade on SEFs.  However, the choice between a CFTC-driven and platform-driven process is a false choice. If the CFTC did not limit SEF execution methods, there would be no need for the flawed MAT process, the commissioner said.

Wetjen: CFTC should lead process. Although the original intent of the MAT process was to let facilities decide, in practice this has not been the best approach, Wetjen said in a written statement. With the MAT process, a single SEF can propose what the CFTC will review. And, if no SEF submits a certain contract for “available to trade” status, SEFs can also choose what the CFTC will not review. The MAT process could be improved by a more orderly Commission-initiated determination, including a traditional comment period process, said Wetjen.

MainStory: TopStory Derivatives Swaps ExchangesMarketRegulation CFTCNews

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