I support the Commission’s decision to withdraw its 2018 proposal to overhaul the regulation of swap execution facilities (SEFs)[1] (2018 SEF NPRM) and proceed instead with targeted adjustments to our SEF rules (Final Rules).  The two Final Rules approved today will make minor changes to SEF requirements while retaining the progress we have made in moving standardized swaps onto electronic trading platforms, which has enhanced the stability, transparency, and competitiveness of our swaps markets.[2]

When the Commission issued the 2018 SEF NPRM, I proposed that we enhance the existing swaps trading system instead of dismantling it.  For example, I urged the Commission to clarify the floor trader exception to the swap dealer registration requirement and abolish the practice of post-trade name give-up for cleared swaps.  I am pleased that the Commission already has acted favorably on both of those matters.  Today’s rulemaking represents a further positive step in this targeted approach. 

Many commenters to the 2018 SEF NPRM supported this incremental approach, advocating discrete amendments rather than wholesale changes.  Today, the Commission is adopting two Final Rules that codify tailored amendments that received general support from commenters.  The first rule—Swap Execution Facilities—amends part 37 to address certain operational challenges that SEFs face in complying with current requirements, some of which are currently the subject of no-action relief or other Commission guidance.  The second rule—Exemptions from Swap Trade Execution Requirement—exempts two categories of swaps from the trade execution requirement, both of which are linked to exceptions to or exemptions from the swap clearing requirement.

Swap Execution Facilities: Audit Trail Data, Financial Resources and Reporting, and Requirements for Chief Compliance Officers

Commission regulations require a SEF to capture and retain all audit trail data necessary to detect, investigate, and prevent customer and market abuses, which currently includes identification of each account to which fills are ultimately allocated.[3]  Following the adoption of these regulations, SEFs represented that they are unable to capture post-execution allocation data because the allocations occur away from the SEF, prompting CFTC staff to issue no-action relief.  Other parties, including DCOs and account managers, must capture and retain post-execution allocation information and produce it to the CFTC upon request, and SEFs are required to establish rules that allow them obtain this allocation information from market participants as necessary to fulfill their self-regulatory responsibilities.  Given that staff is not aware of any regulatory gaps that have resulted from SEFs’ reliance on the no-action letter, codifying this alternative compliance framework is appropriate.

This Swap Execution Facility final rule also will amend part 37 to tie a SEF’s financial resource requirements more closely to the cost of its operations, whether in complying with core principles and Commission regulations or winding down its operations.  Based on its experience implementing the SEF regulatory regime, the Commission believes that these amended resource requirements—some of which simply reflect current practice—will be sufficient to ensure that a SEF is financially stable while avoiding the imposition of unnecessary costs.  Additional amendments to part 37, including requirements that a SEF must prepare its financial statements in accordance with U.S. GAAP standards, identify costs that it has excluded in determining its projected operated costs, and notify the Commission within 48 hours if it is unable to comply with its financial resource requirements, will further enhance the Commission’s ability to exercise it oversight responsibilities.

Finally, this rule makes limited changes to the Chief Compliance Officer (CCO) requirements.  As a general matter, I agree that the Commission should clarify certain CCO duties and streamline CCO reporting requirements where information is duplicative or not useful to the Commission.  Although the CCO requirements diverge somewhat from those for futures commission merchants and swap dealers, the role of SEFs is different and therefore, standardization is not always necessary or appropriate.  I expect that the staff will continue to monitor the effects of all of the changes adopted today and inform the Commission if it believes further changes to our rules are needed.

Exemptions from Swap Trade Execution Requirement

Commodity Exchange Act (CEA) section 2(h)(8) specifies that a swap that is excepted from the clearing requirement pursuant to CEA section 2(h)(7) is not subject to the requirement to trade the swap on a SEF.  Accordingly, swaps that fall into the statutory swap clearing exceptions (e.g., commercial end-users and small banks) are also excepted from the trading mandate.  However, the Commission has also exempted from mandatory clearing swaps entered into by certain entities (e.g., cooperatives, central banks, and swaps between affiliates) using different exemptive authorities from section 2(h)(7). 

The Exemptions from Swap Trade Execution Requirement final rule affirms the link between the clearing mandate and the trading mandate for swaps that are exempted from the clearing mandate under authorities other than CEA section 2(h)(7).  The additional clearing exemptions are typically provided by the Commission to limited types of market participants, such as cooperatives or central banks that use swaps for commercial hedging or have financial structures or purposes that greatly reduce the need for mandatory clearing and SEF trading.  In addition, limited data provided in the release indicates that, at least up to this point in time, these exempted swaps represent a small percentage of the notional amount of swaps traded.

This final rule also exempts inter-affiliate swaps from the trade execution requirement.  These swaps are exempted from the clearing requirement primarily because the risks on both sides of the swap are, at least in some respects, held within the same corporate enterprise.  As described in the final rule release, these swaps may not be traded at arms-length and serve primarily to move risk from one affiliate to another within the same enterprise.  Neither market transparency nor price discovery would be enhanced by including these transactions within the trade execution mandate.  For these reasons, I am approving the Exemptions from Swap Trade Execution Requirement final rule as a sensible exemption consistent with the relevant sections of the CEA.

Conclusion

These two Final Rules provide targeted changes to the SEF regulations based on experience from several years of implementing them.  These limited changes, together with the withdrawal of the remainder of the 2018 SEF NPRM, effectively leave in place the basic framework of the SEF rules as originally adopted by the Commission.  This framework has enhanced market transparency, improved competition, lowered transaction costs, and resulted in better swap prices for end users.  While it may be appropriate to make other incremental changes going forward, it is important that we affirm the established regulatory program for SEFs to maintain these benefits and facilitate further expansion of this framework.

I thank the staff of the Division of Market Oversight for their work on these two rules and their helpful engagement with my office.

[1] Swap Execution Facilities and Trade Execution Requirement, 83 FR 61946 (Nov. 30, 2018).

[2] Dissenting Statement of Commissioner Dan M. Berkovitz Regarding Proposed Rulemaking on Swap Execution Facilities and Trade Execution Requirement (Nov, 5, 2018), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement110518a. 

[3] 17 CFR 37.205(a), b(2)(iv).