Overview

As a former legislative staffer with a front row seat during the development of the Dodd-Frank Act,[1] I observed that the bulk of the debate was devoted to the complicated task of how the clearing mandate would be applied to swaps that previously traded in the over-the-counter market and which types of market participants would need to migrate positions into a cleared environment.  By contrast, the operational aspects of trade execution were left to be finalized near the end of the process, and unfortunately received less attention due to a push for quick completion of the legislation – this is probably evident from the verbiage, or lack thereof, that appears in the statute on this topic.

I have said it before – building an entirely new regulatory regime for an equally new market structure is quite a challenge, especially so for tools, such as swaps, where legacy markets existed long prior to the structure Congress directed us to develop.  No one assumed it was going to be easy, and I admit to a sense of personal relief that I was not at the Commission when it undertook the enormous endeavor of establishing a new framework governing swap execution facilities (SEFs).  It has been over seven years since the Commission adopted its SEF Rules,[2] and I also admit to a sense of admiration for what was achieved in such a short timeframe.  That said, it is not surprising that varying statutory interpretations emerged among Commissioners at that time, with resulting confusion surrounding how best to implement Congress’ goals for SEF trading.  The challenges in implementing the SEF Rules have proven vast, questions have persisted, and uncertainty has reigned.  As a result, Staff of the Commission has issued numerous no-action letters to address shortcomings.

Today, our Commission has a different task derived from the often-overlooked component of the Leaders’ Statement from the 2009 Group of 20 (G-20) Summit in Pittsburgh, which stipulates that regulators should “assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.”[3]  It is noteworthy that in 2009, in the midst of responding to the financial crisis, the G-20 Leaders recognized that, as individual jurisdictions implemented these monumental principles, a look-back would be needed to ensure the objectives were being met.    

In conducting this look-back, we have the benefit of time and experience.  The way SEFs approached the new regulatory framework, while once novel and uncertain, has matured into more established market practice.  While the Commission, SEFs, and swap trading counterparties were once unsure of how the new regime would develop, we are now informed about how these practices have evolved.  And the passage of time also affords us the chance to observe how Staff no-action relief has operated in real-time.  Our role today is to heed the lessons learned and leverage our knowledge from observing these markets in action. 

In fulfilling that role, we are adopting two rulemakings that both arise out of a set of reforms to the SEF Rules proposed in 2018 (the “2018 SEF Proposal”), and that make changes to the Commission’s rules in 5 areas relating to SEFs and the trade execution mandate.  By recognizing the current reality of how SEFs, and those utilizing these venues, have applied our regulations and built their infrastructure and systems, these rulemakings improve upon the original iteration of the SEF Rules.  In some instances, they codify previous Staff action, thereby providing legal certainty and fostering prudent oversight over these swap markets.  Significantly, the Commission did not receive any comment letters voicing substantive opposition to the changes we are adopting in these two rulemakings. 

Rules Relating to SEFs: Part 37 

First, we are amending the Commission’s Part 37 rules for SEFs in 3 areas, concerning a SEF’s:  1) audit trail data; 2) financial resources; and 3) chief compliance officer (CCO) and annual compliance reports (ACRs).   More specifically, among other things, this rulemaking—   

Audit Trail: 

• Requires a SEF to capture and retain in its audit trail information through the execution of a trade on the SEF, but not post-execution allocation information as under the current rules since SEFs do not have access to this type of information.

Financial Resources: 

• Adjusts the liquid assets that a SEF is required to maintain, in order to tailor this requirement to the projected costs needed to wind down the SEF’s operations;
• Provides that a SEF’s calculation of its projected operating costs need include only the costs of activities necessary to comply with the SEF Core Principles under the CEA and the Commission’s rules;
• Requires that the quarterly financial statements that a SEF submits to the Commission be those of the SEF itself, rather than its parent company as currently permitted;
• Extends the time for submitting fourth-quarter financial reports to the Commission in recognition of staffing challenges and timing constraints associated with the regulatory requirements applicable to SEFs at year-end; and
• Requires SEFs to notify the Commission of noncompliance with financial resource requirements within 48 hours after the SEF knows or reasonably should know of its noncompliance. 

CCOs and ACRs: 

• Provides a SEF’s senior officer with the same day-to-day oversight authority over the CCO as the board of directors in recognition that in many instances, the senior officer may be better positioned to exercise these responsibilities;
• Incorporates reasonableness and materiality standards into the duties of the CCO, and the ACR certification responsibility of the CCO, in order to avoid imposing standards of conduct that are impossible for a CCO to meet;
• Enhances the overall quality of ACRs by eliminating requirements that do not provide useful information to the Commission in evaluating SEF compliance; and
• Extends the time for submitting the ACR to the Commission in conformity with the timeline for submitting a SEF’s fiscal year-end financial reports.

These are common-sense amendments that are based on our experience in implementing the SEF Rules, as opposed to drawing assumptions based upon unknowns as constrained previous Commissions.  On balance, the amendments to Part 37 that we are adopting appropriately streamline requirements imposed on SEFs and their CCOs, and make our SEF Rules workable in practice.  As I have stated before, no matter how well-intentioned a rule may be, if it is not workable, it cannot deliver on its intended purpose.[4]  Based on our oversight of these markets and monitoring of no-action relief issued by our Staff, I believe these refinements to the SEF Rules will enhance compliance without adversely affecting our ability to fulfill the Commission’s responsibilities under the CEA. 

Exemptions from the Trade Execution Mandate: Part 36

Second, we are amending the Commission’s Part 36 rules to provide 2 exemptions from the CEA’s trade execution mandate for swaps that:  1) qualify for an exemption to, or exception from, the CEA’s clearing mandate under the Commission’s rules; or 2) are entered into by affiliated counterparties that qualify for the Commission’s inter-affiliate exemption from the clearing mandate, but that the affiliated counterparties elect to clear voluntarily. 

More specifically, the first exemption from the requirement that a swap be traded on a SEF[5] applies to swaps that the Commission has either exempted from, or determined are not subject to, the clearing mandate.  This currently includes, among others, and subject to applicable conditions—

• Swaps entered into by cooperatives;
• Swaps that qualify for the inter-affiliate exemption; and
• Swaps entered into by banks and bank holding companies, savings associations and savings and loan holding companies, farm credit system institutions, credit unions, central banks, sovereign entities, certain international financial institutions, and certain swaps entered into by community development financial institutions.

The Dodd-Frank Act amended the CEA to establish a trade execution mandate for “swaps subject to the clearing requirement.”[6]  Thus, Congress intended that swaps that are not subject to a clearing mandate should not be subject to a trade execution mandate, either.  The exemption to the trade execution mandate that we are adopting for swaps that the Commission has exempted, or found to be excepted, from the clearing mandate is consistent with this Congressional intent.

The second exemption from the requirement that a swap be traded on a SEF applies to swaps that qualify for the Commission’s clearing exemption for swaps between affiliates – but that the affiliated counterparties voluntarily elect to clear anyway.  As discussed in the release, inter-affiliate swaps offer significant benefits to corporate groups from a risk management perspective; and, since these swaps are not arm’s length, market-facing, or competitively executed, they do not contribute to price discovery if executed on a SEF.  This exemption also advances the objective of the G-20 Leaders’ Statement and the Dodd-Frank Act to promote central clearing of swaps.  Accordingly, this is a prudent exemption to the trade execution mandate. 

Withdrawal of Unadopted Portions of 2018 Proposal

With respect to the remainder of the 2018 SEF Proposal, I commend former Chairman Giancarlo for his thought leadership in putting forward a principled proposal for public consideration.  Commenters, however, expressed substantial concerns about the expansive nature of some of the structural reforms for SEFs that were included in that proposal.  In light of this public feedback, I concur in the decision to adopt the targeted rule changes regarding SEF operations and the trade execution mandate discussed above, and to withdraw the broader market reforms contained in the 2018 SEF Proposal.

Conclusion

In closing, let me say how pleased I am at the work the Commission has done this year to enhance our SEF Rules.  These two rulemakings follow on our recent rulemakings addressing other pressing SEF-related issues such as package transactions, error trades, and block trades.[7]  Through these actions, we have made the SEF Rules more workable in practice, answered fundamental questions that have been lingering for awhile, and provided the legal certainty that comes from policymaking by rulemaking rather than Staff relief. 

But that is not to say that our work regarding SEFs is necessarily complete.  Some staff relief remains outstanding, such as Letter No. 17-17 regarding SEF confirmation and recordkeeping requirements,[8] that might also be appropriate for a transition into formal regulations.  And I suspect that market participants have additional thoughts about areas for constructive changes in our SEF Rules.  I would like to reiterate my view that we need an ongoing review of our rules implementing the Dodd-Frank Act that builds upon the efforts of this agency in the aftermath of the financial crisis.[9] 

I would like to express my thanks and sincere gratitude to the Staff who diligently worked to prepare the rulemakings that we are adopting, and who worked patiently with my Office to answer our questions and address our comments.  I also want to commend those Staff members, particularly in the Division of Market Oversight, who have been thoughtfully considering ways to improve the Commission’s regulatory framework for SEFs for quite some time, and who worked on the 2018 SEF Proposal (including those portions that we are withdrawing).  Those efforts predated my arrival at the Commission, but helped to highlight issues that are of importance to me, and I appreciate your excellent work in that regard.

[1] Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, Title VII, 124 Stat. 1376 (2010) (Dodd-Frank Act). 

[2] See Core Principles and Other Requirements for Swap Execution Facilities, 78 Fed. Reg. 33476 (June 4, 2013).  As used in this Statement, references to the “SEF Rules” encompass rules governing SEFs themselves, as well as rules regarding the trade execution mandate set forth in Section 2(h)(8), 7 U.S.C. 2(h)(8), of the Commodity Exchange Act (CEA).

[3] See Leaders’ Statement from the 2009 G-20 Summit in Pittsburgh, Pa. at 9 (September 24-25, 2009), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.

[4] Statement of Commissioner Dawn D. Stump Regarding Final Rule:  Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants (July 23, 2020), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement072320.

[5] Swaps that are subject to the CEA’s trade execution mandate may be traded on a designated contract market in lieu of a SEF.

[6] CEA Section 2(h)(8)(A), 7 U.S.C. 2(h)(8)(A).

[7] See Swap Execution Facility Requirements (adopted November 18, 2020, publication in Federal Register pending) (package transactions, error trades), available at https://www.cftc.gov/PressRoom/PressReleases/8313-20; Real-Time Public Reporting Requirements, 85 Fed. Reg. 75422 (November 25, 2020) (block trades).

[8] CFTC Letter No. 17-17, Extension of No-Action Relief for Swap Execution Facility Confirmation and Recordkeeping Requirements under Commodity Futures Trading Commission Regulations 37.6(b), 37.1000, 37.1001, 45.2, and 45.3(a) (March 24, 2017), available at https://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-17.pdf.

[9] As I have said before, “[i]t is simply good government to re-visit our rules and assess whether certain rules need to be updated, evaluate whether rules are achieving their objectives, and identify rules that are falling short and should be withdrawn or improved.”  Statement of Commissioner Dawn D. Stump for CFTC Open Meeting on:  1) Final Rule on Position Limits and Position Accountability for Security Futures Products; and 2) Proposed Rule on Public Rulemaking Procedures (Part 13 Amendments) (September 16, 2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement091619.