SPEECHES & TESTIMONY

Statement of Concurrence of Commissioner Rostin Behnam Regarding Swap Execution Facilities and Trade Execution Requirement

November 5, 2018

Introduction

Today, the Commission votes to issue proposed rules that would constitute an overhaul of the existing framework for swap execution facilities (SEFs).  I wish to commend staff for all of their very hard work in producing the document before us.  I appreciate the long hours that were spent by the staff presenting today, and by many other members of our dedicated staff working behind the scenes. 

The Commission’s action today begins the process of public notice and comment under the Administrative Procedure Act.[1]  Given the breadth and complexity of the proposed rules before us, the process of public comment is particularly important.  I look forward to receiving input from market participants and the public who would be impacted, in any way, by a reworking of the SEF rules. 

Background

As we consider the goals and therefore the direction of any SEF reform, I think it is very important that we first review how we got where we are today.  Prior to the 2008 financial crisis, swaps were largely exempt from regulation and traded exclusively over-the-counter, rather than on a regulated exchange.[2]  Lack of transparency in the over-the-counter swaps market contributed to the financial crisis because both regulators and market participants lacked the visibility necessary to identify and assess swaps market exposures and counterparty relationships.[3]  In the aftermath of the financial crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 (Dodd-Frank Act).[4]  The Dodd-Frank Act largely incorporated the international financial reform initiatives for over-the-counter derivatives laid out at the 2009 G20 Pittsburgh Summit aimed at improving transparency, mitigating systemic risk, and protecting against market abuse.[5]  Title VII of the Dodd-Frank Act amended the Commodity Exchange Act (CEA or Act) to establish a comprehensive new swaps regulatory framework that includes the registration and oversight of a new registered entity – SEFs.  A key goal of Title VII of the Dodd-Frank Act is to bring greater pre-trade and post-trade transparency to the swaps market.  The concept of transparency runs throughout Title VII – starting with the title itself:  the “Wall Street Transparency and Accountability Act of 2010.”[6] 

As part of the Dodd-Frank effort to provide more transparency, in 2013 the Commission adopted the part 37 rules in order to implement a regulatory framework for SEFs.[7]  In so doing, the Commission emphasized that “[pre-trade] transparency lowers costs for investors, consumers, and businesses; lowers the risks of the swaps market to the economy; and enhances market integrity to protect market participants and the public.”[8] 

The relatively young SEF framework has in many ways been a success.  There are currently 25 registered SEFs.[9]  Trading volume on SEF has been steadily growing each year.[10]  The Commission’s work to promote swaps trading on SEFs has resulted in increased liquidity, while adding pre-trade price transparency and competition. [11]

This is not to say that the SEF rules were perfect from the start and would not benefit from some targeted changes.  Most SEFs operate under multiple no-action letters granted by the Division of Market Oversight.  While the purpose of this form of targeted relief was often to smooth the implementation of the SEF framework, codifying or eliminating the need for existing no-action relief would provide market participants with greater legal certainty. 

The current SEF rules have not brought as much trading onto SEFs as intended or envisioned.  We can improve upon that.  Currently, the Commission has a regulatory process for SEFs to demonstrate through a multi-factor analysis that a swap has been made-available-to-trade, or “MAT,”[12] meaning that it is required to trade on a SEF or DCM.  The current process has resulted in relatively few MAT determinations and, after an initial flurry of submissions for the most standardized and liquid products, no further submissions have been made.  I believe that addressing the MAT process could bring more activity on SEF, bringing pre-trade transparency to more products without dismantling the aspects of the SEF rules that are working currently. 

Notice of Proposed Rulemaking (NPRM)

While I believe targeted reforms could bring more products onto SEFs, increase transparency, and lower costs for market participants, today’s NPRM is far from targeted, and in some instances may represent a regulatory overreach.  I therefore have a number of very serious concerns with the NPRM’s approach and its far-ranging alterations.  First, the NPRM violates the clear language of the Act, which states that one of the major goals of the SEF regulatory regime is to promote pre-trade transparency in the swaps market.  As discussed below, the NPRM does exactly the opposite.  Second, in addition to reducing transparency, the proposed rule also increases limitations on access to SEFs.  The NPRM purports to increase choice and flexibility for SEFs; however, it simultaneously allows SEFs to limit choice and flexibility for market participants.  Third, as commenters and the Commission think about the NPRM, I think it is also important to consider whether we would be creating a new registration scheme that adds significant costs for market participants, while failing to address the fixable issues that exist in the market today. 

Pre-trade Transparency

Section 1a(50) of the Act defines a SEF as “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce . . ..”[13]  Section 5h(e) of the Act states that “[t]he goal of this section is to promote trading of swaps on swap execution facilities and to promote pre-trade transparency in the swaps market.”[14]  The existing SEF rules establish two methods of execution for required transactions:  the central limit order book (CLOB) and the Request for Quote (RFQ) system.[15]  These methods were chosen specifically because they provide pre-trade transparency.

I am concerned that the NPRM goes too far by allowing, literally, any means of execution.  The NPRM’s preamble states that the approach “should also promote pre-trade transparency in the swaps market by allowing execution methods that maximize participation and concentrate liquidity. . .”  This simply cannot be true.  Absent a clear standard of what constitutes pre-trade transparency, it is fairly easy to envision an execution method that would not provide pre-trade transparency – one need look no further than the over-the-counter system that preceded the financial crisis.  But this is more than a case of what the Commission should or should not do.  The statute is clear.  The Commission must “promote pre-trade transparency in the swaps market.”  Today’s NPRM would not do that. 

That is not to say that expanding methods of execution – in a more limited and targeted way – is a bad idea or violates the Act.  There are likely other execution methods that fit within section 1a(50) and would promote pre-trade transparency.  I look forward to hearing from commenters as to what those methods might be, and debating with my fellow Commissioners as to whether they are appropriate within the confines of congressional intent and ultimately the Act.    

Made Available to Trade

As I mentioned earlier, the MAT process is seemingly broken.  The Commission stopped receiving MAT submissions after an initial set of submissions for the most standardized and liquid swaps contracts.[16]  The Commission has not received any MAT submissions or made any MAT determinations since 2014.[17]  This is not what the Commission envisioned in promulgating the Made Available to Trade rule.[18]  The solution posited today is, in a sense, a simple, elegant one.  The NPRM states that the phrase “makes the swap available to trade” in CEA section 2h(8) should be interpreted to mean that “once the clearing requirement applies to a swap, then the trade execution requirement applies to that swap upon any single SEF or DCM listing the swap for trading.”  This would take both the SEF and the Commission out of the determination process. 

My concern, however, is that there may be products that are more appropriately traded off SEF.  In addition, tying the trade execution requirement to the clearing requirement could have unintended consequences – it could actually discourage voluntary central clearing. 

I look forward to hearing from commenters regarding the appropriate interpretation of the term “made available to trade”, including how to improve the existing process. 

Impartial Access

One of the most troubling aspects of the NPRM is that it would alter the Commission’s interpretation of “impartial access” under SEF Core Principle 2.  Core Principle 2 of the Act requires SEFs to establish and enforce participation rules that “provide market participants with impartial access to the market.”[19]  Current Commission regulation 37.202(a) states that a SEF “shall provide any eligible contract participant . . . with impartial access to its market(s) and market services.” (emphasis added).  The Commission was clear in the preamble to the existing rules that “the purpose of the impartial access requirement is to prevent a SEF’s owners from using discriminatory access requirements as a competitive tool” against certain eligible contract participants.[20]  The current rule provides that a SEF can restrict access based on disciplinary history or financial or operational soundness, if objective, pre-established criteria are used.  What a SEF cannot do is restrict access to certain types of participants. 

Today’s NPRM would roll back this interpretation, leaving the term “impartial access” an empty shell.  The proposed rule would “allow SEFs to serve different types of market participants or have different access criteria for different execution methods.”  This is exactly the type of discrimination that the “impartial access” provision in the Act was intended to prevent.

I believe that all market participants should have impartial access to a SEF whose access criteria is applied in a fair and non-discriminatory manner.  Rather than erecting new barriers to participation, we should focus on applying our existing regulations as they are clearly written.  It seems to me that impartial access theoretically would go hand-in-hand with the proposed widening of SEF execution methods.  Instead, the Commission seems to be bending over backwards to be impartial regarding SEFs’ modes of execution, while allowing the SEFs themselves to discriminate.  This threatens to take us back to the world as it was pre-Dodd-Frank and pre-financial crisis, undermining some of the key successes of the existing SEF regulatory regime regarding transparency and market access. 

Registration/Costs

I would like to turn for a minute to the potential costs to market participants – and the Commission – from this proposed rule.  Currently, there are 25 registered SEFs.[21]  The Proposal will drastically increase the number of SEFs – likely by multiples.  In the cost benefit considerations to the NPRM, the Commission estimates that approximately 40-60 swaps broking entities, including interdealer brokers, and one single-dealer aggregator platform would need to register as a SEF.  That is the universe that we know – the market as we understand it to exist today.  There could be more – perhaps many more – entities that will fall under the expanded registration requirements.  Just as importantly, we do not know how these new rules will incentivize SEFs – whether they will lead to consolidation or myriad SEFs with myriad methods of execution. 

The new registration regime, and the many changes that come along with it, will result in substantial costs all around:  to both existing SEFs and new SEF registrants, and to their participants.  I note with some concern that, while the preamble provides a laundry list of what rule changes will result in costs, there is no effort to quantify them.  Operating or participating in a regulated market comes with costs; but, these incremental costs are offset, in part, by the benefits of having access to a transparent, safe market ecosystem that demands accountability and punishes wrongdoers.  I do not mean to suggest anything else.  However, as the Commission proceeds with this NPRM, I am hopeful that the best, most cost effective regulatory solutions will prevail as the Commission seeks to improve and advance the health and vibrancy of the SEF marketplace.    

Comment Period

I also want to quickly raise a non-substantive concern, but one that may greatly impact the substance of the NPRM.  The comment period for the proposal is only 75 days.  As I have stated previously, this rulemaking is complex and impacts a wide range of market participants in fundamental ways.  There are 105 numbered questions for commenters in the NPRM’s preamble, in addition to general requests for comment.  I think it is very important that we give market participants time to carefully consider the proposed rule and make reasoned comments.  Recent proposed rules that raised complex issues, like the capital rule and Reg AT, had 90 day comment periods followed by extensions of at least an additional 60 days.[22]  The original part 37 notice of proposed rulemaking ultimately had open comment periods totaling 90 days, and market participants had 7 months between publication of the notice of proposed rulemaking and the end of the final comment period.[23]  Today’s NPRM deserves careful consideration, both from the public and from the Commission, and I hope that the Commission will give market participants the time they need to respond thoughtfully and thoroughly. 

Name Give Up Request For Comment

Before I conclude, I would like to turn briefly to the name give-up request for comment that is before us as well, as it is inextricably tied to the SEF NPRM.  Post-trade name give-up also relates to the issue of impartial access, which I discussed earlier.  While today’s SEF NPRM reworks the SEF rules generally, the NPRM does not address the long standing practice of disclosing the identity of each swap counterparty to the other after a trade has been matched anonymously.  Instead, the Commission is voting to issue a request for comment seeking public comment on the practice.  While I appreciate the desire to be measured and thoughtful on this issue, I fear that not taking a view at this time in the proposal may function as an endorsement of the status quo.  The request for comment puts name give-up on a slower track than the rest of the rule.  Any rule to address the issue will now be well behind the process for the rest of the SEF rules. 

Conclusion

As outlined above, I have numerous concerns about this NPRM, both in terms of what the Commission should do as policy makers, and in terms of what the Commission can do under the law.  Congress was clear in the Dodd-Frank Act – the Commission is tasked with bringing greater pre-trade transparency to the swaps market.  Today’s NPRM not only fails to advance pre-trade transparency, it actually undermines pre-trade transparency that has been achieved through our existing regulations.  In addition to the few issues I raise today, the NPRM’s changes also demand thoughtful deliberation on equally important issues related to cross-border implications, investigations, audit trails, recordkeeping, and disciplinary hearings to name just a few. 

As I read through the NPRM, I noticed a common thread that naturally aims to shift the current part 37 regime to a less prescriptive, and more principles based regime.  The frequent weaving of words into the text of the NPRM like, defer, flexible, reasonable, and discretion stand as a clear declaration of where this proposal’s authors want it to go.  I have long been a proponent of sensible principles based regulation.  I believe our markets, and more importantly this agency, are strongly rooted in a principles based regulatory regime.  However, like the words of this NPRM, I have woven my own thoughts on striking the right balance between principles based and rules based regulation.  Principles based regulation certainly does not mean an absence of rules—or the absence of supervision.

In remarks I delivered in February of this year, I stated, “…[w]hile I strongly oppose any roll backs of Dodd-Frank initiatives, I believe a principles-based approach to implementation can be suitable in certain instances.  A principles-based approach provides greater flexibility, but more importantly focuses on thoughtful consideration, evaluation, and adoption of policies, procedures, and practices as opposed to checking the box on a predetermined, one-size-fits-all outcome.  However, the best principles-based rules in the world will not succeed absent: (1) clear guidance from regulators; (2) adequate means to measure and ensure compliance; and (3) willingness to enforce compliance and punish those who fail to ensure compliance with the rules.” [24]  

If the Commission was voting on a final rule today, my vote would be no.  However, I fully recognize that our existing part 37 rules are not perfect.  Bringing more activity on SEF is a laudable goal, both from a policy perspective and because Congress has tasked the Commission with doing so.  I will support  today’s proposed rule because I believe that it is important that we hear from market participants regarding what aspects of the NPRM will improve the regulatory framework for SEFs, while staying within our responsibilities under the law.

 

[1] The Administrative Procedure Act, 5 U.S.C. § 500 et seq.

[2] See Commodity Futures Modernization Act of 2000, Public Law 106-554, 114 Stat. 2763 (2000).

[3] See The Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report:  Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (Official Government Edition), at 299, 352, 363-364, 386, 621 n. 56 (2011), available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

[4] See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

[5] G20, Leaders’ Statement, The Pittsburgh Summit (Sept. 24-25, 2009) at 9, available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf

[6] See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, tit. VII, Section 701, 124 Stat. 1376 (2010).

[7] Core Principles and Other Requirements for Swap Execution Facilities, 78 FR 33476 (Jun. 4, 2013).

[8] Id. at 33477.

[9] See Trading Organizations – Swap Execution Facilities (SEF), CFTC.gov, https://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities (last visited Nov. 4, 2018).

[10] See FIA SEF Tracker, FIA.org, https://fia.org/node/1901/ (last visited Nov. 4, 2018).

[11] See Bank of England Staff Working Paper No. 580, Centralized Trading, Transparency and Interest Rate Swap Market Liquidity:  Evidence from the Implementation of the Dodd-Frank Act (May 2018), pp. 2-4, 18-24, available at https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2018/centralized-trading-transparency-and-interest-rate-swap-market-liquidity-update. 

[12] See 17 C.F.R. §§ 37.10, 38.12.

[13] 7 U.S.C. 1a(50).

[14] 7 U.S.C. 7b-3(e). 

[15] See 17 C.F.R. § 37.9.

[16] See CFTC, Industry Oversight, Industry Filings, Swaps Made Available to Trade Determination, https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination. 

[17] Id.

[18] See Process for a Designated Contract Market or Swap Execution Facility To Make a Swap Available to Trade, Swap Transaction Compliance and Implementation Schedule, and Trade Execution Requirement Under the Commodity Exchange Act, 78 FR 33606 (Jun. 4, 2013).

[19] 7 U.S.C. 7b-3(f)(2). 

[20] Supra note 7 at 33508. 

[21] See Trading Organizations – Swap Execution Facilities (SEF), CFTC.gov, https://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities (last visited Nov. 4, 2018).

[22] Capital Requirements of Swap Dealers and Major Swap Participants, 81 FR 91252 (proposed Dec. 16, 2016), and Capital Requirements of Swap Dealers and Major Swap Participants, 82 FR 13971 (March 16, 2017) (extending comment period an additional 60 days); Regulation Automated Trading, 80 FR 78824 (proposed Dec. 17, 2015), Regulation Automated Trading, 81 FR 85334 (proposed Nov. 25, 2016), and Regulation Automated Trading, 82 FR 8502 (Jan. 26, 2017).

[23] Reopening and Extension of Comment Periods for Rulemakings Implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act, 76 FR 25274 (May 4, 2011), available at https://www.gpo.gov/fdsys/pkg/FR-2011-05-04/pdf/2011-10884.pdf.

 

[24] Rostin Behnam, Commissioner, U.S. Comm. Fut. Trading Comm’n, Remarks of Rostin Behnam before FIA/SIFMA Asset Management Group, Asset Management Derivatives Forum 2018, Dana Point, California (Feb. 8, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam2.