2020-02721
Federal Register, Volume 85 Issue 33 (Wednesday, February 19, 2020)
[Federal Register Volume 85, Number 33 (Wednesday, February 19, 2020)]
[Proposed Rules]
[Pages 9407-9430]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-02721]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 36, 37, and 43
RIN 3038-AE94
Swap Execution Facility Requirements and Real-Time Reporting
Requirements
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') proposes to amend certain parts of its regulations relating
to the execution of package transactions on swap execution facilities
(``SEFs''); the execution of block trades on SEFs; and the resolution
of error trades on SEFs. These matters are currently the subject of
relief in certain no-action letters from Commission staff.
DATES: Comments must be received on or before April 20, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AE94, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an
[[Page 9408]]
English translation. Comments will be posted as received to https://www.cftc.gov. You should submit only information that you wish to make
available publicly. If you wish the Commission to consider information
that you believe is exempt from disclosure under the Freedom of
Information Act (``FOIA''),\1\ a petition for confidential treatment of
the exempt information may be submitted according to the procedures
established in the Commission's regulations, 17 CFR 145.9.
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\1\ 5 U.S.C. 552.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all of
your submission from https://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
FOIA.
FOR FURTHER INFORMATION CONTACT: Roger Smith, Special Counsel, (202)
418-5344, [email protected], Division of Market Oversight, Commodity
Futures Trading Commission, 525 West Monroe Street, Suite 1100,
Chicago, Illinois 60661, or Michael Penick, Senior Economist, (202)
418-5279, [email protected], Office of the Chief Economist, Commodity
Futures Trading Commission, Three Lafayette Centre, 1151 21st Street
NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Parts 37 and 43 of the Commission's Regulations
B. Summary of Proposed Changes to Parts 36, 37, and 43
C. Consultation With Other U.S. Financial Regulators
II. The Proposed Regulations
A. Execution of Package Transactions
1. Background
2. Proposed Addition of Sec. 37.9(d) and Amendment of Sec.
37.9(a)(2)
3. Request for Comment
4. Existing Sec. 37.3(a)
5. Proposed Addition of Sec. 37.3(a)(4)
6. Request for Comment
7. Exemption of New Issuance Bond Package Transaction From the
Trade Execution Requirement
8. Discussion of CEA Section 4(c) Enumerated Factors
9. Request for Comment
B. Error Trades: Execution of Trades To Correct Operational and
Clerical Errors on Swap Execution Facilities
1. Background
2. Proposed Sec. 37.9(e)
3. Request for Comment
C. Real-Time Public Reporting: Block Trade Definition
1. Existing Sec. 43.2
2. Proposed Amendment to Sec. 43.2
3. Request for Comment
III. Effective Date and Transition Period
IV. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
D. Antitrust Considerations
I. Background
A. Parts 37 and 43 of the Commission's Regulations
The Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act'') amended the Commodity Exchange Act (``CEA'' or
``Act'') by adding section 5h, which establishes registration
requirements and core principles for swap execution facilities
(``SEFs'').\2\ The Commission implemented section 5h by adopting
regulations that establish various trading requirements for swaps
traded on SEFs \3\ and articulating, where appropriate, guidance and
acceptable practices. In particular, the Commission promulgated part 37
of its regulations to implement section 5h of the CEA and set forth the
registration and operational requirements for SEFs.\4\ Among those are
requirements in part 37 specifying minimum trading functionality that a
SEF must offer to participants for all listed swaps, i.e., an ``order
book,'' as defined in Sec. 37.3 (``Order Book''); \5\ specifying the
types of systems or platforms that a SEF must offer for swaps trading,
including swaps subject to the trade execution requirement under CEA
section 2(h)(8); \6\ and setting forth other relevant regulations
applicable to the fifteen core principles with which a SEF must comply
to obtain and maintain registration with the Commission.
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\2\ 7 U.S.C. 7b-3.
\3\ The Dodd-Frank Act also added to the CEA certain provisions
related to the trading of swaps on designated contract markets
(``DCMs''). Given that almost all platform trading of swaps in the
U.S. occurs on SEFs, the Commission is not at this time proposing to
amend any regulatory requirements pertaining to DCMs within part 38
of the Commission's regulations.
\4\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476 (June 4, 2013) (hereinafter ``SEF Core
Principles Final Rule'').
\5\ 17 CFR 37.3(a)(2). An Order Book is defined as (i) an
``electronic trading facility,'' as that term is defined in CEA
section 1a(16); (ii) a ``trading facility,'' as that term is defined
in CEA section 1a(51); or (iii) a trading system or platform in
which all market participants 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. See 17
CFR 37.3(a)(3).
\6\ CEA section 2(h)(8) requires that transactions involving
swaps subject to the CEA section 2(h)(1) clearing requirement be
executed on or pursuant to the rules of a DCM or SEF, or a SEF that
is exempt from registration, unless no DCM or SEF makes such swaps
available to trade (``MAT'') or such swaps qualify for the clearing
exception under CEA section 2(h)(7) (the ``trade execution
requirement''). See 7 U.S.C. 2(h)(8).
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Commission regulation 37.9 prescribes the methods of execution that
a SEF must offer to market participants to execute swap transactions on
the SEF. In particular, Sec. 37.9 defines ``Required Transactions'' as
swaps subject to the trade execution requirement. Section 37.9 also
requires a SEF to offer, as required methods of execution, either (i)
an Order Book or (ii) a request-for-quote system that sends a request-
for-quote to no less than three unaffiliated market participants and
operates in conjunction with an Order Book (``RFQ System'') for the
execution of these transactions.\7\ Swaps that are not subject to the
trade execution requirement are defined as ``Permitted Transactions,''
for which a SEF may offer any execution method and for which market
participants may voluntarily trade on a SEF.\8\ The Commission's
regulations specify additional requirements that correspond to the use
of an Order Book or RFQ System to execute Required Transactions.\9\
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\7\ 17 CFR 37.9(a). With the exception of block trades, as
defined in Sec. 43.2 of the Commission's regulations, Required
Transactions must be executed on a SEF's Order Book or RFQ System.
See 17 CFR 37.9(a)(2)(i).
\8\ 17 CFR 37.9(c).
\9\ For example, under Sec. 37.9(b), the Commission implemented
a fifteen-second time-delay requirement for Required Transactions
that are pre-arranged or pre-negotiated by a broker and submitted as
cross trades for execution through the SEF's Order Book. This
requirement allows a broker or dealer to execute a Required
Transaction by trading against a customer's order, or executing two
customers' orders against each other, through pre-negotiation or
pre-arrangement, provided that one side of the transaction is
exposed to the Order Book for fifteen seconds before the other side
of the transaction is submitted for execution. See 17 CFR 37.9(b).
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Pursuant to section 727 of the Dodd-Frank Act, the Commission also
established a regulatory framework for the real-time public reporting
of swap transaction and pricing data, including swap block trades
within CEA section 2(a)(13).\10\ Part 43 of the Commission's
regulations implements section 727 of the Dodd-Frank Act by, among
other things, defining the requisite criteria for when a publicly
reportable swap transaction will be classified as a block trade,
including the requirement that
[[Page 9409]]
the swap transaction ``occur[] away'' from a SEF's trading system or
platform, but pursuant to the SEF's rules and procedures.\11\ Part 43
also sets forth the procedures for calculating appropriate minimum
block sizes for each swap asset class \12\ and specifying the public
reporting delays available for such trades.\13\
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\10\ 7 U.S.C. 2(a)(13).
\11\ 17 CFR 43.2.
\12\ 17 CFR 43.6.
\13\ 17 CFR 43.5(d).
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B. Summary of Proposed Changes to Parts 36, 37, and 43
During the implementation of parts 37 and 43, market participants
and SEFs identified certain operational and compliance burdens related
to various requirements. To mitigate these burdens, Commission staff
issued to SEFs and market participants time-limited no-action relief
from certain provisions of the CEA and the Commission's
regulations.\14\ Based on this implementation experience, the
Commission believes it may be appropriate to amend the current SEF
regulatory framework to address the following issues, which have been
identified in staff no-action letters: \15\
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\14\ As defined in Sec. 140.99(a)(2) of the Commission's
regulations, a no-action letter is a written statement issued by a
Division stating that it will not recommend enforcement action to
the Commission for failure to comply with a specific provision of
the Act or a Commission rule, regulation, or order. A no-action
letter represents only the issuing Division's position and binds
only that Division. 17 CFR 140.99(a)(2).
\15\ In November 2018, the Commission issued a comprehensive
proposal to amend the SEF regulatory framework. See generally Swap
Execution Facilities and Trade Execution Requirement, 83 FR 61946
(Nov. 30, 2018) (``2018 SEF Proposal''). Among other things, the
2018 SEF Proposal addresses existing relief under various no-action
letters as part of the proposal's holistic approach to amending the
SEF regulatory framework. Given the complex, expansive, and
comprehensive nature of the 2018 SEF Proposal, however, the
Commission continues to evaluate it. Therefore, the Commission is
proposing rules herein independent of that proposal. To be clear,
this rule proposal does not supersede the 2018 SEF Proposal in any
way.
Further, while the proposals and rationales contained herein
are, in some cases, identical or similar to the proposals and
rationales used in the 2018 SEF Proposal, the Commission believes
the context surrounding these two proposals distinguishes them in
application and scope. While the Commission received comments on the
2018 SEF Proposal, the Commission believes that it is important for
the public to be able to provide comments focused on the facts and
circumstances of the proposal at hand. Therefore, comments made on
the 2018 SEF Proposal relevant to this rulemaking should be
resubmitted as comments to this rule proposal in order to be
considered.
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The Commission proposes to amend part 37 to allow the swap
components of certain categories of ``package transactions'' \16\ to be
executed on-SEF through flexible means of execution pursuant to Sec.
37.9(c)(2), rather than through the required methods of execution under
Sec. 37.9 for ``Required Transactions.'' In addition, the Commission
is proposing to amend part 36 to include an exemption from the trade
execution requirement for swap transactions that are executed as a
component of a package transaction that also includes a component that
is a new issuance bond (``New Issuance Bond package transactions'').
CFTC No-Action Letter No. 17-55 (``NAL No. 17-55'') \17\ currently
provides no-action relief for the swap components of certain categories
of package transactions from the required methods of execution, and in
some instances, from the trade execution requirement.
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\16\ As used herein a package transaction consists of two or
more component transactions executed between two or more
counterparties where: (i) At least one component transaction is a
Required Transaction; (ii) execution of each component transaction
is contingent upon the execution of all other component
transactions; and (iii) the component transactions are priced or
quoted together as one economic transaction with simultaneous or
near-simultaneous execution of all components.
\17\ NAL No. 17-55, Re: Extension of No-Action Relief from
Sections 2(h)(8) and 5(d)(9) of the Commodity Exchange Act and from
Commission Regulations 37.3(a)(2) and 37.9 for Swaps Executed as
Part of Certain Package Transactions (Oct. 31, 2017). NAL No. 17-55
extended no-action relief and related conditions previously granted
by Commission staff. See CFTC Letter No. 14-12, No-Action Relief
from the Commodity Exchange Act Sections 2(h)(8) and 5(d)(9) and
from Commission Regulation Sec. 37.9 for Swaps Executed as Part of
a Package Transaction (Feb. 10, 2014) (``NAL No. 14-12''); CFTC
Letter No. 14-62, No-Action Relief from the Commodity Exchange Act
Sections 2(h)(8) and 5(d)(9) and from Commission Regulation Sec.
37.9 for Swaps Executed as Part of Certain Package Transactions and
No-Action Relief for Swap Execution Facilities from Compliance with
Certain Requirements of Commission Regulations Sec. 37.9(a)(2),
Sec. 37.203(a) and Sec. 38.152 for Package Transactions (May 1,
2014) (``NAL No. 14-62''); CFTC Letter No. 14-121, Extension of No-
Action Relief for Swap Execution Facilities and Designated Contract
Markets from Compliance with Certain Requirements of Commission
Regulations Sec. 37.9(a)(2), Sec. 37.203(a) and Sec. 38.152 for
Package Transactions (Sept. 30, 2014) (``NAL No. 14-121''); CFTC
Letter No. 14-137, Extension of No-Action Relief from the Commodity
Exchange Act Sections 2(h)(8) and 5(d)(9) and from Commission
Regulation Sec. 37.9 and Additional No-Action Relief for Swap
Execution Facilities from Commission Regulation Sec. 37.3(a)(2) for
Swaps Executed as Part of Certain Package Transactions (Nov. 10,
2014) (``NAL No. 14-137''); CFTC Letter No. 15-55, Extension of No-
Action Relief from the Commodity Exchange Act Sections 2(h)(8) and
5(d)(9) and from Commission Regulation Sec. 37.9 and No-Action
Relief for Swap Execution Facilities from Commission Regulation
Sec. 37.3(a)(2) for Swaps Executed as Part of Certain Package
Transactions (Oct. 15, 2015) (``NAL No. 15-55''); and CFTC Letter
No. 16-76, Re: Extension of No-Action Relief from the Commodity
Exchange Act Sections 2(h)(8) and 5(d)(9) and from Commission
Regulation Sec. 37.9 and No-Action Relief for Swap Execution
Facilities from Commission Regulation Sec. 37.3(a)(2) for Swaps
Executed as Part of Certain Package Transactions (Nov. 1, 2016)
(``NAL No. 16-76''). NAL No. 17-55 also provided relief for package
transactions where at least one individual swap component is subject
to the trade execution requirement and all other components are
futures contracts (``MAT/Futures package transactions''). The
Commission continues to evaluate MAT/Futures package transactions
and their regulatory treatment. Therefore, this rulemaking does not
encompass MAT/Futures package transactions.
Further, NAL No. 17-55 also applies to package transactions
occurring on a DCM. See supra note 3.
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The Commission proposes to amend part 37 to establish a
principles-based approach for SEF error trade policies that
incorporates relief from the required methods of execution under Sec.
37.9 for Required Transactions for trades intended to resolve error
trades.\18\ The amendment would enable SEFs to permit market
participants to execute swaps transactions to correct operational or
clerical errors using execution methods other than those required under
Sec. 37.9 for Required Transactions. This proposal does not seek to
codify the specific conditions contained in CFTC No-Action Letter No.
17-27 (``NAL No. 17-27'').\19\ Rather, this proposal is intended to
capture the intent of NAL No. 17-27 to permit market participants to
correct error trades in Required Transactions through non-required
methods of execution while ensuring flexibility for SEFs to determine
the most suitable error trade rules for their markets and
participants.\20\
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\18\ The Commission notes that in addition to relief from the
required methods of execution, staff has also provided relief from
Sec. 37.203(a) of the Commission's regulations, which prohibits
``pre-arranged trading,'' for offsetting trades and correcting
trades. See NAL No. 17-27, Re: No-Action Relief for Swap Execution
Facilities and Designated Contract Markets in Connection with Swaps
with Operational or Clerical Errors Executed on a Swap Execution
Facility or Designated Contract Market (May 30, 2017). As discussed
further below, the Commission does not, however, view a regulatory
amendment corresponding to that relief as necessary. See infra note
70.
\19\ This proposal also does not codify the supplemental
conditions to NAL No. 17-27 contained in CFTC No-Action Letter No.
20-01, Re: Supplemental No-Action Relief for Swap Execution
Facilities and Designated Contract Markets in Connection with Swaps
with Operational or Clerical Errors Executed on a Swap Execution
Facility or Designated Contract Market (Jan. 8, 2020) (``NAL No. 20-
01''), conditions that allow market participants to correct error
trades that have been accepted for clearing with an ex post facto
review by the SEF. As discussed below, nothing in this proposal
would prohibit SEFs from incorporating such conditions within their
error trade rules. See infra note 74.
\20\ NAL No. 17-27, Re: No-Action Relief for Swap Execution
Facilities and Designated Contract Markets in Connection with Swaps
with Operational or Clerical Errors Executed on a Swap Execution
Facility or Designated Contract Market (May 30, 2017). NAL No. 17-27
extended no-action relief and related conditions previously granted
by Commission staff. See CFTC Letter No. 16-58, Re: No-Action Relief
for Swap Execution Facilities and Designated Contract Markets in
Connection with Swaps with Operational or Clerical Errors Executed
on a Swap Execution Facility or Designated Contract Market (June 10,
2016) (``NAL No. 16-58''); CFTC Letter 15-24, Re: No-Action Relief
for Swap Execution Facilities and Designated Contract Markets in
Connection with Swaps with Operational or Clerical Errors Executed
on a Swap Execution Facility or Designated Contract Market (Apr. 22,
2015) (``NAL No. 15-24''); and CFTC Letter No. 13-66, Time-Limited
No-Action Relief for Swap Execution Facilities from Compliance with
Certain Requirements of Commission Regulation 37.9(a)(2) and
37.203(a) (Oct. 25, 2013) (initial relief provided by Commission
staff with respect to error trades that are rejected from
clearing)(``NAL No. 13-66''). NAL No. 17-27 also applies to swap
transactions occurring on a DCM. See supra note 3. In addition, DMO
recently released NAL No. 20-01, which supplements the conditions in
NAL No. 17-27 to allow market participants, sua sponte, to correct
error trades that have been accepted to clearing with an ex post
facto review by the SEF.
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The Commission proposes to amend the definition of ``block
trade'' in Sec. 43.2, which requires the execution of block trades
pursuant to the rules of a SEF to ``occur[] away'' from the SEF, i.e.,
to be executed outside of any of the SEF's trading systems or
platforms. The amendment would enable SEFs to offer non-Order Book
methods of execution for market participants to execute swap block
trades on the SEF. The proposal codifies CFTC No-Action Letter No. 17-
60 (``NAL No. 17-60'') while also allowing block trades for swaps that
are not intended to be cleared (``ITBC'') to be executed on SEF via
non-Order Book methods of execution.\21\
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\21\ NAL No. 17-60, Re: Extension of No-Action Relief for Swap
Execution Facilities from Certain ``Block Trade'' Requirements in
Commission Regulation 43.2 (Nov. 14, 2017). NAL No. 17-60 extended
no-action relief and related conditions previously granted by
Commission staff. See CFTC Letter No. 16-74, Re: Extension of No-
Action Relief for Swap Execution Facilities from Certain ``Block
Trade'' Requirements in Commission Regulation 43.2 (Oct. 7, 2016)
(``NAL No. 16-74''); CFTC Letter No. 15-60, Re: Extension of No-
Action Relief for Swap Execution Facilities from Certain ``Block
Trade'' Requirements in Commission Regulation 43.2 (Nov. 2, 2015)
(``NAL No. 15-60''); and CFTC Letter No. 14-118, No-Action Relief
for Swap Execution Facilities from Certain ``Block Trade''
Requirements in Commission Regulation 43.2 (Sept. 19, 2015) (``NAL
No. 14-118''). NAL No. 17-60 only provides relief for swap block
trades that are ITBC.
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The Commission believes that the above-described amendments would
continue to effectuate the statutory SEF provisions and better promote
the statutory SEF goals, as discussed below.
C. Consultation With Other U.S. Financial Regulators
In developing these rules, the Commission has consulted with the
Securities and Exchange Commission, pursuant to section 712(a)(1) of
the Dodd-Frank Act.\22\
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\22\ Dodd-Frank Act, Public Law 111-203, title VII, sec.
712(a)(1), 124 Stat. 1376 (2010).
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II. The Proposed Regulations
A. Execution of Package Transactions
1. Background
Package transactions generally involve the execution of multiple
component transactions together that market participants consider to
represent one economic transaction.\23\ The types of transactions that
constitute a package transaction are wide-ranging and diverse. In
particular, there are package transactions that consist solely of swaps
subject to the trade execution requirement; those that include a mix of
swaps subject to the trade execution requirement and swaps that are
not; those made up of swaps and non-swaps; and those comprised of both
swaps that are and swaps that are not exclusively subject to the
Commission's jurisdiction.\24\ These components range from being very
liquid and standardized to being illiquid and bespoke.\25\ The variety
of package transactions derives, in part, from the fact that the
different types of package transactions are fit for distinct purposes.
The Commission understands that certain package transactions are
utilized as tools within market participants' portfolio management and
hedging programs, while other types of package transactions are used to
allow market participants to express views of the market--for example,
by allowing participants to trade the spread between certain products
or different maturities in the same product.
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\23\ See supra note 16. The Commission notes that there are
transactions that otherwise meet the package transaction definition
but do not involve a swap subject to the trade execution
requirement. While these transactions may colloquially be referred
to as package transactions, the Commission notes that such
transactions are not the subject of this proposal.
\24\ See infra note 36 for a more precise description of various
package transactions.
To the extent that counterparties may be facilitating package
transactions that involve a ``security,'' as defined in section
2(a)(1) of the Securities Act of 1933 or section 3(a)(10) of the
Securities Exchange Act of 1934, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
\25\ Some non-swap components may be subject to different
regulatory requirements than the swap components in the package
transactions.
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Given the diverse characteristics of the component transactions
that may be involved, the Commission understands that package
transactions often pose unique pricing and execution characteristics.
The Commission understands that the negotiation or arrangement of each
of these components generally occurs concurrently or on a singular
basis; in particular, negotiations for the pricing of such package
transactions may be based primarily on the components that are not
subject to the trade execution requirement. Further, given the
individual liquidity and trading characteristics of each component,
certain package transactions will have to trade through methods of
execution that are suitable for an illiquid and bespoke component,
which in many cases are not the required methods of execution.\26\
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\26\ For example, while a swap that is subject to the trade
execution requirement is suitable to be executed through the
required methods of execution as an outright transaction, when that
same swap is bundled together with an illiquid and bespoke component
in a package transaction, the package transaction takes on the
liquidity and trading profile of the illiquid and bespoke component.
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Notwithstanding the complexity of their pricing and execution, the
Commission is aware of their benefits of such package transactions. By
executing multiple components together as part of a package
transaction, market participants can improve transaction pricing and
cost, increase execution efficiency, and decrease execution risk beyond
what would have been possible if the market participant had executed
each component individually, i.e., ``legged'' or ``legging'' into the
transaction.\27\
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\27\ For example, a market participant seeking to execute two
component transactions independent of one another, instead of
executing the two components together in a package transaction,
would be forced to pay the bid/offer spread on each leg, which in
many cases is more costly and less efficient than paying the single
bid/offer spread for a package transaction composed of the same two
components.
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During the implementation of the trade execution requirement for
certain interest rate swaps and credit default swaps, SEFs and market
participants informed the Commission that requiring swaps that are
otherwise Required Transactions--but are components of a package
transaction \28\--to be executed through the required methods of
execution \29\ under Sec. 37.9 was in many cases impracticable and
increased execution risks and operational challenges. Market
participants and SEFs informed the Commission that these risks and
challenges generally
[[Page 9411]]
reflect (i) an initial lack of market infrastructure available to trade
and clear certain package transactions; \30\ and (ii) the complex,
bespoke, and idiosyncratic nature of several categories of package
transactions that precluded them from being suitable for execution
through required methods of execution.\31\
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\28\ See supra note 16. Consistent with the proposed definition
of package transaction under Sec. 37.9(d) the Commission notes
that, unless otherwise stated, the term ``swap component(s)'' as
used herein refers to a swap component that is subject to the trade
execution requirement under CEA section 2h(8), and therefore a
Required Transaction.
\29\ As noted above, pursuant to Sec. 37.9, SEFs must provide
as the required methods of execution for Required Transactions
either an Order Book or an RFQ System.
\30\ See, e.g., NAL No. 14-12 at 2-3 n.10 (describing the
inability of a DCO to simultaneously screen and accept all
components of a package transaction for clearing).
\31\ See, e.g., CFTC Public Roundtable: Trade Execution
Requirements and Package Transactions, 72, 84-85 (Feb. 12, 2014),
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/transcript021214.pdf (commenting on
the challenges of applying required methods of execution to package
transactions with complex component swaps).
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In response to concerns from market participants, Commission staff
in the Division of Market Oversight (``DMO'') provided a series of
time-limited no-action relief in order to allow the swap components of
certain package transactions to be executed through flexible methods of
execution on a SEF, and in some cases completely away from a SEF. Over
time, the initial dearth of available market infrastructure to trade
and clear certain package transactions has diminished, especially for
package transactions composed of liquid and standardized components. As
a result, Commission staff has allowed the relief for certain package
transactions to expire as the capabilities and functionalities of
market participants and SEFs have progressed to the point of permitting
the swap component of various package transactions to be executed
through the required methods of execution.\32\ The Commission notes
that the expiration of relief has been successful for many types of
package transactions given (i) market participants now actively trade
the swap component of several types of package transactions through the
required methods of execution, and (ii) the trading of such package
transactions constitutes a significant portion of swaps trading.\33\
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\32\ See infra note 36 for an overview and description of the
evolution of the relief for package transactions.
\33\ For example, according to publicly available data from
ClarusFT, nearly seventy percent of U.S. Dollar interest rate swaps
trading in the inter-dealer swap market were carried out as part of
just a single type of package transaction: U.S. Dollar Spreadover
package transactions, as defined in note 35. See Chris Barnes, USD
Spreadovers and SEF Market Share, Clarus Financial Technology Blog
(August 14, 2018), available at https://www.clarusft.com/usd-spreadovers-and-sef-market-share/. Further, package transactions
involving spreads and butterflies of interest rate swaps make up a
material amount of trading in the swaps markets.
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Despite the progress, however, Commission staff has continued to
provide relief for the swap components of certain package transactions
where relief is necessary for market participants to be able to
effectively execute the package transaction due to specific attributes
of such transactions.
2. Proposed Addition of Sec. 37.9(d) and Amendment of Sec. 37.9(a)(2)
In light of the complex nature of these package transactions, the
Commission recognizes that the required methods of execution under
Sec. 37.9 may inhibit market participants from tailoring the execution
of the swap component of the relevant package transactions. This may
force market participants to effect such transactions on a leg-by-leg
basis--leading to increased execution and operational risk--or prevent
them from engaging in the relevant package transactions altogether,
precluding effective hedging strategies and decreasing market
liquidity. Since DMO's issuance of this no-action relief, the
Commission has gained considerable knowledge and experience with the
dynamics of the trading of package transactions, particularly with
respect to the existing no-action relief from the required methods of
execution. Based on this knowledge and experience, the Commission
believes that certain aspects of the current requirements for the
required methods of execution under Sec. 37.9 should be enhanced to
better account for the complex nature of the relevant package
transactions.
Therefore, the Commission proposes to add Sec. 37.9(d) and amend
Sec. 37.9(a)(2) to permit the swap components of certain package
transactions to be executed via flexible methods of execution pursuant
to Sec. 37.9(c)(2). The Commission proposes to define a ``package
transaction'' as a transaction consisting of two or more component
transactions executed between two or more counterparties where: (i) At
least one component transaction is a Required Transaction; (ii)
execution of each component transaction is contingent upon the
execution of all other component transactions; and (iii) the component
transactions are priced or quoted together as one economic transaction
with simultaneous or near-simultaneous execution of all components.\34\
Based on this proposed definition and consistent with existing no-
action relief, the Commission proposes to allow the Required
Transaction swap component of the following three categories of package
transactions to be executed via flexible means of execution pursuant to
Sec. 37.9(c)(2):
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\34\ See proposed Sec. 37.9(d)(1). The Commission notes that
there are transactions which otherwise meet the package transaction
definition but do not involve a swap that is subject to the trade
execution requirement. While these transactions may colloquially be
referred to as package transactions, the Commission notes that such
transactions are not the subject of this proposal. See supra note
16.
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(1) A package transaction where at least one of the components is a
swap exclusively within the Commission's jurisdiction that is not
subject to the clearing requirement (``MAT/Non-MAT Uncleared'');
(2) A package transaction where at least one of the components is
not a swap (excluding certain package transaction categories as
discussed below) (``MAT/Non-Swap Instrument''); \35\ and
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\35\ Under proposed Sec. 37.9(d)(3), consistent with the no-
action relief, this category specifically excludes package
transactions in which all non-swap components are U.S. Treasury
securities (``U.S. Dollar Spreadover package transactions''); MAT/
Futures package transactions; package transactions in which all
other non-swap components are agency mortgage-backed securities
(``MAT/Agency MBS package transactions''); and New Issuance Bond
package transactions. See also Section II.A.7--Exemption of New
Issuance Bond Package Transactions from the Trade Execution
Requirement.
To the extent that counterparties may be facilitating package
transactions that involve a ``security,'' as defined in section
2(a)(1) of the Securities Act of 1933 or section 3(a)(10) of the
Securities Exchange Act of 1934, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
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(3) A package transaction where at least one of the components is a
swap for which the CFTC does not have exclusive jurisdiction, e.g., a
mixed swap (``MAT/Non-Exclusive CFTC Swap'').\36\
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\36\ The Commission notes that the swap components of different
categories of package transactions have been subject to time-limited
no-action relief provided by Commission staff from the trade
execution requirement and required methods of execution. These
categories of package transactions include those where: (i) Each of
the components is a swap subject to the trade execution requirement
(``MAT/MAT package transactions''); (ii) at least one of the
components is subject to the trade execution requirement and each of
the other components is subject to the clearing requirement (``MAT/
Non-MAT (Cleared)''); (iii) U.S. Dollar Spreadover package
transactions; (iv) MAT/Agency MBS package transactions; (v) New
Issuance Bond package transactions; (vi) MAT/Futures package
transactions; (vii) MAT/Non-MAT (Uncleared); (viii) excluding
aforementioned categories, MAT/Non-Swap Instruments; and (ix) MAT/
Non-Exclusive CFTC Swap. See NAL No. 14-12; NAL No. 14-62; NAL No.
14-121; NAL No. 14-137; NAL No. 15-55; NAL No. 16-76; and NAL No.
17-55.
Over time, the swap components of the following categories of
package transactions were no longer provided relief: MAT/MAT package
transactions, MAT/Non-MAT (Cleared) package transactions, U.S.
Dollar Spreadover package transactions, and MAT/Agency MBS package
transactions. As a result, the swap components of these package
transactions must be executed through the required methods of
execution under Sec. 37.9(a).
Currently, the swap components of the following categories of
package transactions receive no-action relief from the required
methods of execution under Sec. 37.9 under NAL No. 17-55: (i) MAT/
Non-MAT (Uncleared) package transactions; (ii) MAT/Non-Swap
Instruments package transactions (subject to the exclusions
previously discussed); and (iii) MAT/Non-Exclusive CFTC Swap package
transactions. The proposed addition of Sec. 37.9(d) is consistent
with the relief from the required methods of execution under NAL No.
17-55. Within this section, the term ``relevant package
transactions,'' unless context requires otherwise, refers to these
three categories of package transactions.
In addition to the relief from the required methods of execution
in Sec. 37.9, NAL No. 17-55 also provides relief from the trade
execution for the swap components of MAT/Futures package
transactions and New Issuance Bond Package transactions. As
discussed above, the Commission is still evaluating MAT/Futures
package transactions. See supra note 17.
Further, as discussed in more detail below, the Commission is
proposing to exempt the swap components of New Issuance Bond package
transactions from the trade execution requirement. This is
consistent with the relief currently provided to New Issuance Bond
package transactions under NAL No. 17-55. To the extent that
counterparties may be facilitating package transactions that involve
a ``security,'' as defined in section 2(a)(1) of the Securities Act
of 1933 or section 3(a)(10) of the Securities Exchange Act of 1934,
or any component agreement, contract, or transaction over which the
Commission does not have exclusive jurisdiction, the Commission does
not opine on whether such activity complies with other applicable
law and regulations.
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[[Page 9412]]
While, as noted above, the swap components of several types of
package transactions have been successfully transitioned to SEF and are
executed via the required methods of execution, the Commission believes
that the types of package transactions covered by this proposal may not
be suitable to be traded through the required methods of execution due
to their specific characteristics. In particular, the Commission
recognizes that these package transactions contain components that are
illiquid and bespoke, such as swaptions, or contain components that are
subject to regulatory requirements other than or in addition to the CEA
and the Commission's regulations issued thereunder.\37\
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\37\ The Commission will continue to evaluate these categories
of package transactions for new developments in execution methods on
SEFs and may in the future revise the categories of package
transactions in which the swap component is eligible to be executed
through flexible means of execution. For example, the Commission
notes that Tradeweb Markets Inc. recently released an electronic
trading method for package transactions involving swaps and bonds.
Such transactions--provided they are not U.S. Dollar Spreadover
package transactions--would fall under the MAT/Non-Swap Instruments
category of package transactions. Therefore, the Commission asks in
this proposal whether the proposed package transaction categories
are appropriate.
---------------------------------------------------------------------------
The Commission believes that if market participants are unable to
utilize flexible methods of execution for the swap components of these
package transactions, they would potentially be forced to break the
package transaction into its individual components, otherwise known as
``legging'' into the transaction. The Commission understands from
market participants that legging into a package transaction is
inefficient and increases transaction costs and execution risks. Given
that components of package transactions are each priced or quoted
together as part of one economic transaction, the Commission recognizes
the impracticality of breaking the package transaction into individual
legs or components in order to trade the swap components via the
required methods of execution under Sec. 37.9.
Based on its experience with the existing no-action relief, the
Commission believes that the proposed addition of Sec. 37.9(d) and
amendment of Sec. 37.9(a) will allow market participants to choose the
most suitable execution method for their package transactions, which
will decrease execution risks, improve efficiency, and decrease
transaction costs because market participants will no longer be forced
to leg into transactions. Given the inherent complexity of the relevant
package transactions, the Commission believes that this proposal
ensures that market participants are able to trade these package
transactions in the most effective, efficient, transparent, and
economical manner. SEFs would be able to offer, and market participants
would be able to utilize, methods of execution that best suit the
characteristics of the relevant package transaction being traded. The
Commission believes this would preserve the benefits and purpose of
executing such package transactions.
In addition to causing inefficient execution and increasing risks
and cost, forcing the swap components of the relevant package
transactions through required methods of execution may also limit the
commercial utility of such transactions or entirely frustrate the
purposes of entering in such package transactions in the first place.
For example, the Commission understands that in some of the relevant
package transactions, (i) the swap component serves as the hedging
instrument to other instruments in the package transaction, or (ii) the
package transaction as a whole may be utilized as part of a market
participant's portfolio management program. If the swap component of
such package transactions were impractical or unable to be executed due
to the required methods of execution, market participants would be
prevented from entering or effectively entering into the package
transaction, nullifying the package transaction's purpose and benefits
as a hedging and portfolio management tool. Based on its experience
with the existing no-action relief, the Commission believes that this
proposal would allow market participants to utilize flexible methods of
execution for the swap component of the relevant package transaction,
thereby ensuring that market participants are able to continue to
utilize these effective hedging tools.
Finally, the Commission believes that its proposed approach would
advance the SEF statutory goal of promoting trading on SEFs.\38\ The
proposed rule provides relief from execution method requirements that
are generally intended to help promote trading on SEFs. However, the
relevant package transactions are not suitable for trading via such
required methods of execution, as discussed above. Accordingly, the
Commission believes that in this case flexibility with respect to
execution methods will better promote trading of such component swaps
on SEFs, consistent with the statutory SEF goals.
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\38\ See 7 U.S.C. 7b-3(e).
---------------------------------------------------------------------------
3. Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.9(d) and the proposed amendment of Sec. 37.9(a)(2). The Commission
also invites specific comments on the following:
(1) Is the proposed definition of ``package transaction'' in
proposed Sec. 37.9(d)(1) appropriate? Please explain why or why not.
(2) Is the proposed definition's condition that the ``execution of
each component transaction is contingent upon the execution of all
other component transactions'' clear in its meaning? If not, please
explain how the Commission should clarify this provision.
(3) Similarly, is the proposed definition's condition that ``[t]he
component transactions are priced or quoted together as one economic
transaction'' clear in its meaning? If not, please explain how the
Commission should clarify this provision.
(4) Is it clear what is meant within the proposed definition's
statement that execution of all component transactions is to be
``simultaneous or near-simultaneous''? If not, please explain how the
Commission should clarify this provision.
(5) Is the proposed addition of Sec. 37.9(d)(2) for MAT/Non-MAT
(Uncleared) package transactions
[[Page 9413]]
appropriate? Please explain why or why not.
(6) Is the proposed addition of Sec. 37.9(d)(3) for MAT/Non-Swap
package transactions appropriate? Please explain why or why not.
(7) Are the categories of package transactions that are excluded
from Sec. 37.9(d)(3) appropriate? Please explain why or why not.
(8) Are there additional package transactions that should be
excluded from Sec. 37.9(d)(3)?
(9) Is the proposed addition of Sec. 37.9(d)(4) for MAT/Non-
Exclusive CFTC Swap package transactions appropriate? Please explain
why or why not.
(10) Are there additional types or categories of package
transactions not covered in this proposal for which the Commission
should allow the swap component to be executed through the flexible
means of execution in Sec. 37.9(c)(2)? Please explain in detail why or
why not.
(11) Should the Commission allow swap components to be executed via
flexible methods of execution where a package transaction contains more
than four components or legs, regardless of the types of components?
(12) In addition to U.S. Dollar Spreadover package transactions,
are there additional package transactions with sovereign debt
components for which the Commission should exclude the swap component
from flexible methods of execution? Please explain why or why not.
(13) Should the Commission allow all swap components of a package
transaction to be executed via flexible means of execution where a
single swap component subject to the trade execution requirement is
above the applicable block size? Please explain why or why not.
(14) Should the Commission allow a package transaction composed of
a Credit Default Swap (``CDS'') index swap subject to the trade
execution requirement and a CDS index swap that is several series off-
the-run to be executed through flexible means of execution? Please
explain why or why not.
4. Existing Sec. 37.3(a)
An Order Book is one of the two required methods of execution under
Sec. 37.9(a). The Commission designated an Order Book as the ``minimum
trading functionality'' each SEF must maintain and offer for each swap
that it lists for trading. An Order Book is defined under Sec.
37.3(a)(3) as (i) an electronic trading facility; \39\ (ii) a trading
facility; \40\ or (iii) 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.'' \41\
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\39\ CEA section 1a(16) defines ``electronic trading facility''
as a trading facility that (i) operates by means of an electronic or
telecommunications network; and (ii) maintains an automated audit
trail of bids, offers, and the matching of orders or the execution
of transactions on the facility. 7 U.S.C. 1a(16).
\40\ CEA section 1a(51) defines ``trading facility'' as a person
or group of persons that constitutes, maintains, or provides a
physical or electronic facility or system in which multiple
participants have the ability to execute or trade agreements,
contracts, or transactions by accepting bids or offers made by other
participants that are open to multiple participants in the facility
or system; or through the interaction of multiple bids or multiple
offers within a system with a pre-determined non-discretionary
automated trade matching and execution algorithm. 7 U.S.C.
1a(51)(A).
\41\ 17 CFR 37.3(a)(3).
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Generally speaking, it may be complex to apply the existing Order
Book requirement in Sec. 37.3(a)(2) to the swap components of the
package transactions covered by this proposed amendment. In some
situations, Sec. 37.3(a)(2) may require that a SEF maintain separate
Order Books for the same type of swap: One Order Book for when the swap
is executed as a single transaction (referred to as an ``outright
transaction''), and a separate Order Book for when the swap is executed
as part of a package transaction. In fact, multiple Order Books could
be required for the same type of swap if it were included as part of
multiple types of package transactions. The Commission understands
that, in part because of the availability of relief under the staff
letters described above, SEFs have put in place relatively few Order
Books for swaps to be executed as part of the package transactions
covered by this proposed amendment, and any such Order Books in place
are not actively used.
5. Proposed Addition of Sec. 37.3(a)(4)
The Commission proposes to add Sec. 37.3(a)(4), which would allow
SEFs not to offer an Order Book for the swap components of the package
transactions covered by this proposed amendment: (i) MAT/Non-MAT
Uncleared package transactions; (ii) MAT/Non-Swap Instrument package
transactions; and (iii) MAT/Non-Exclusive CFTC Swap package
transactions. However, this proposal would not alter any requirement
applicable to such swap components to the extent they are executed in
transactions that are not package transactions covered by this proposed
amendment. The text of proposed Sec. 37.3(a)(4) makes clear that Sec.
37.3(a)(2) of the Commission's regulations would continue to apply to
such swap components and SEFs would be required to offer Order Books
for these Required Transactions as outright transactions.
As noted above,\42\ executing Required Transaction swap components
of certain package transactions through the required methods of
execution is operationally complex, and in many instances,
impracticable. Given that the Commission has preliminarily determined
that it is infeasible or inefficient to facilitate swap components of
these package transactions through the required methods of execution,
which includes an Order Book under Sec. 37.3(a), it logically follows
that requiring SEFs to offer an Order Book for the swap components of
package transactions would be superfluous.
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\42\ See section II.A.1--Background and section II.A.2--Proposed
Addition of Sec. 37.9(d) and Amendment of Sec. 37.9(a)(2).
---------------------------------------------------------------------------
Finally, the Commission believes that not requiring SEFs to offer
an Order Book for the swap components of the relevant package
transactions would help reduce operating costs for SEFs, as they would
no longer be required to operate and maintain order book systems that
are not suitable for trading the swap components of the relevant
package transactions. Instead of employing resources to build (or
attempt to build) and support an unused or underutilized Order Book for
the swap components of certain package transactions, the proposal would
instead provide a SEF with the flexibility to determine how to allocate
its resources, particularly as it relates to developing methods of
execution that are better suited to trading the relevant package
transactions.\43\
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\43\ The Commission notes that nothing in this proposal would
preclude a SEF from offering an Order Book if it is able to develop
an Order Book solution that is effective in trading the swap
component of certain package transactions.
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6. Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.3(a)(4). The Commission also invites comments specifically on the
following:
(15) Is the addition of Sec. 37.3(a)(4) appropriate?
(16) Should the Commission still require SEFs to offer an Order
Book for MAT/Non-MAT (Uncleared) package transactions as defined in
Sec. 37.9(d)(2)?
(17) Should the Commission still require SEFs to offer an Order
Book for
[[Page 9414]]
the swap components of MAT/Non-Swap package transactions as defined in
Sec. 37.9(d)(3)?
(18) Should the Commission still require SEFs to offer an Order
Book for MAT/Non-Exclusive CFTC Swap package transactions as defined in
Sec. 37.9(d)(4)?
(19) Are there additional types of package transactions that the
Commission should consider allowing SEFs to not offer Order Books for?
(20) Should the Commission allow SEFs not to offer an Order Book
for swaps that are not subject to the trade execution requirement but
are components of any package transaction? Would this lead to
additional types of package transactions being listed and traded on
SEFs?
7. Exemption of New Issuance Bond Package Transactions From the Trade
Execution Requirement
The Commission proposes to establish an exemption to the trade
execution requirement for swap transactions that are components of a
``New Issuance Bond'' package transaction.\44\ The Commission believes
that exempting these types of transactions from the trade execution
requirement is authorized by, and would be consistent with the
objectives of, CEA section 4(c).\45\ This proposed approach is
consistent with the time-limited no-action relief provided by
Commission staff for this category of package transactions.\46\
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\44\ The Commission notes that both this proposal and the 2018
SEF Proposal propose to exempt New Issuance Bond package
transactions from the trade execution requirement under section
2(h)(8) of the CEA. See 2018 SEF Proposal at 62039. However, while
these proposals and the supporting rationales are nearly identical,
these two proposals are dissimilar in practical effect and scope.
Under the 2018 SEF Proposal, the Commission proposed to apply the
trade execution requirement to all swaps that are subject to the
clearing requirement in section 2(h)(1) of the CEA and are listed on
a SEF or a DCM. The 2018 SEF Proposal thus would have significantly
expanded the scope of swaps that are subject to the trade execution
requirement, including materially expanding the requirement to
numerous forward starting interest rate swaps which are used as the
swap components for New Issuance Bond package transactions.
Contrastingly, this proposal would not alter the scope of swaps that
are currently subject to the trade execution requirement, the
majority of which are not swaps that are used as a component in New
Issuance Bond package transactions. This means that the proposal to
exempt New Issuance Bond package transaction under the 2018 SEF
Proposal would have a significantly broader impact on the market
than the proposed exemption within this proposal.
\45\ 7 U.S.C. 6(c).
\46\ See supra note 36 (describing the no-action relief from the
trade execution requirement provided by Commission staff for
categories of package transactions).
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New Issuance Bond package transactions include at least one
individual swap component that is subject to the trade execution
requirement and at least one individual component that is a bond \47\
issued and sold in the primary market.\48\ An underwriter (on behalf of
an issuer) arranges the issuance of a bond packaged with a fixed-to-
floating interest rate swap (``IRS'') that features the issuer as a
counterparty. The terms of the IRS, which include tenor and payment
terms, typically match the terms of the bond issuance. By issuing a
bond with a fixed-to-floating IRS, issuers are able to effectively turn
fixed-rate liabilities into variable-rate liabilities, or vice
versa.\49\ To match the terms between these two components and
facilitate the bond issuance in an efficient and cost-effective manner,
the IRS component is customized and negotiated in a manner that closely
corresponds to the bond issuance process.
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\47\ The Commission notes that this proposed exemption would not
apply to swap components of package transactions that include
sovereign debt, such as U.S. Treasury bonds, notes, and bills.
\48\ The Commission understands that a bond issued and sold in
the primary market that may constitute part of a package transaction
is a ``security,'' as defined in section 2(a)(1) of the Securities
Act of 1933 or section 3(a)(10) of the Securities Exchange Act of
1934. To the extent that counterparties may be facilitating package
transactions that involve a security, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
\49\ For example, a bond issuer seeks to pay variable rates on
its bonds, but prospective investors may seek a fixed rate of
return. By arranging a New Issuance Bond package transaction, the
bond issuer can issue a fixed-rate bond and simultaneously enter
into an offsetting IRS. The IRS enables the issuer to receive a
fixed rate that matches the fixed rate on its bond to be issued,
while paying the variable rate that it originally sought.
Ultimately, this arrangement may allow the bond issuer to issue the
fixed-rate bond at a lower cost.
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Given the process under which the swap is negotiated,\50\ this type
of package transaction has not been conducive to execution on a SEF
trading system or platform. The Commission notes that the no-action
relief that has been provided by Commission staff for these swaps
components reflects the ongoing lack of an available execution method
on an appropriate trading venue.\51\ Based on the integral role of the
bond issuance in facilitating the component swap execution, the
Commission believes that the IRS component is not suitable for
execution on a SEF, even if a SEF were able to offer flexible means of
execution, as the Commission is proposing for swap components of other
package transactions within this proposal.\52\
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\50\ The Commission notes that these types of package
transactions differ from other package transactions that involve the
purchase or sale of a security in the secondary market, given that
they involve the issuance of a new security.
\51\ See NAL No. 17-55 at 2-3.
\52\ See Section II.A.2.
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Therefore, consistent with current no-action relief provided by
Commission staff, the Commission proposes to exempt swap components of
a New Issuance Bond package transaction from the trade execution
requirement. The proposed exemption would establish that a ``package
transaction'' consists of two or more component transactions executed
between two or more counterparties, where (i) at least one component
transaction is subject to the trade execution requirement in section
2(h)(8) of the Act; (ii) execution of each component transaction is
contingent upon the execution of all other component transactions; and
(iii) the component transactions are priced or quoted together as one
economic transaction with simultaneous or near-simultaneous execution
of all components.\53\ The Commission recognizes the inherent
challenges in trading or executing these swap components on a SEF or
DCM and, therefore, recognizes the benefits of continuing to allow
market participants to maintain established market practices with
respect to this type of package transaction.
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\53\ The Commission notes that this definition is consistent
with the proposed definition for package transaction in Sec.
37.9(d)(1).
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8. Discussion of CEA Section 4(c) Enumerated Factors
Section 4(c) of the CEA grants the Commission the authority to
exempt any transaction or class of transactions, including swaps, from
certain provisions of the CEA, including the Commission's clearing
requirement, in order to ``promote responsible economic or financial
innovation and fair competition.'' \54\ Section 4(c)(2) of the CEA
further provides that the Commission may not grant exemptive relief
unless it determines that: (i) The exemption is appropriate for the
transaction and consistent with the public interest; (ii) the exemption
is consistent with the purposes of the CEA; (iii) the transaction will
be entered into solely between ``appropriate persons;'' and (iv) the
exemption will not have a material adverse effect on the ability of the
Commission or any contract market to discharge its regulatory or self-
regulatory responsibilities under the CEA. In enacting section 4(c),
Congress noted
[[Page 9415]]
that the purpose of the provision is to give the Commission a means of
providing certainty and stability to existing and emerging markets so
that financial innovation and market development can proceed in an
effective and competitive manner.\55\
---------------------------------------------------------------------------
\54\ 7 U.S.C 6(c).
\55\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,
3213.
---------------------------------------------------------------------------
The Commission believes that exempting swap components of New
Issuance Bond package transactions from the trade execution requirement
would be consistent with the objectives of CEA section 4(c).
The Commission recognizes the importance of new bond issuances in
helping market participants to raise capital and fund origination loans
for businesses and homeowners. The Commission recognizes that allowing
the swap components of New Issuance Bond package transactions to be
executed away from a SEF or DCM--consistent with current market
practice--is integral to facilitating the bond issuance. Further, the
Commission recognizes that the proposed exemption is limited in nature,
i.e., the swap transaction remains subject to all other applicable
Commission rules and regulations.
Therefore, the Commission preliminarily believes that the proposed
exemption from the trade execution requirement for swap components of
New Issuance Bond package transactions is appropriate and would be
consistent with the public interest and purposes of the CEA.
The Commission further believes that the proposed regulation would
not have a material adverse effect on the ability of the Commission or
any SEF or DCM to discharge its regulatory or self-regulatory duties
under the CEA. The Commission notes that the exemption is limited in
scope and the swap components subject to this exemption are still
required to be reported to a swap data repository pursuant to parts 43
and 45 of the Commission's regulations. Further, the Commission retains
its special call, anti-fraud, and anti-evasion authorities, which will
enable it to adequately discharge its regulatory responsibilities under
the CEA.
The Commission notes that under the proposed exemption, swap
transactions would still be entered into solely between eligible
contract participants (``ECPs''), whom the Commission believes, for
purposes of this proposal, to be appropriate persons. Previously, the
Commission determined that ECPs are appropriate persons within the
scope of section 4(c)(3)(K) of the CEA.\56\ The Commission noted that
the elements of the ECP definition (as set forth in section 1a(18)(A)
of the CEA and Commission regulation 1.3) generally are more
restrictive than the comparable elements of the enumerated
``appropriate person'' definition.\57\ Given that only ECPs are
permitted to enter into swaps off of a DCM, there is no risk that a
non-ECP or a person who does not satisfy the requirements for an
``appropriate person'' could enter into a New Issuance Bond package
transaction using this proposed exemption. Therefore, the Commission
believes that the class of persons eligible to rely on the exemption
for New Bond Issuance package transactions will be limited to
``appropriate persons'' within the scope of section 4(c)(3) of the CEA.
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\56\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21750, 21754 (Apr. 11, 2013).
\57\ Id.
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9. Request for Comment
The Commission requests comment on all aspects of the proposed
exemption of swap components of New Issuance Bond package transactions
from the trade execution requirement under proposed Sec. 36.1(a),
including whether the proposed exemptive relief is consistent with the
public interest and the other requirements of CEA section 4(c). As
noted above, the 2018 SEF Proposal contained a nearly identical
provision. Comments made on the 2018 SEF Proposal that are relevant to
this rulemaking must be resubmitted to be considered. The Commission
specifically requests comment on the following questions:
(21) Pursuant to its authority in CEA section 4(c), should the
Commission exempt the swap components of a New Issuance Bond package
transaction from the trade execution requirement?
(22) Is the proposed definition of ``package transaction'' in
proposed Sec. 36.1(a)(1) appropriate?
(23) Is it clear what is meant within the proposed definition when
it states that the ``execution of each component transaction is
contingent upon the execution of all other component transactions''? If
not, please explain how the Commission should clarify this provision.
(24) Is it clear what is meant within the proposed definition when
it states that ``[t]he component transactions are priced or quoted
together as one economic transaction''? If not, please explain how the
Commission should clarify this provision.
(25) Is it clear what is meant within the proposed definition when
it states that all component transactions are to be executed on a
``simultaneous or near-simultaneous'' basis? If not, please explain how
the Commission should clarify this provision.
(26) Are there additional swap components of different types or
categories of package transactions that should be exempt from the trade
execution requirement? If so, then please describe in detail why such
swap components of these types or categories of package transactions
should be exempt from the trade execution requirement.
B. Error Trades: Execution of Trades To Correct Operational and
Clerical Errors on Swap Execution Facilities
1. Background
The Commission notes that SEFs have adopted policies to identify
and resolve error trades as part of the rules and procedures that
govern their respective trading and trade processing operations. Errors
in SEF transactions, as observed by the Commission, may be operational
or clerical in nature and attributable to either the SEF, the
counterparties to the transaction, the counterparties' intermediaries,
or the clearing members involved. Clerical errors, in particular, may
occur in the process of entering trade details into a SEF's trading
system and may relate to the swap's terms and conditions, such as
price, size, or direction, as well as counterparty or clearing member
identities. The adoption of error trade policies by SEFs reflects the
importance of addressing errors to ensure that counterparties are able
to execute swap transactions as intended on a SEF, which promotes a
fair and orderly trading market for SEF market participants.\58\
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\58\ The Commission notes that the guidance to Core Principle 4
in Appendix B cites ``clear error-trade and order-cancellation''
policies as a type of trading risk control that could be part of an
acceptable program for preventing market disruptions. 17 CFR part 37
app. B (guidance to Core Principle 4--paragraph (a)(5)--``Risk
controls for trading'').
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Under the current SEF regulatory framework, however, resolving
error trades for swaps subject to the Commission's required methods of
execution and straight-through processing requirements has occurred
pursuant to no-action relief provided by Commission staff on an ongoing
basis. Since 2013, the Division of Clearing and Risk (``DCR'') and DMO
(together, the ``Divisions'') have issued time-limited no-action relief
to allow counterparties to correct swap ``error trades''--transactions
containing an ``operational
[[Page 9416]]
or clerical error'' \59\--involving swaps designated as Required
Transactions, which are subject both to the clearing requirement and
the trade execution requirement.\60\ This relief, as described further
below, has facilitated corrections where the error trade has either
been (i) rejected by a DCO from clearing due to the error; or (ii)
accepted for clearing, and therefore requires correction through an
offsetting trade. Pursuant to the relief, SEFs may provide
counterparties with a bilateral, ``corrective'' execution process for
Required Transactions that does not satisfy the required methods of
execution under Sec. 37.9(a)(2) for swaps subject to the trade
execution requirement.
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\59\ The Divisions previously defined ``operational or clerical
error'' as any type of error other than a rejection from clearing
due to credit reasons. See NAL No. 17-27 at 1 n.2.
\60\ See NAL No. 13-66. In April 2015, staff issued additional
no-action relief, which not only reinstated the previous time-
limited no-action relief from NAL No. 13-66 for SEFs from the
requirements of Sec. 37.9(a)(2) and Sec. 37.203(a) for error
trades rejected from clearing, but also provided relief for error
trades accepted for clearing in NAL No. 15-24. Commission staff
subsequently extended the relief provided in NAL No. 15-24 in June
2016 with NAL No. 16-58. This relief was most recently extended in
May 2017 by NAL No. 17-27 and would expire on the effective date of
any applicable changes in the Commission's regulations. Commission
staff in DMO recently issued NAL No. 20-01, which supplements NAL
No. 17-27 to allow market participants, sua sponte, to correct error
trades that have been accepted for clearing. In instances where
market participants correct an error trade sua sponte, NAL No. 20-01
requires an ex post facto review by the SEF of the error trade,
offsetting trade, and correcting trade on a T+1 basis. Such review
must consider whether a transaction cancellation or price adjustment
will adversely impact market integrity, facilitate market
manipulation or other illegitimate activity, or otherwise violate
the CEA, Commission regulations, or the SEF's rules.
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For error trades rejected from clearing by a DCO, the no-action
relief has provided operational flexibility from the required methods
of execution that otherwise apply in conjunction with the Commission's
``straight-through processing'' requirements for swaps submitted to a
DCO for clearing.\61\ To promote the ``near[-]instantaneous acceptance
or rejection of each trade [for clearing],'' \62\ the Divisions issued
a 2013 staff guidance expressing the view that SEFs should have rules
stating that trades that are rejected from clearing are ``void ab
initio.'' \63\ Accordingly, executed swaps that a DCO rejects from
clearing would be deemed void, including swaps that are rejected due to
an operational or clerical error by the SEF or the counterparties.
Where the counterparties still seek to execute the transaction as
intended, void ab initio compels the counterparties to execute a new
transaction between one another with the corrected terms. Where the
counterparties seek to execute a correcting swap that is a Required
Transaction, the no-action relief allows SEFs to accept bilaterally-
arranged swaps from the counterparties for execution and submission for
clearing, rather than requiring them to execute the correcting swap
through an Order Book or RFQ System.
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\61\ The Commission's ``straight-through processing''
requirements address the process of routing transactions from
execution through clearing. See Customer Clearing Documentation,
Timing of Acceptance for Clearing, and Clearing Member Risk
Management, 77 FR 21278, 21283 (Apr. 9, 2012) (``Timing of
Acceptance for Clearing Final Rule''). The Commission has previously
stated that the ``acceptance or rejection for clearing in close to
real time is crucial for both effective risk management and for the
efficient operation of trading venues.'' Id. at 21285.
\62\ Staff Guidance on Swaps Straight-Through Processing at 2
(Sept. 26, 2013)(``2013 Staff STP Guidance'').
\63\ 2013 Staff STP Guidance at 5. The 2013 Staff STP Guidance
also addresses other elements of ``straight-through processing'' for
swap transactions, including void ab initio. See 2018 SEF Proposal
at 61999-62002, 62019-62024. The Commission notes that it proposed
to address certain provisions from the 2013 Staff STP Guidance in
the 2018 SEF Proposal, including a clarification that mandatory
application of void ab initio would be limited to swap transactions
that are rejected from clearing for credit-related reasons; for
rejections arising from clerical or operational errors, the proposed
clarifications would allow a SEF to adopt other corrective
approaches that may not involve execution of a offsetting trade or a
correcting trade. Id. at 62000-62001. As noted above, this proposal
is independent of the 2018 SEF Proposal.
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For error trades accepted for clearing by a DCO in spite of an
operational or clerical error in the swap, the no-action relief has
provided similar operational flexibility from the prescribed execution
methods under Sec. 37.9(a)(2).\64\ Accordingly, the relief allows SEFs
to accept a bilaterally arranged swap from the counterparties for
execution and submission for clearing that (i) economically offsets the
initial error trade that was accepted from clearing; and (ii) corrects
the initial error trade with corrected terms as originally intended by
the counterparties.
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\64\ See NAL No. 17-27 at 5.
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The Divisions also attached certain conditions to this no-action
relief that, among other things, specified timing requirements for
submitting these transactions to a SEF for execution and to a DCO for
clearing. For transactions correcting error trades that a DCO has
rejected from clearing, the Divisions specified that the counterparties
must execute the transaction on a SEF, and the SEF must submit the
transaction for clearing, as quickly as technologically practicable
after receipt of notice of the rejection by the DCO to the clearing
members, but no later than one hour from the notice.\65\ For offsetting
and correcting transactions to error trades that a DCO has accepted for
clearing, the Divisions specified that such execution and submission to
clearing of those transactions must occur no later than three days
after the error trade was executed.\66\
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\65\ Id. at 6.
\66\ Id. In addition, for error trades that are accepted for
clearing, DMO issued NAL No. 20-01, which supplements NAL No. 17-27
to allow market participants, sua sponte, to correct error trades
that have been accepted for clearing with an ex post facto review by
the SEF. For error trades accepted for clearing and corrected under
the relief in NAL No. 20-01, DMO specified that such error trades
would need to be corrected no later than 24 hours after the error
trade was executed. See NAL No. 20-01 at 4.
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2. Proposed Sec. 37.9(e)
The Commission proposes to amend the SEF regulatory framework by
adding subsection (e) to Sec. 37.9 to establish a flexible SEF error
trade policy standard that would, among other things, incorporate the
intent of the existing no-action relief in NAL No. 17-27 for resolving
errors in Required Transactions. Proposed Sec. 37.9(e)(2)(i) would
specify that a SEF must maintain rules and procedures that are fair,
transparent, consistent, and allow for timely resolution of an ``error
trade,'' as defined under proposed Sec. 37.9(e)(1)(ii).\67\ This
proposed standard would apply to any error trade that occurs on a SEF,
regardless of whether the swap is submitted for clearing or not. The
Commission believes that the proposed standard is a flexible approach
that also clarifies the key principles that any SEF's error trade
policy should address.
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\67\ As proposed, an ``error trade'' would be defined as any
trade executed on or subject to the rules of a swap execution
facility that contains an operational or clerical error. With
respect to ``package transactions,'' as defined under proposed Sec.
37.9(d)(1), the Commission deems the submission of the component
transactions in a sequence that causes a rejection from clearing of
an individual component to constitute an operational error that
could be resolved through a correcting trade under proposed Sec.
37.9(e)(2)(i)(A). Market participants had previously informed the
Commission that an individual component transaction may be rejected
from clearing if prematurely submitted because the risk of that
component, in isolation, could cause a trader to exceed its credit
limit. Under a different submission sequence of component
transactions to the DCO, however, the net risk of all of those
transactions may not have exceeded the credit limit, thereby
avoiding the rejection. The Commission emphasizes, however, the use
of a corrective trade may only apply to the rejected component and
otherwise would not apply to the other legs of the package
transaction that have been accepted for clearing.
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Further, under proposed Sec. 37.9(e)(2)(i) SEFs must have error
trade rules and procedures that require market participants to provide
prompt notice to the SEF of an error trade and, as
[[Page 9417]]
applicable, the corresponding correcting trade and offsetting
trade.\68\ This notice need not be separate from the error trade
correction process.
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\68\ To the extent a SEF implements error trade rules and
procedures that allow market participants to correct error trades
sua sponte with an ex post facto review by the SEF, that the SEF
must require that market participants notify it of the subsequent
correcting and offsetting trades. Conversely, a SEF that adopts
error trades rules and procedures in which the SEF is responsible
for correcting the error trade, that SEF would not be required to
have market participants notify it of the subsequent correcting and
offsetting trades. Regardless of the type of error trade rules and
procedures a SEF adopts, it is required to adopt rules and
procedures which require its market participants to provide prompt
notice to it of an error trade that has occurred on its trading
system(s) or platform(s).
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The Commission believes that such a requirement is important to
facilitate SEFs' fulfillment of their self-regulatory obligations. In
particular, the Commission believes that providing a SEF prompt notice
that an error trade has occurred on its trading system(s) or
platform(s) will further enable it to facilitate direct supervision of
it markets in order to determine whether a rule violation has occurred
as required under Sec. 37.203(b) as well as enhance its ability to
carry out real-time market monitoring of all trading activity on its
system(s) or platform(s) to identify disorderly trading and any market
or system anomalies pursuant to Sec. 37.203(e).\69\
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\69\ See 17 CFR 37.203(b); 17 CFR 37.203(e).
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Proposed Sec. 37.9(e) would also require a SEF to adopt rules to
resolve error trades that involve swaps submitted for clearing. For an
error trade rejected from clearing and therefore deemed void ab initio,
proposed Sec. 37.9(e)(2)(i)(A) would require a SEF to permit the
counterparties to subsequently execute a correcting trade, as defined
in proposed Sec. 37.9(e)(1)(i), through any method of execution
offered by the SEF. For an error trade that has been accepted for
clearing, proposed Sec. 37.9(e)(2)(i)(B) would require a SEF to permit
the counterparties to subsequently execute both an offsetting trade, as
defined in proposed Sec. 37.9(e)(1)(iii), and a correcting trade
through any method of execution offered by the SEF.\70\
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\70\ NAL No. 17-27 also provided relief from Sec. 37.203(a),
which prohibits pre-arranged trading, for offsetting trades and
correcting trades. The Commission, however, does not view a
regulatory amendment corresponding to that relief as necessary. The
existing prohibition already provides an exception to that
prohibition by allowing a SEF to adopt trading practices that are
certified or approved by the Commission pursuant to part 40 of the
Commission's regulations. See 17 CFR 37.203(a). Accordingly, the
Commission anticipates that a SEF would implement proposed Sec.
37.9(e) by self-certifying or adopting rules subject to Commission
review under part 40 that specify the manner in which counterparties
may execute offsetting and correcting trades.
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Consistent with the existing no-action relief, this approach would
continue to provide flexibility in the execution methods that a SEF may
offer to counterparties to execute offsetting and correcting trades
that involve swaps that are Required Transactions.\71\ Based on its
experience with the existing no-action relief, the Commission believes
that this flexibility would continue to promote SEF operational
efficiency by allowing SEFs to offer error trade protocols that are
tailored to their markets and to allow identification and resolution of
operational and clerical errors in a timely manner. Without such
flexibility, market participants with an error in Required Transactions
would otherwise be prohibited from determining how to resolve the error
between themselves by entering into an offsetting trade or a new trade
with the correct terms due to the execution method requirements under
Sec. 37.9(a)(2), which require that all Required Transactions be
traded via either an Order Book or RFQ System.
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\71\ The Commission notes that swaps that are Permitted
Transactions, including those that are submitted to a DCO for
clearing, may already be executed through any method of execution
offered by a SEF pursuant to Sec. 37.9(c)(2).
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The Commission also believes that the proposed approach would
further the SEF statutory goals of promoting trading on SEFs and pre-
trade price transparency in the swaps market.\72\ The proposed rules
provide flexibility to depart from required execution methods that are
otherwise intended to advance those statutory goals; allowing
counterparties to correctly and efficiently execute swaps with the
intended terms and conditions, however, enhances market integrity on
SEFs, which promotes SEF participation. Additionally, the proposed
rules would also help to ensure that trade data, which market
participants rely upon to inform their swaps trading decisions,
accurately reflects prevailing market pricing at any given time.
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\72\ See 7 U.S.C. 7b-3(e).
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The Commission notes that the existing no-action relief is
currently subject to several conditions applicable to SEFs and
counterparties--for example, SEFs must affirmatively determine, or
determine after an ex post facto review, that an error trade has
occurred.\73\ Except as incorporated in the proposed rules herein, the
Commission intends for the proposed approach to otherwise provide SEFs
with the flexibility to address such aspects of its error trade policy
in a manner that is best suited to its trading and trade processing
operations.\74\
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\73\ See NAL No. 17-27 at 5-7 and NAL No. 20-01 at 4-5.
\74\ Under the proposal's principles-based approach, the
Commission notes that a SEF would not be prohibited from
incorporating the conditions contained within NAL No. 17-27, or
implementing rules that allow market participants, sua sponte, to
correct error trades that have been accepted for clearing with an ex
post facto review by the SEF of the error trade, offsetting trade,
and correcting trade on a T+1 basis as is contemplated by NAL No.
20-01. Further, this proposal would not preclude SEFs from deploying
error trade rules and procedures which consider whether a
transaction cancellation or price adjustment will adversely impact
market integrity, facilitate market manipulation or other
illegitimate activity, or otherwise violate the CEA, Commission
regulations, or the SEF's rules. However, regardless of the error
trade rules and procedures that a SEF may adopt, the Commission
notes that pursuant to this proposal such rules must be fair,
transparent, and consistent. For example, in a scenario where a SEF
is unsure as to how to address an error, the SEF may have rules
which make it clear that the SEF will seek guidance and consent from
both counterparties to the error trade before correcting the error
trade. The Commission believes that such rule would be fair as it
considers the positions of both counterparties and is transparent as
it makes clear what the SEF will do in a specific scenario.
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The proposed rules, however, would also adopt some limitations that
are similar to the existing no-action relief, including specified
timeframes for executing and submitting these trades for clearing. For
correcting trades associated with an error trade that has been rejected
from clearing, proposed Sec. 37.9(e)(2)(i)(A) would require the SEF to
submit the correcting trade for clearing to the registered DCO or
exempt DCO as soon as technologically practicable, but no later than
one hour after notice of the rejection to the relevant clearing
members. For an offsetting trade and a correcting trade associated with
an error trade that already has been accepted for clearing, proposed
Sec. 37.9(e)(2)(i)(B) would require the SEF to submit both types of
trades to the registered DCO or exempt DCO as soon as technologically
practicable, but no later than three days after the registered DCO or
exempt DCO accepted the error trade for clearing.\75\
[[Page 9418]]
In addition to these proposed timeframes, proposed Sec. 37.9(e)(2)(ii)
would prohibit counterparties from executing a second correcting trade
to fix an error trade if the initial correcting trade is rejected from
clearing.
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\75\ The Commission notes that the supplemental conditions
contained in NAL No. 20-01 require error trades that have been
accepted to clearing to be corrected as soon as technologically
practicable but no later than 24 hours after the error trade was
executed. See NAL No. 20-01 at 4. However, as noted above, the
Commission intends for this proposal to provide a SEF with the
flexibility to address such aspects of its error trade policy in a
manner that is best suited to its trading and trade processing
operations. As such, SEFs may continue to have error trade rules and
procedures that are contemplated in both NAL No. 17-27 and NAL No.
20-01 for error trades that have been accepted for clearing.
Therefore, the Commission is proposing that an error trade that has
already been accepted for clearing would be required to be corrected
as soon as technologically practicable, but no later than three days
after the registered DCO or exempt DCO accepted the error trade for
clearing, as this is the longest timeframe for correcting such error
trades as contemplated in both NAL No. 17-27 and NAL No. 20-01.
Nonetheless, the Commission is seeking comment on whether three days
is an appropriate timeframe for error trades that have been accepted
for clearing to be corrected. Further, despite the proposed outer
limit of three days for correcting error trades that have been
accepted for clearing, the Commission notes that SEFs and market
participants are expected to correct such error trades as soon as
technologically practicable as is proposed under Sec.
37.9(e)(2)(i)(B).
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The Commission believes that these proposed limitations are
consistent with the goal of promoting straight-through processing. The
proposed timing requirements, in particular, are intended to provide a
SEF and the counterparties to an error trade with an appropriate amount
of time to identify and resolve error trades, while also minimizing
delays to achieving prompt and efficient clearing of transactions.
Similarly, limiting the number of instances in which counterparties may
attempt to correct an error trade would also help to facilitate prompt
and efficient clearing by incentivizing the counterparties to
accurately execute their correcting trade as quickly as possible. The
Commission, however, seeks additional public comment regarding this
proposed limitation, as well as the appropriateness of the proposed
timeframes.
3. Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.9(e). As noted above, the 2018 SEF Proposal also discussed this
topic. Comments made on the 2018 SEF Proposal that are relevant to this
rulemaking must be resubmitted to be considered. The Commission also
invites comments specifically on the following:
(27) The Commission notes that Sec. 37.203(e) already specifies
that a SEF may resolve errors by adjusting trade prices or canceling
trades to mitigate ``market disrupting events;'' such action by a SEF
must be ``transparent to the market and subject to standards that are
clear, fair, and publicly available.'' Should the Commission adopt a
single rule for all error trades under proposed Sec. 37.9(e) that is
similar to this standard, or is the proposed standard, i.e., ``fair,
transparent, consistent, [and] allow for timely resolution'' more
appropriate? If the Commission should maintain separate standards,
please explain why.
(28) Is the proposed timeframe adequate for the submission of a
correcting trade to resolve an error trade rejected from clearing for
non-credit reasons? If not, please provide an alternative timeframe and
explain why such an alternative would be more appropriate.
(29) Is the proposed timeframe adequate for submitting an
offsetting trade and correcting trade to resolve an error trade
accepted for clearing? If not, please provide an alternative timeframe
and explain why such an alternative would be more appropriate.
(30) Under proposed Sec. 37.9(e)(2)(i), SEFs must have rules which
require market participants to provide prompt notice to the SEF that an
error trade has occurred. Is it clear what is meant by ``prompt
notice'' in Sec. 37.9(e)(2)(i)? If not, please explain how the
Commission should clarify this provision.
(31) Should the Commission require that notification to a SEF of an
error trade occur within a specified timeframe? If so, what is the
appropriate time frame for that notification to occur?
(32) If a SEF adopts error trade rules and procedures that allow
market participants to sua sponte correct an error trade with an ex
post facto review by the SEF, should the Commission allow the SEF to
have rules permitting market participants to withhold notice of the
error trade until the market participant notifies the SEF of the
correcting trade and, as applicable, the offsetting trade?
(33) Should the Commission require SEFs to affirmatively determine,
or determine after an ex post facto review, that an error trade has
occurred? Why or why not?
(34) If a SEF should affirmatively determine that an error trade
had occurred, what is the appropriate time frame for that declaration
to occur?
(35) If a SEF should determine that an error trade has occurred
after an ex post facto review, what is the appropriate time frame for
that review and determination to occur?
(36) If a SEF should affirmatively determine that an error trade
had occurred, should the SEF's review consider whether a transaction
cancellation or price adjustment will adversely impact market
integrity, facilitate market manipulation or other illegitimate
activity, or otherwise violate the CEA, Commission regulations, or the
SEF's rules?
(37) If a SEF should determine that an error trade has occurred
after an ex post facto review, should the SEF's review consider whether
a transaction cancellation or price adjustment will adversely impact
market integrity, facilitate market manipulation or other illegitimate
activity, or otherwise violate the CEA, Commission regulations, or the
SEF's rules?
(38) Does Sec. 37.9(e) sufficiently address potential situations
in which a component of a package transaction is rejected from clearing
by the relevant registered DCO or exempt DCO because of the sequencing
of the components of the package transaction submitted for clearing at
the registered DCO or exempt DCO? With respect to proposed Sec.
37.9(e), are there any other issues that should be addressed regarding
package transactions?
(39) Should the same error trade policy also be available to
correct any errors contained in a correcting trade or an offsetting
trade, or should the number of corrections be limited? If an initial
correcting trade or offsetting trade that is executed to correct an
error trade contains an operational or clerical error, should the
counterparties be allowed to submit another correcting trade or
offsetting trade?
(40) Should the Commission require SEFs to notify its market when
it receives notice from a market participant that an error trade has
occurred?
(41) Should the Commission prescribe different error trade rules
and procedures depending on the status (i.e., Required Transactions or
Permitted Transactions) of the original swap transaction? Please
explain why or why not.
(42) Are there any conditions in NAL No. 17-27 or supplemental NAL
No. 20-01 not contained within this proposal that the Commission should
require SEFs to adopt in their error trade rules and procedures? If so,
please explain in detail why such conditions are necessary and
appropriate to be required in SEF error trade rules and procedures.
C. Real-Time Public Reporting: Block Trade Definition
1. Existing Sec. 43.2
Section 43.2 defines a swap ``block trade'' as a publicly
reportable swap transaction that (i) involves a swap that is listed on
a SEF or DCM; (ii) occurs away from the SEF's or DCM's trading system
or platform and is executed pursuant to the SEF's or DCM's rules and
procedures; (iii) has a notional or principal amount at or above the
appropriate minimum block trade size applicable to such swap; and (iv)
is reported subject to the rules or procedures of the SEF or DCM and
the rules set forth under part 43, including the appropriate time delay
requirements set forth under Sec. 43.5.\76\ In specifying
[[Page 9419]]
these elements, the Commission considered the treatment of block trades
in various swap and non-swap markets.\77\ In particular, the Commission
looked to the futures markets, where futures block trades are
permissible, privately-negotiated transactions that equal or exceed a
DCM's specified minimum quantity of futures or options contracts and is
executed away from the DCM's centralized market but pursuant to its
rules.\78\ Accordingly, the Commission's regulatory definition of a
``block trade'' for swaps closely tracks this futures market concept of
a block trade.
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\76\ 17 CFR 43.2.
\77\ Real-Time Public Reporting of Swap Transaction Data, 75 FR
76140, 76159 (proposed Dec. 7, 2010) (discussion of block trades
with respect to futures).
\78\ Id.
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Similar to futures block trades, the Commission requires that swap
block trades ``occur away'' from a SEF's or a DCM's trading system or
platform, but pursuant to the SEF's or a DCM's rules and
procedures.\79\ The Commission clarified the ``block trade'' definition
by stating that ``[a]ny swap that is executed on a SEF or a DCM's
trading system or platform, regardless of whether it is for a size at
or above the appropriate minimum block size for such swap, is not a
block trade under this definition. . . .'' \80\ Accordingly, to receive
the fifteen-minute public reporting delay that block trades are
entitled to under Sec. 43.5(d), the swap transaction not only must
have a notional amount at or above the appropriate minimum block size,
but must also ``occur away'' from the SEF's or the DCM's trading system
or platform.\81\
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\79\ 17 CFR 43.2.
\80\ Procedures To Establish Appropriate Minimum Block Sizes for
Large Notional Off-Facility Swaps and Block Trades, 78 FR 32866,
32904 n.425 (May 31, 2013).
\81\ CEA section 2(a)(13) requires the Commission to establish
rules that govern the real-time reporting of swap transaction and
pricing data to the public, but also directs the Commission, among
other things, to prescribe rules that specify the appropriate
reporting time delay for block trades, including the criteria for
determining what constitutes a block trade. 7 U.S.C. 2(a)(13).
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2. Proposed Amendment to Sec. 43.2
During the part 37 implementation process, SEFs and market
participants informed the Commission that for swap transactions that
are intended to be cleared, requiring that such swaps ``occur away''
from a SEF's trading system or platform creates an issue with carrying
out pre-execution credit screening.\82\ These market participants noted
that, in many cases, clearing FCMs are unable to conduct pre-execution
credit screening for such block trades because they are unaware that a
block trade has occurred away from a SEF until after it has been
executed and reported to the SEF.\83\ Accordingly, SEFs were unable to
facilitate pre-execution credit checks for block trades.
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\82\ For the avoidance of doubt, the Commission believes that if
the parties purport to execute a block trade away from the SEF
without first obtaining a credit check, an FCM clearing member that
clears such trade and does not have knowledge of such purported
execution is not in violation of the pre-execution credit check
requirement under Commission regulation 1.73. NAL No. 17-60 n.9. The
Commission understands that currently no mechanism exists to enable
a pre-execution credit check where blocks are executed away from a
SEF; however, this proposal does not preclude participants from
developing and using such a mechanism in the future.
\83\ NAL No. 17-60 at 2.
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DMO acknowledged this operational challenge and accordingly has
granted ongoing no-action relief from the requirement that swap block
trades ``occur away'' from a SEF.\84\ Based on Commission staff no-
action relief provided in NAL No. 17-60, a SEF may allow market
participants to execute swap block trades that are ITBC \85\ on a SEF's
non-Order Book trading system or platform.\86\ As a result, FCMs and
SEFs have been able to comply with their respective pre-execution
credit screening obligations.
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\84\ NAL No. 17-60; NAL No. 16-74; NAL No. 15-60; NAL No. 14-
118.
\85\ As used herein, swaps that are ITBC are swaps (i) of a type
accepted for clearing by a DCO, and (ii) intended to be submitted
for clearing contemporaneously with execution. NAL No. 17-60 n.2.
\86\ NAL No. 17-60 at 2-3.
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The Commission proposes to revise the ``block trade'' definition
under Sec. 43.2 in order to allow market participants to utilize a
SEF's non-Order Book trading system or platform while still allowing
swap block trades to ``occur away'' from a SEF.\87\ The proposed
revision to the ``block trade'' definition not only allows swap block
trades that are ITBC to be executed on a SEF's non-Order Book trading
system or platform--as is currently provided for in NAL No. 17-60--but
the proposed definition would also permit swap block trades that are
not ITBC to be executed on SEF.\88\ The Commission believes that having
a single set of block trade rules for both ITBC and non-ITBC swap block
trades will help to reduce operational complexity for both SEFs and
market participants. Further, the Commission believes that permitting
execution of block trades on a SEF's non-Order Book trading systems or
platforms furthers the statutory SEF goal of promoting the trading of
swaps on SEFs.\89\ Moreover, for swap block trades that are ITBC and
executed on a SEF's non-Order Book trading system or platform, the
Commission believes that the proposed revised definition would (i)
allow FCMs to conduct pre-execution credit screenings in accordance
with Sec. 1.73; and (ii) allow SEFs to facilitate those screenings in
accordance with the Commission's proposed requirement under Sec.
37.702(b).\90\
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\87\ The Commission notes that it has proposed to address the
issue of block trades on SEFs in the 2018 SEF Proposal. As noted
above, this proposal is independent of the 2018 SEF Proposal.
\88\ The Commission notes that in the 2018 SEF Proposal, it
proposed for all SEF swap block trades to be executed on the SEF.
The Commission continues to evaluate this proposal. See supra note
15.
\89\ See 7 U.S.C. 7b-3(e).
\90\ The Commission notes that proposed Sec. 37.702(b) applies
to SEFs that list (i) swaps that are subject to the clearing
requirement; and/or (ii) swaps that are not subject to the clearing
requirement, but for which the SEF facilitates processing and
routing to a DCO for clearing.
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Further, the Commission notes that this revised block trade
definition is consistent with the provisions of the Dodd-Frank Act. CEA
section 2(a)(13), as amended by the Dodd-Frank Act, directs the
Commission to prescribe criteria for determining what constitutes a
block trade and to establish appropriate post-trade reporting time
delays. The provision, however, does not set forth any pre-trade
requirements, such as a requirement that the transaction be executed
away from a SEF. In addition, the Commission believes that allowing
participants to use a SEF's non-Order Book functionalities to execute
swap block trades is consistent with the Commission's regulatory
approach to mitigate risks of information leakage (i.e., a ``winner's
curse'') as market participants can use the functionality of the SEF to
execute a block trade in a manner that will not disclose the order to
the entire market.\91\ SEFs currently provide various modes of
execution to enable market participants to execute a block trade on the
SEF without providing disclosure of the block trade to the market or to
multiple market participants.\92\
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\91\ SEF Core Principles Final Rule, 78 FR 33498, 33562, and
33563.
\92\ For example, the Commission has observed that some SEFs
offer a ``RFQ-to-one'' functionality that allows counterparties to
bilaterally negotiate a block trade between two potential
counterparties, without requiring disclosure of the potential trade
to other market participants on a pre-trade basis.
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Finally, the Commission believes that permitting swap block trades
to be executed on a SEF's non-Order Book trading platforms while also
allowing them to ``occur away'' from a SEF provides SEFs increased
flexibility. In particular, SEFs will be able to provide execution
methods for swap block
[[Page 9420]]
trades that are most suitable, efficient, and cost-effective for the
product being traded, the SEF's market, and its market participants.
3. Request for Comment
The Commission requests comment on all aspects of the proposed
revision to the definition of ``block trade'' in Sec. 43.2. The 2018
SEF Proposal also proposed revisions to this definition. Comments made
on the 2018 SEF Proposal that are relevant to this rulemaking must be
resubmitted to be considered. The Commission also invites comments
specifically on the following:
(43) Is the Commission's proposed revision to the definition of
``block trade'' appropriate? If not, how should the Commission amend
the proposed definition?
(44) Should the Commission continue to permit market participants
to execute ITBC swap block trades away from but pursuant to the rules
of a SEF? Please explain why or why not.
(45) Should the Commission continue to permit market participants
to execute non-ITBC swap block trades away from but pursuant to the
rules of a SEF? Please explain why or why not.
(46) Should the Commission prohibit swap block trades that are
subject to the trade execution requirement from ``occurring away'' from
a SEF but pursuant to its rules?
(47) Should the Commission further limit or prohibit the execution
of swap block trades through an RFQ system, as defined in Sec.
37.9(a)(3)? For example, should the Commission limit the number of
market participants that may receive a RFQ for a swap block trade that
is intended to be executed on the SEF? Please explain why or why not.
(48) Should the Commission allow swap block trades to be executed
through an Order Book, as defined in Sec. 37.3(a)(3)? Please explain
why or why not.
III. Effective Date and Transition Period
The Commission proposes that the effective date for the proposed
regulations be 60 days after publication of final regulations in the
Federal Register. The Commission preliminarily believes that such an
effective date would allow SEFs and market participants sufficient time
to adapt to the amended and additional rules in an efficient and
orderly manner.
Request for Comment
The Commission requests comment on whether the proposed effective
date is appropriate and, if not, the Commission further requests
comment on possible alternative effective dates and the basis for any
such alternative dates.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \93\ requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small businesses. The regulations adopted herein will
affect SEFs and their market participants. The Commission has
previously established certain definitions of ``small entities'' to be
used by the Commission in evaluating the impact of its regulations on
small entities in accordance with the RFA.\94\ The Commission
previously concluded that SEFs are not small entities for the purpose
of the RFA.\95\ The Commission has also previously stated its belief in
the context of relevant rulemakings that SEFs' market participants,
which are all required to be eligible contract participants (``ECPs'')
\96\ as defined in section 1a(18) of the CEA,\97\ are not small
entities for purposes of the RFA.\98\ Therefore, the Chairman, on
behalf of the Commission, hereby preliminarily certifies, pursuant to 5
U.S.C. 605(b), that the regulations will not have a significant
economic impact on a substantial number of small entities. The
Commission invites the public to comment on whether SEFs and SEF market
participants covered by these proposed rules should be considered small
entities for the purpose of the RFA.
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\93\ 5 U.S.C. 601 et seq.
\94\ 47 FR 18618--18621 (Apr. 30, 1982).
\95\ SEF Core Principles Final Rule, 78 FR 33476, 33548 (June 4,
2013) (citing 47 FR 18618, 18621 (Apr. 30, 1982) (discussing DCMs);
66 FR 42256, 42268 (Aug. 10, 2001) (discussing DTFs, ECMs, and
EBOTs); and 66 FR 45604, 45609 (Aug. 29, 2001) (discussing
registered DCOs)).
\96\ 17 CFR 37.703.
\97\ 7 U.S.C. 1(a)(18).
\98\ 66 FR 20740, 20743 (Apr. 25, 2001) (stating that ECPs by
the nature of their definition in the CEA should not be considered
small entities).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq.
(``PRA'') imposes certain requirements on Federal agencies (including
the Commission) in connection with conducting or sponsoring any
``collection of information,'' \99\ as defined by the PRA. Among its
purposes, the PRA is intended to minimize the paperwork burden to the
private sector, to ensure that any collection of information by a
government agency is put to the greatest possible uses, and to minimize
duplicative information collections across the government.\100\
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\99\ See 44 U.S.C. 3502(3)(A).
\100\ See 44 U.S.C. 3501.
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The PRA applies to all information, regardless of form or format,
whenever the government is obtaining, causing to be obtained, or
soliciting information, and includes required disclosure to third
parties or the public, of facts or opinions, when the information
collection calls for answers to identical questions posed to, or
identical reporting or recordkeeping requirements imposed on, ten or
more persons.\101\ The PRA requirements have been determined to include
not only mandatory, but also voluntary information collections, and
include both written and oral communications.\102\ The Commission may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid Office
of Management and Budget (``OMB'') control number.
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\101\ See 44 U.S.C. 3502(3).
\102\ See 5 CFR 1320.3(c)(1).
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This proposed rulemaking contains collections of information for
which the Commission has previously received control numbers from OMB.
The titles for these collections of information are ``Real-Time Public
Reporting and Block Trades, OMB control number 3038-0070'' and ``Core
Principles and Other Requirements for Swap Execution Facilities, OMB
control number 3038-0074.'' This proposed rulemaking would not impose
any new information collection requirements from any persons or
entities that require approval of OMB under the PRA.
C. Cost-Benefit Considerations
Section 15(a) of the CEA \103\ requires the Commission to consider
the costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The Commission considers the costs and benefits
resulting from its discretionary determinations with respect to the
section 15(a) factors.
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\103\ 7 U.S.C. 19(a).
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[[Page 9421]]
1. Background
The Commission is proposing to amend certain rules in parts 36, 37,
and 43 of its regulations relating to the execution of certain package
transactions on SEFs; the resolution of error trades on SEFs; and the
execution of block trades on SEFs.
The baseline against which the Commission considers the costs and
benefits of these proposed rules is the statutory and regulatory
requirements of the CEA and Commission regulations now in effect, in
particular CEA section 5h and certain rules in parts 37 and 43 of the
Commission's regulations. The Commission, however, notes that as a
practical matter SEFs and market participants have adopted some current
practices based upon no-action relief provided by Commission staff that
is time-limited in nature.\104\ As such, to the extent that SEFs and
market participants have relied on relevant staff no-action letters,
the actual costs and benefits of the proposed rules as realized in the
market may not be as significant.
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\104\ In its discussion of alternatives, the Commission believes
it is also relevant to consider the costs and benefits of the
proposed regulations in comparison to circumstances in which such
no-action relief has expired and is no longer available. The
Commission further notes that in connection with NAL No. 16-58 and
its extension NAL No. 17-27 (relief related to clerical or
operational error trade resolution), market participants
specifically requested that the Commission undertake rulemakings to
establish a permanent solution for addressing these clerical and
operational errors, rather than merely extending the previous NAL
relief. See NAL No. 16-58 and NAL No. 17-27. In contrast, previous
requests for no-action relief from market participants for the NALs
which preceded NAL No.16-58 and NAL No. 17-27 were merely for
temporary relief.
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In some instances, it is not reasonably feasible to quantify the
costs and benefits to SEFs and certain market participants with respect
to certain factors, for example, market integrity. Notwithstanding
these types of limitations, however, the Commission otherwise
identifies and considers the costs and benefits of these rules in
qualitative terms.
The following consideration of costs and benefits is organized
according to the rules and rule amendments proposed in this release.
For each rule, the Commission summarizes the proposed amendments and
identifies and discusses the costs and benefits attributable to such
rule. The Commission, where applicable, then considers the costs and
benefits of the proposed rules in light of the five public interest
considerations set out in section 15(a) of the CEA.
The Commission notes that this consideration of costs and benefits
is based on the understanding that the swaps market functions
internationally, with many transactions involving U.S. firms taking
place across international boundaries, with some Commission registrants
being organized outside of the United States, with leading industry
members typically conducting operations both within and outside the
United States, and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
proposed rules on all swaps activity subject to the proposed and
amended regulations, whether by virtue of the activity's physical
location in the United States or by virtue of the activity's connection
with or effect on U.S. commerce under CEA section 2(i).\105\
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\105\ Section 2(i)(1) applies the swaps provisions of both the
Dodd-Frank Act and Commission regulations promulgated under those
provisions to activities outside the United States that ``have a
direct and significant connection with activities in, or effect on,
commerce of the United States[.]'' 7 U.S.C. 2(i). Section 2(i)(2)
makes them applicable to activities outside the United States that
contravene Commission rules promulgated to prevent evasion of Dodd-
Frank.
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2. Package Transactions
The Commission proposes to add Sec. 37.9(d) and amend Sec.
37.9(a)(2) to permit the swap components of certain package
transactions to be executed via flexible methods of execution pursuant
to Sec. 37.9(c)(2). The Commission proposes to define a ``package
transaction'' for the purpose of the proposed rule as a transaction
consisting of two or more component transactions executed between two
or more counterparties where (i) at least one component transaction is
subject to the trade execution requirement in section 2(h)(8) of the
Act; (ii) execution of each component transaction is contingent upon
the execution of all other component transactions; and (iii) the
component transactions are priced or quoted together as one economic
transaction with simultaneous or near-simultaneous execution of all
components. Based on this proposed definition and consistent with
existing no-action relief, the Commission proposes to allow the swap
component of the following three categories of package transactions to
be executed via flexible means of execution pursuant to Sec.
37.9(c)(2): (1) MAT/Non-MAT Uncleared package transactions; (2) MAT/
Non-Swap Instrument package transactions; \106\ and (3) MAT/Non-
Exclusive CFTC Swap package transactions.
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\106\ Under proposed Sec. 37.9(d)(3), consistent with the no-
action relief, this category specifically excludes U.S. Dollar
Spreadover package transactions; MAT/Futures package transactions,
MAT/Agency MBS package transactions; and New Issuance Bond package
transactions.
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In addition, the Commission is proposing to exempt the swap
components of these three types of package transactions from the
requirement in Sec. 37.3 that the SEF offer an Order Book for every
swap listed for trading on the SEF, while continuing to require that
SEFs offer an Order Book for outright transactions in every swap listed
for trading on the SEF. Finally, the Commission is proposing to use its
exemptive authority pursuant to CEA section 4(c) to exempt swap
transactions that are executed as a component of a package transaction
that includes a component that is a new issuance bond from the trade
execution requirement under section 2(h)(8) of the Act.
Benefits: The proposed rule would allow market participants to
choose the most suitable execution method for each package transaction
and will allow SEFs to continue to offer flexible execution methods for
these package transactions rather than only offer the required methods
of execution for swaps subject to the trade execution requirement. The
Commission expects this would reduce execution risks, improve
efficiency, and decrease transaction costs as market participants would
be able to avoid legging into transactions, that is, entering into each
part of the package separately. The Commission notes that these
benefits are currently available to market participants through
existing no-action relief. The Commission further believes that the
proposed rule would provide the liquidity and transparency benefits of
increased trading of component swaps on SEFs, as without the proposed
flexibility market participants would be unable or unwilling to trade
such swap components through SEFs' required methods of execution.\107\
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\107\ Further, while the proposed rules also provide flexibility
from the required methods of execution that are otherwise intended
to help promote pre-trade transparency on SEFs, the Commission notes
that permitting market participants to use flexible methods of
execution is consistent with how package transactions are treated
within other jurisdictions. For example, in the European Union
(``EU'') certain package transactions (including package
transactions for which the Commission currently requires the swap
component to be executed through the required methods of execution,
such as U.S. Dollar Spreadover package transactions) are eligible to
be waived from the EU's transparency regime. The Commission believes
that this proposal strikes an appropriate balance between promoting
pre-trade transparency and ensuring that U.S. markets and their
participants are not unnecessarily burdened. See Regulation (EU)
2016/1033 of the European Parliament and of the Council of 23 June
2016 amending Regulation (EU) No 600/2014 on markets in financial
instruments, Regulation (EU) No 596/2014 on market abuse and
Regulation (EU) No 909/2014 on improving securities settlement in
the European Union and on central securities depositories.
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[[Page 9422]]
The Commission believes that not requiring SEFs to offer an Order
Book for the swap components of the three types of relevant package
transactions would benefit SEFs by helping them to reduce operating
costs, as they would no longer be required to operate and maintain an
Order Book for trading those swaps that are components of those package
transactions. However, SEFs would need to retain the availability of
Order Books for those swaps executed as outright transactions.
Further, as discussed above, given the illiquid and bespoke nature
of various components within the relevant package transactions, the
Commission acknowledges that the Order Book is not the ideal method of
execution for many such transactions. Therefore, the Commission
anticipates that if SEFs are not required to provide an Order Book for
relevant package transactions that are not suitable for Order Book
trading, SEFs will be able to more effectively employ their resources,
and no longer face the prospect of being required to provide Order
Books that will not be utilized given the complex, illiquid, and
bespoke nature of various components of the relevant package
transactions.
The Commission believes that the proposal to exempt swap
transactions that are executed as a component of a package transaction
that includes a component that is a new issuance bond from the trade
execution requirement will ensure that market participants such as bond
underwriters and issuers can continue to execute these packages (where
the new-issuance bond is hedged by an interest rate swap with tenor and
payment terms that typically match the terms of the bond issuance) off-
SEF. As discussed above, this proposed exemption may facilitate new
bond issuances, which may benefit capital formation by helping market
participants to raise capital and fund origination loans for businesses
and homeowners. Moreover, in light of the involvement of the bond
issuer and the underwriter in arranging and executing a package
transaction in conjunction with a new issuance bond and the unique
negotiation and fit-for-purpose nature of these package transactions,
the Commission understands that it remains difficult or impossible to
trade these package transactions on a SEF. SEFs have not been able to
design an execution method suitable for this particular type of
package, rendering it impracticable to execute these packages on-SEF.
While the swap components of many swap/new-issuance bond packages
executed today are not currently subject to the trade execution
requirement,\108\ the proposed rule would ensure that those
transactions would remain exempt in the event the trade execution
requirement is expanded to include more types of swaps.
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\108\ For example, the swap component may be a forwarding-
starting swap whose start date corresponds to the issuance date of
the bond. Forward starting swaps are not currently subject to the
trade execution requirement.
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Costs: The proposed amendments to allow flexible execution methods
for certain package transactions and the proposed exemption for package
transactions that include a new issuance bond should not impose costs
on market participants since they only provide flexibility to market
participants and do not require them to change their current trade
practices. Moreover, to the extent that market participants are relying
on existing no-action relief, they could continue to implement existing
industry practice. The Commission believes that current SEF rules
typically allow participants to utilize flexible execution methods
pursuant to the existing no-action relief, but to the extent that SEFs
need to modify their rules to incorporate the proposed amendments, they
may incur modest costs.
As noted, not requiring SEFs to offer an Order Book for the swap
components of the relevant package transactions may enable SEFs to
reduce operating costs. Since any existing Order Books for swap
components of the relevant package transactions are not actively used
and are not practicable for market participants to use, removing these
Order Books (and not requiring SEFs to create such Order Books) should
not impose significant costs on market participants.
Section 15(a) Factors
a. Protection of Market Participants and the Public
The Commission believes that the proposed amendments and exemption
will protect market participants from the risks associated with legging
into the relevant packages by enabling market participants to enter
into package transactions using appropriate execution methods.
Permitting SEFs to eliminate the Order Book for use when swaps are
components of package transactions should not impact protection of
market participants. While protecting market participants also benefits
the public, the Commission has not identified any further effect of the
proposal on protection of the public.
b. Efficiency, Competitiveness, and Financial Integrity of the Markets
The proposed amendments would enhance efficiency by enabling market
participants to continue to execute the relevant packages in a single
transaction with an appropriate execution method, rather than via the
inefficient process of legging into the package one component at a
time. The proposed amendments would also enhance financial integrity by
enabling market participants to continue to avoid the execution risk
associated with potential adverse price movements while attempting to
leg a transaction. The Commission has not identified any likely effects
of the proposed amendments on competition in the swap markets. The
Commission expects that, since there are few, if any, active Order
Books for swaps as components of the relevant package transactions,
SEFs will not use proposed Sec. 37.3(a)(4) to remove active Order
Books that are providing competitive markets.
c. Price Discovery
Package transactions are typically executed at a single price for
the entire package, rather than at the prices of the individual
components. The proposed amendments would continue to allow the
relevant package transactions to be executed using the execution
methods that are designed to facilitate price discovery in these
packages. For packages that include new issuance bonds, the proposed
exemption will permit price discovery to occur at the appropriate
venue. The Commission believes that the proposed Sec. 37.3(a)(4),
which would exempt swaps that are part of the relevant package
transactions from the Order Book requirement, would not materially
inhibit price discovery since the Commission anticipates that SEFs
would retain Order Books where price discovery is occurring and that
currently price discovery is not occurring in Order Books for swap
components of the package transactions addressed within this proposal.
d. Sound Risk Management Practices
The Commission believes that the proposal will continue to promote
sound risk management by facilitating the execution of package
transactions as market participants consider package transactions to
often be useful and appropriate instruments for
[[Page 9423]]
management and transfer of risk and to avoid the execution risks
associated with legging of transactions.
e. Other Public Interest Considerations
The proposed exemption from the trade execution requirement for the
swap components of packages involving new issuance bonds may help
promote capital formation by facilitating the issuance of bonds to
raise capital. The Commission has not identified any other effect of
the proposed rules and proposed exemption regarding package
transactions on other public interest considerations.
Request for Comment
The Commission requests comment on the costs and benefits of all
aspects of the proposed amendments related to certain package
transactions, including the discussion of the section 15(a) factors.
Comments made on the 2018 SEF Proposal that are relevant to this
rulemaking should be resubmitted to be considered. The Commission
requests comment on the alternatives discussed above as well as any
other alternatives that commenters believe present a superior cost-
benefit profile to the proposed amendments. Commenters are requested to
provide data and any other information or statistics to support their
position. In particular, to the extent commenters believe that the
costs or benefits of any aspect of the proposed rules are reasonably
quantifiable, the Commission requests that they provide data and any
other information or statistics to assist the Commission in
quantification.
3. Error Trades
The Commission proposes to add subsection (e) to Sec. 37.9 to
establish a flexible SEF error trade policy standard that would, among
other things, incorporate the intent of the existing no-action relief
in NAL No. 17-27 for resolving errors in Required Transactions.
Proposed Sec. 37.9(e)(2)(i) would specify that a SEF must maintain
rules and procedures that are ``fair, transparent, consistent'' and
``allow for timely resolution'' of an ``error trade,'' as defined under
proposed Sec. 37.9(e)(1)(ii). This proposed standard would apply to
any error trade that occurs on a SEF, regardless of whether or not the
swap is submitted for clearing. Further, under proposed Sec.
37.9(e)(2)(i), SEFs must have error trade rules and procedures that
require that market participants provide prompt notice to the SEF of an
error trade and, as applicable, correcting and offsetting trades.
Proposed Sec. 37.9(e) would also require a SEF to adopt rules to
resolve error trades that involve swaps submitted for clearing. For an
error trade rejected from clearing and therefore deemed void ab initio,
proposed Sec. 37.9(e)(2)(i)(A) would require a SEF to permit the
counterparties to subsequently execute a correcting trade, as defined
in proposed Sec. 37.9(e)(1)(i), through any method of execution
offered by the SEF. For an error trade that has been accepted for
clearing, proposed Sec. 37.9(e)(2)(i)(B) would require a SEF to permit
the counterparties to subsequently execute both an offsetting trade, as
defined in proposed Sec. 37.9(e)(1)(iii), and a correcting trade
through any method of execution offered by the SEF.
The proposed rule includes some limitations that are similar to the
existing no-action relief, including specified timeframes for executing
and submitting these trades for clearing. For correcting trades
associated with an error trade that has been rejected from clearing,
proposed Sec. 37.9(e)(2)(i)(A) would require the SEF to submit the
correcting trade for clearing to the registered DCO or exempt DCO as
soon as technologically practicable, but no later than one hour after
notice of the rejection to the relevant clearing members. For an
offsetting trade and a correcting trade associated with an error trade
that already has been accepted for clearing, proposed Sec.
37.9(e)(2)(i)(B) would require the SEF to submit both types of trades
to the registered DCO or exempt DCO as soon as technologically
practicable, but no later than three days after the registered DCO or
exempt DCO accepted the error trade for clearing. In addition to these
proposed timeframes, proposed Sec. 37.9(e)(2)(ii) would prohibit
counterparties from executing a second correcting trade to fix an error
trade if the initial correcting trade is rejected from clearing.
However, the proposed rule does not include certain additional
conditions applicable to SEFs and counterparties that are contained in
the no-action relief under NAL No. 17-27 or NAL No. 20-01. For example,
the no-action relief in NAL No. 17-27 requires that a SEF must make an
affirmative finding that an alleged error trade has occurred and must
have rules setting forth the procedures for making such a finding.
Benefits: Absent an adoption of these proposed rules, both SEFs and
market participants would need to comply with the existing Commission
regulations, notwithstanding the significant procedural and logistical
difficulties of doing so. In particular, market participants would have
to resolve error trades in Required Transactions using the Order Book
or RFQ System, which would likely make it impossible to recreate the
trade as originally intended. These difficulties could dissuade SEFs
from being actively involved in the error trade resolution process and
market participants from executing swaps on a SEF. The Commission
believes that the proposal would avoid these potential difficulties.
The Commission preliminarily believes that, given that the proposed
amendments are largely consistent with current industry practice, SEFs
and market participants may likely have already realized much of the
benefit of proposed Sec. 37.9(e). The Commission preliminarily
believes, however, that the proposed rules additionally would provide a
tangible benefit to market participants on a longer-term basis by
allowing market participants to continue utilizing policies and
protocols which the Commission understands most SEFs adopted in
reliance upon the relief provided in existing no-action letters to
resolve error trades.
The proposed rule does not require that a SEF affirmatively
determine that an error trade has occurred, either before resolution or
via an ex post facto review. The Commission preliminarily believes that
such a requirement, which is in the existing no-action relief, would
impose unnecessary costs on SEFs and market participants, and
potentially impair the efficiency of the error trade resolution
process. To the extent that SEFs and market participants are currently
availing themselves of current no-action relief, they may realize
reduced costs under the proposed rule.
The proposed requirement under Sec. 37.9(e)(2)(i) that market
participants provide prompt notice to a SEF of an error trade and, as
applicable, the corresponding correcting trade and offsetting trade
would benefit SEFs in carrying out their self-regulatory obligations.
In particular, the Commission believes that providing SEFs prompt
notice that an error trade has occurred on their trading system(s) or
platform(s) would enhance their ability to carry real-time market
monitoring of all trading activity on their system(s) or platform(s) to
identify disorderly trading and any market or system anomalies or
violations of SEF rules.
The Commission also believes that the proposed amendments will
facilitate the goal of promoting consistency in the swaps market with
respect to how errors are evaluated and resolved. First, the proposed
amendments would require all SEFs to adopt such policies. To the extent
SEFs have not yet implemented such policies, the proposed
[[Page 9424]]
amendments will benefit market participants who will now be able to
correct error trades and avoid related economic losses. Further, market
participants can obtain the benefit of executing a swap transaction
that corrects an error trade with the terms originally intended.
Finally, some SEFs have already implemented robust error trade
resolution policies pursuant to existing no-action relief, while other
SEFs have not implemented robust error trade policies. This
inconsistency among SEFs otherwise causes a ``race to the bottom'' for
SEFs' compliance and market oversight, as certain market participants
may prefer SEFs with less stringent error trade policies. As a result,
SEFs that have implemented robust error trade policies--and the swaps
market in general--will benefit by eliminating this potential ``race to
the bottom,'' and the Commission will underscore the importance of SEF
market oversight by adopting such requirements in Commission
regulations.\109\
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\109\ The Commission notes that a robust error trade resolution
policy is also consistent with an effective compliance and oversight
program because the ability to resolve error trades (i) helps
protect market integrity by unwinding certain error trades that
otherwise would have an adverse effect on the market and (ii)
promotes legal certainty by ensuring that market participants obtain
the economic position in the transaction that they intended.
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Costs: Similar to the conditions established by Commission staff in
time-limited no-action relief, the proposed amendments would require
SEFs to establish rules implementing various policies and procedures
for resolving error trades. Under the proposal, SEFs would have to
submit new rules to the Commission pursuant to part 40 of the
Commission's regulations. However, the Commission understands that
pursuant to the existing no-action relief, most SEFs currently have
rules that otherwise would comply with the proposed regulations. SEFs
may choose to adjust their rules in light of the absence in the
proposed rules of the requirement in the no-action relief that SEFs
affirmatively determine that an error trade has occurred.\110\ To the
extent that SEFs must draft and submit new rules to the Commission, the
Commission estimates that the costs will be modest.
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\110\ In light of the flexibility of the proposed rule, SEFs can
continue to require such an affirmative declaration if the determine
that such requirement provides benefits to market participants or
the SEF.
---------------------------------------------------------------------------
The Commission preliminarily believes that the proposed amendments
would not impose significant additional costs on market participants
and intermediaries, because resolving error trades is inherently costly
regardless of regulations imposed by the Commission, and market
participants and intermediaries are currently subject to SEF policies
and procedures. The proposed requirement that market participants
provide prompt notice to a SEF of an error trade and, as applicable,
the correcting trade and offsetting trade would impose modest costs on
market participants, but, in practice, market participants have likely
needed to report error trades to SEFs in order to facilitate SEF
determinations that an error trade has occurred pursuant to NAL No. 17-
27, and would have had to report the correcting trade and offsetting
trade in order to facilitate the SEF's ex post facto review pursuant to
NAL No. 20-01. Not requiring that a SEF find that an error trade has
occurred either before it has been resolved or via an ex post facto
review should impose only minor costs on market participants associated
with changes in procedures to no longer request that a SEF make such a
determination.
The Commission notes that NAL No. 17-27 and NAL No. 20-01 apply to
both SEFs and DCMs, but the proposed rule would apply only to SEFs.
Therefore, the Commission believes that the proposed rule would impose
no costs on DCMs, and notes that no DCM is currently availing itself of
the no-action relief.
Section 15(a) Factors
a. Protection of Market Participants and the Public
The proposed addition of Sec. 37.9(e) regarding error trades will
protect market participants and the public by providing SEFs with
greater authority under Commission regulations to resolve error trades.
Further, by providing SEFs with the authority to permit counterparties
to execute correcting trades and offsetting trades, the proposed
amendments would protect market stability and transparency by
preventing potential losses to market participants in connection with
error trades and reducing instances in which market participants rely
on inaccurate pricing information to inform their trading decisions.
The proposed addition of Sec. 37.9(e) would also promote greater
transparency of the error trade resolution process to SEFs' market
participants as SEFs would be required to establish policies and
procedures for reviewing and determining how to resolve alleged error
trades. The proposed requirement under Sec. 37.9(e)(2)(i) that market
participants provide prompt notice to a SEF of an error trade and, as
applicable, the correcting trade and offsetting trade would promote
protection of market participants and the public by enhancing a SEF's
ability to carry out its market oversight and monitoring
responsibilities. The Commission believes that the absence of a
requirement in the proposed rule that SEFs must affirmatively
determine, or determine after an ex post facto review, that an error
trade has occurred (which are conditions in the existing no-action
relief under NAL No. 17-27 and NAL No. 20-01) would not materially
impact the protection of market participants and the public.
b. Efficiency, Competitiveness, and Financial Integrity of the Markets
The proposed addition of Sec. 37.9(e) may improve the efficiency
and financial integrity of markets by enabling counterparties to
correct operational or clerical errors in a swap transaction. In
particular, the proposed rules would help promote greater trading
accuracy in the market by allowing counterparties to ultimately carry
out transactions as originally intended, and would avoid unexpected
trading losses caused by error trades. The proposed requirement under
Sec. 37.9(e)(2)(i) that market participants provide prompt notice to a
SEF of an error trade and, as applicable, the correcting trade and
offsetting trade would enhance a SEF's ability to carry out its market
oversight and monitoring responsibilities which helps promote the
financial integrity of its markets. The Commission believes that the
absence of the no-action provision that SEFs must affirmatively
determine that an error trade has occurred could enhance the efficiency
of the error trade resolution process and would not materially impact
the competitiveness or financial integrity of the swap market on SEFs.
Absent these proposed rules, counterparties would be required in
certain circumstances to correct or re-execute swap transactions in a
less efficient and effective manner on a SEF, such as through the
required methods of execution under Sec. 37.9(a). The proposed rules,
which also require SEFs to adopt certain policies and procedures for
addressing error trades, should further promote efficiency in the
resolution process by providing market participants that transact on
multiple SEFs with a more consistent approach across different
platforms for correcting error trades.
c. Price Discovery
The proposed addition of Sec. 37.9(e) regarding error trades would
enable
[[Page 9425]]
SEFs to correct error trades containing a clerical or operational error
while maintaining the price discovery benefits associated with the pre-
trade transparency requirements of Sec. 37.9. In particular, the
proposed rules would help promote price discovery by allowing
counterparties, whose original trade has been cancelled upon rejection
from clearing due to a clerical or operational error, to re-execute the
trade with the terms as originally intended. For error trades that have
been accepted by a registered DCO or exempt DCO for clearing, the
proposed rules promote greater accuracy in the price discovery process
by allowing the counterparties to correct the error trade by executing
an offsetting swap transaction and a subsequent swap transaction with
the terms as originally intended.
d. Sound Risk Management Practices
The proposed addition of Sec. 37.9(e) regarding error trades may
promote sound risk management practices by providing SEFs with greater
authority under Commission regulations to facilitate error trade
resolution. The proposed rules will help to mitigate potential losses
to market participants arising out of trade cancellations, where the
error trade is rejected from clearing, or arising from maintaining the
position of an unintended error trade.
e. Other Public Interest Considerations
The Commission has not identified any effect of proposed Sec.
37.9(e) on other public interest considerations.
Request for Comment
The Commission invites public comment on all aspects of its cost
benefit considerations related to the proposed amendments regarding
SEFs' error trade policies, including the discussion of the section
15(a) factors. Comments made on the 2018 SEF Proposal that are relevant
to this rulemaking should be resubmitted to be considered. Commenters
are requested to provide data and any other information or statistics
to support their position. In particular, to the extent commenters
believe that the costs or benefits of any aspect of the proposed rules
are reasonably quantifiable, the Commission requests that they provide
data and any other information or statistics to assist the Commission
in quantification.
The Commission requests comment on the impact of the proposed rule
on market participants who may need to adjust their error trade rules
and policies to comply with SEFs' error trade rules implemented to
comply with proposed Sec. 37.9(e). The Commission also requests
comment on any alternatives that commenters believe present a superior
cost-benefit profile to the proposed amendments.
4. Block Trades
The Commission proposes amendments to the definition of block
trade, set forth in Sec. 43.2, to allow SEFs to permit market
participants to execute swap block trades using a SEF's trading system
or platform, with the exception of the Order Book.\111\ Market
participants could continue to execute a block trade away from the
SEF's trading system or platform, but pursuant to the SEF's rules.\112\
This rule is similar to existing relief set out in NAL No. 17-60, but
the proposed rule would apply to uncleared swaps as well ITBC swaps,
while the existing no-action relief only applies to ITBC swaps.
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\111\ The Commission notes that a swap transaction with a
notional size above the appropriate minimum block trade size could
still be executed on an Order Book, but would not qualify as a block
trade, and therefore, would not receive a time delay from public
dissemination requirements set forth in Sec. 43.5(d).
\112\ The Commission notes that Sec. 43.6(g)(1)--required
notification of block trade election--would still apply to block
trade transactions executed on the SEF via the SEF's non-Order Book
trading systems and platforms. For example, pursuant to Sec.
43.6(g)(1)(i), SEFs would need to implement a mechanism by which the
counterparties notify the SEF of the counterparties' intention to
have an on-SEF executed block trade treated as a block trade for
reporting purposes. Additionally, pursuant to Sec. 43.6(i)(2), a
person transacting a cleared swap block trade on behalf of a
customer would still need to receive prior written instruction or
consent from the customer to transact the trade as a cleared swap
block trade on the SEF. See 17 CFR 43.6(i)(2).
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Benefits: The Commission believes that permitting swap block trades
to be executed on SEFs pursuant to Commission regulation would provide
tangible benefits to market participants by allowing them to further
utilize a SEF's trading systems and platforms with the exception of the
Order Book. To the extent that a SEF provides the most operationally-
and cost-efficient method of executing swap block trades, the proposed
amendment would help market participants to continue realizing such
benefits. Additionally, allowing market participants to execute swap
block trades on a SEF helps to facilitate the pre-execution screening
of transactions against risk-based limits in an efficient manner
through SEF-based mechanisms. The Commission also recognizes that many
SEFs and market participants have already expended resources to
implement technological and operational changes needed to avail
themselves of the no-action relief under NAL No. 17-60. The proposed
amendments would preclude the need to expend additional resources to
negate those changes. Further, incorporating the current no-action
relief in the Commission's regulations would promote the statutory goal
in CEA section 5h(e) of promoting swaps trading on SEFs. Finally, the
proposed amendment would permit SEFs to extend the benefits of executed
swap block trades on-SEF to uncleared swaps as well as ITBC swaps.
Costs: The Commission notes that the majority of SEFs have
implemented the existing no-action relief. To the extent that SEFs have
implemented such relief, they may incur modest costs in adjusting their
rulebooks to, for example, include uncleared swaps in their block
trading provisions. Any SEF that has not implemented the existing no-
action relief but wishes to implement block trading rules consistent
with the proposed amendment will incur somewhat higher, but still
modest costs.
Section 15(a) Factors
a. Protection of Market Participants and the Public
The proposed amendment to the definition of a swap block trade in
Sec. 43.2, which would allow for both ITBC and non-ITBC swap block
trades to be executed on a SEF's non-Order Book trading system or
platform will provide more options to market participants for executing
swap block trades without impeding the protection of market
participants and the public provided under existing Commission
regulations.
b. Efficiency, Competitiveness, and Financial Integrity of the Markets
The proposed amendment to the definition of block trade under Sec.
43.2 to allow cleared and uncleared swap block trades to be executed on
a SEF's non-Order Book trading system or platform may improve the
efficiency and financial integrity of the swaps markets. The proposed
amendments would provide market participants with the ability to
execute block trades either on a SEF or away from, but pursuant to the
rules of, a SEF. From an efficiency perspective, such choice should
allow participants to choose the most operationally efficient and cost-
efficient method of executing block trades. With respect to the
financial integrity of the swaps market, this proposed amendment would
also facilitate the use of pre-trade credit screening functionalities
or protocols offered by the SEF to fulfill its obligations under SEF
Core Principle 7--Financial Integrity of Transactions.\113\
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\113\ 17 CFR 37.700.
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[[Page 9426]]
c. Price Discovery
The Commission is not aware of significant effects on the price
discovery process of the proposed amendment to the definition of block
trade under Sec. 43.2 to allow block trades to be executed on a SEF's
non-Order Book trading system or platform. The Commission notes that
block trades are currently not subject to the execution methods for
required transactions under Sec. 37.9, which are intended to promote
pre-trade price transparency pursuant to section 5h of the CEA.\114\
Based on the previous recognition that market participants are likely
to execute large-sized trades, i.e., block trades, in a manner that
would mitigate pre-trade information leakage concerns, the Commission
does not anticipate that the proposed amendment would diminish the
price discovery process for block trades executed on a SEF.
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\114\ The Commission stated its belief in the part 37 final rule
release that an order book, as defined in Sec. 37.3(a)(3), and the
RFQ System, as defined in Sec. 37.9(a)(3), are intended to promote
the goals articulated in section 733 of the Dodd-Frank Act, which
include promoting pre-trade price transparency. 78 FR 33484, 33497.
---------------------------------------------------------------------------
d. Sound Risk Management Practices
The proposed amendment to allow block trades to occur on the SEF
(but not on the SEF's order book) may promote sound risk management
practices by providing more options for the execution of block trades.
In this regard, the Commission notes that block trading can facilitate
risk management by providing a means for commercial firms to transact
large orders without the need for significant price concessions and
resulting price uncertainty for parties to the transaction that would
occur if transacted on the centralized market.
e. Other Public Interest Considerations
The proposed amendments should help promote SEF trading and pre-
trade price transparency, i.e., the statutory goals set forth under
section 5h(f)(2) of the CEA with respect to SEFs.\115\
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\115\ 7 U.S.C. 7b-3(e).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on the costs and benefits of all
aspects of the proposed amendments to permit block trades to be
executed on a SEF, including the discussion of the section 15(a)
factors. Comments made on the 2018 SEF Proposal that are relevant to
this rulemaking should be resubmitted to be considered. The Commission
requests comment on the alternatives discussed above as well as any
other alternatives that commenters believe present a superior cost-
benefit profile to the proposed amendments. Commenters are requested to
provide data and any other information or statistics to support their
position. In particular, to the extent commenters believe that the
costs or benefits of any aspect of the proposed rules are reasonably
quantifiable, the Commission requests that they provide data and any
other information or statistics to assist the Commission in
quantification.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
objectives of the CEA, in issuing any order or adopting any Commission
rule or regulation. The Commission does not anticipate that the
proposed amendments to parts 36, 37, and 43 would promote or result in
anti-competitive consequences or behavior. However, the Commission
encourages comments from the public with respect to any aspect of the
proposal that maybe perceived as potentially inconsistent with the
antitrust laws or anti-competitive in nature.
List of Subjects
17 CFR Part 36
Package transactions, Trade execution requirement.
17 CFR Part 37
Block trades, Error trades, Package transactions, Required methods
of execution, Swap execution facilities, Swaps, Trade execution
requirement.
17 CFR Part 43
Block trades, Large notional off-facility swaps, Real-time public
reporting, Reporting and recordkeeping requirements.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR chapter I as follows:
0
1. Revise part 36 to read as follows:
PART 36--TRADE EXECUTION REQUIREMENT
Sec.
36.1 Exemptions to trade execution requirement.
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3, 2a2, and 21,
as amended by Titles VII and VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376
(2010).
Sec. 36.1 Exemptions to trade execution requirement.
(a) A swap transaction that is executed as a component of a package
transaction that also includes a component transaction that is the
issuance of a bond in a primary market is exempt from the trade
execution requirement in section 2(h)(8) of the Act.
(1) For purposes of paragraph (a) of this section, a package
transaction consists of two or more component transactions executed
between two or more counterparties where:
(i) At least one component transaction is subject to the trade
execution requirement in section 2(h)(8) of the Act;
(ii) Execution of each component transaction is contingent upon the
execution of all other component transactions; and
(iii) The component transactions are priced or quoted together as
one economic transaction with simultaneous or near-simultaneous
execution of all components.
(2) [Reserved]
(b) [Reserved]
PART 37--SWAP EXECUTION FACILITIES
0
2. The authority citation for part 37 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3, and 12a, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376.
0
3. In Sec. 37.3, add paragraph (a)(4) to read as follows:
Sec. 37.3 Requirements and procedures for registration.
(a) * * *
(4) A swap execution facility is not required to provide an order
book under this section for transactions defined in Sec. 37.9(d)(2),
(3), and (4), except that a swap execution facility must provide an
order book under this section for Required Transactions that are
components of transactions defined in Sec. 37.9(d)(2), (3), and (4)
when such Required Transactions are not executed as components of
transactions defined in Sec. 37.9(d)(2), (3), and (4).
* * * * *
0
4. In Sec. 37.9, revise paragraph (a)(2)(i) introductory text and add
paragraphs (d) and (e) to read as follows:
Sec. 37.9 Methods of execution for required and permitted
transactions.
(a) * * *
(2) * * *
(i) Each Required Transaction that is not a block trade as defined
in Sec. 43.2 of
[[Page 9427]]
this chapter shall be executed on a swap execution facility in
accordance with one of the following methods of execution except as
provided in paragraph (d) or (e) of this section:
* * * * *
(d) Exceptions to required methods of execution for package
transactions. (1) For purposes of this paragraph, a package transaction
consists of two or more component transactions executed between two or
more counterparties where:
(i) At least one component transaction is a Required Transaction;
(ii) Execution of each component transaction is contingent upon the
execution of all other component transactions; and
(iii) The component transactions are priced or quoted together as
one economic transaction with simultaneous or near-simultaneous
execution of all components.
(2) A Required Transaction that is executed as a component of a
package transaction that includes a component swap that is subject
exclusively to the Commission's jurisdiction, but is not subject to the
clearing requirement under section 2(h)(1)(A) of the Act, may be
executed on a swap execution facility in accordance with paragraph
(c)(2) of this section as if it were a Permitted Transaction;
(3) A Required Transaction that is executed as a component of a
package transaction that includes a component that is not a swap, as
defined under section 1a(47) of the Act, may be executed on a swap
execution facility in accordance with paragraph (c)(2) of this section
as if it were a Permitted Transaction. This provision shall not apply
to:
(i) A Required Transaction that is executed as a component of a
package transaction in which all other non-swap components are U.S.
Treasury securities;
(ii) A Required Transaction that is executed as a component of a
package transaction in which all other non-swap components are
contracts for the purchase or sale of a commodity for future delivery;
(iii) A Required Transaction that is executed as a component of a
package transaction in which all other non-swap components are agency
mortgage-backed securities; and
(iv) A Required Transaction that is executed as a component of a
package transaction that includes a component transaction that is the
issuance of a bond in a primary market.
(4) A Required Transaction that is executed as a component of a
package transaction that includes a component swap that is not
exclusively subject to the Commission's jurisdiction may be executed on
a swap execution facility in accordance with paragraph (c)(2) of this
section as if it were a Permitted Transaction.
(e) Resolution of operational and clerical error trades. (1) As
used in this paragraph:
(i) Correcting trade means a trade executed and submitted for
clearing to a registered derivatives clearing organization, or a
derivatives clearing organization that the Commission has determined is
exempt from registration, with the same terms and conditions as an
error trade other than any corrections to any operational or clerical
error and the time of execution.
(ii) Error trade means any trade executed on or subject to the
rules of a swap execution facility that contains an operational or
clerical error.
(iii) Offsetting trade means a trade executed and submitted for
clearing to a registered derivatives clearing organization, or a
derivatives clearing organization that the Commission has determined is
exempt from registration, with terms and conditions that economically
reverse an error trade that was accepted for clearing.
(2) Execution of correcting trades and offsetting trades. (i) A
swap execution facility shall maintain rules and procedures that
facilitate the resolution of error trades. Such rules shall be fair,
transparent, and consistent; allow for timely resolution; require
market participants to provide prompt notice of an error trade--and, as
applicable, offsetting and correcting trades--to the swap execution
facility; and permit market participants to:
(A) Execute a correcting trade, in accordance with paragraph (c)(2)
of this section, regardless of whether it is a Required or Permitted
Transaction, for an error trade that has been rejected from clearing as
soon as technologically practicable, but no later than one hour after a
registered derivatives clearing organization, or a derivatives clearing
organization that the Commission has determined is exempt from
registration, provides notice of the rejection; or
(B) Execute an offsetting trade and a correcting trade, in
accordance with paragraph (c)(2) of this section, regardless of whether
it is a Required or Permitted Transaction, for an error trade that was
accepted for clearing as soon as technologically practicable, but no
later than three days after the error trade was accepted for clearing
at a derivatives clearing organization or a derivatives clearing
organization that the Commission has determined is exempt from
registration.
(ii) If a correcting trade is rejected from clearing, then a swap
execution facility shall not allow the counterparties to execute
another correcting trade.
PART 43--REAL-TIME PUBLIC REPORTING
0
5. The authority citation for part 43 continues to read as follows:
Authority: 7 U.S.C. 2(a), 12a(5) and 24a, as amended by Pub. L.
111-203, 124 Stat. 1376 (2010).
0
6. Revise Sec. 43.2 to read as follows:
Sec. 43.2 Definitions.
As used in this part:
Act means the Commodity Exchange Act, as amended, 7 U.S.C. 1 et
seq.
Affirmation means the process by which parties to a swap verify
(orally, in writing, electronically or otherwise) that they agree on
the primary economic terms of a swap (but not necessarily all terms of
the swap). Affirmation may constitute ``execution'' of the swap or may
provide evidence of execution of the swap, but does not constitute
confirmation (or confirmation by affirmation) of the swap.
Appropriate minimum block size means the minimum notional or
principal amount for a category of swaps that qualifies a swap within
such category as a block trade or large notional off-facility swap.
As soon as technologically practicable means as soon as possible,
taking into consideration the prevalence, implementation and use of
technology by comparable market participants.
Asset class means a broad category of commodities including,
without limitation, any ``excluded commodity'' as defined in section
1a(19) of the Act, with common characteristics underlying a swap. The
asset classes include interest rate, foreign exchange, credit, equity,
other commodity and such other asset classes as may be determined by
the Commission.
Block trade means a publicly reportable swap transaction that:
(1) Involves a swap that is listed on a registered swap execution
facility or designated contract market;
(2) Is executed on a trading system or platform of a registered
swap execution facility that is not an order book as defined in Sec.
37.3(a)(3) of this chapter, or occurs away from a registered swap
execution facility's or designated contract market's trading system or
platform and is executed pursuant to the registered swap execution
facility's or designated contract market's rules and procedures;
[[Page 9428]]
(3) Has a notional or principal amount at or above the appropriate
minimum block size applicable to such swap; and
(4) Is reported subject to the rules and procedures of the
registered swap execution facility or designated contract market and
the rules described in this part, including the appropriate time delay
requirements set forth in Sec. 43.5.
Business day means the twenty-four hour day, on all days except
Saturdays, Sundays and legal holidays, in the location of the reporting
party or registered entity reporting data for the swap.
Business hours means the consecutive hours of one or more
consecutive business days.
Cap size means, for each swap category, the maximum notional or
principal amount of a publicly reportable swap transaction that is
publicly disseminated.
Confirmation means the consummation (electronic or otherwise) of
legally binding documentation (electronic or otherwise) that
memorializes the agreement of the parties to all terms of a swap. A
confirmation shall be in writing (electronic or otherwise) and shall
legally supersede any previous agreement (electronic or otherwise)
relating to the swap.
Confirmation by affirmation means the process by which one party to
a swap acknowledges its assent to the complete swap terms submitted by
the other party to the swap. If the parties to a swap are using a
confirmation service vendor, complete swap terms may be submitted
electronically by a party to such vendor's platform and the other party
may affirm such terms on such platform.
Economically related means a direct or indirect reference to the
same commodity at the same delivery location or locations, or with the
same or a substantially similar cash market price series.
Embedded option means any right, but not an obligation, provided to
one party of a swap by the other party to the swap that provides the
party holding the option with the ability to change any one or more of
the economic terms of the swap as those terms previously were
established at confirmation (or were in effect on the start date).
Executed means the completion of the execution process.
Execution means an agreement by the parties (whether orally, in
writing, electronically, or otherwise) to the terms of a swap that
legally binds the parties to such swap terms under applicable law.
Execution occurs simultaneous with or immediately following the
affirmation of the swap.
Futures-related swap means a swap (as defined in section 1a(47) of
the Act and as further defined by the Commission in implementing
regulations) that is economically related to a futures contract.
Large notional off-facility swap means an off-facility swap that
has a notional or principal amount at or above the appropriate minimum
block size applicable to such publicly reportable swap transaction and
is not a block trade as defined in this section.
Major currencies means the currencies, and the cross-rates between
the currencies, of Australia, Canada, Denmark, New Zealand, Norway,
South Africa, South Korea, Sweden, and Switzerland.
Non-major currencies means all other currencies that are not super-
major currencies or major currencies.
Novation means the process by which a party to a swap transfers all
of its rights, liabilities, duties and obligations under the swap to a
new legal party other than the counterparty to the swap. The transferee
accepts all of the transferor's rights, liabilities, duties and
obligations under the swap. A novation is valid as long as the
transferor and the remaining party to the swap are given notice, and
the transferor, transferee and remaining party to the swap consent to
the transfer.
Off-facility swap means any publicly reportable swap transaction
that is not executed on or pursuant to the rules of a registered swap
execution facility or designated contract market.
Other commodity means any commodity that is not categorized in the
other asset classes as may be determined by the Commission.
Physical commodity swap means a swap in the other commodity asset
class that is based on a tangible commodity.
Public dissemination and publicly disseminate means to publish and
make available swap transaction and pricing data in a non-
discriminatory manner, through the internet or other electronic data
feed that is widely published and in machine-readable electronic
format.
Publicly reportable swap transaction means:
(1) Unless otherwise provided in this part--
(i) Any executed swap that is an arm's-length transaction between
two parties that results in a corresponding change in the market risk
position between the two parties; or
(ii) Any termination, assignment, novation, exchange, transfer,
amendment, conveyance, or extinguishing of rights or obligations of a
swap that changes the pricing of the swap.
(2) Examples of executed swaps that do not fall within the
definition of publicly reportable swap may include:
(i) Internal swaps between one-hundred percent owned subsidiaries
of the same parent entity; and
(ii) Portfolio compression exercises.
(3) These examples represent swaps that are not at arm's length and
thus are not publicly reportable swap transactions, notwithstanding
that they do result in a corresponding change in the market risk
position between two parties.
Real-time public reporting means the reporting of data relating to
a swap transaction, including price and volume, as soon as
technologically practicable after the time at which the swap
transaction has been executed.
Reference price means a floating price series (including
derivatives contract prices and cash market prices or price indices)
used by the parties to a swap or swaption to determine payments made,
exchanged or accrued under the terms of a swap contract.
Remaining party means a party to a swap that consents to a
transferor's transfer by novation of all of the transferor's rights,
liabilities, duties and obligations under such swap to a transferee.
Reporting party means the party to a swap with the duty to report a
publicly reportable swap transaction in accordance with this part and
section 2(a)(13)(F) of the Act.
Super-major currencies means the currencies of the European
Monetary Union, Japan, the United Kingdom, and United States.
Swaps with composite reference prices means swaps based on
reference prices that are composed of more than one reference price
from more than one swap category.
Transferee means a party to a swap that accepts, by way of
novation, all of a transferor's rights, liabilities, duties and
obligations under such swap with respect to a remaining party.
Transferor means a party to a swap that transfers, by way of
novation, all of its rights, liabilities, duties and obligations under
such swap, with respect to a remaining party, to a transferee.
Trimmed data set means a data set that has had extraordinarily
large notional transactions removed by transforming the data into a
logarithm with a base of 10, computing the mean, and excluding
transactions that are beyond four standard deviations above the mean.
[[Page 9429]]
Unique product identifier means a unique identification of a
particular level of the taxonomy of the product in an asset class or
sub-asset class in question, as further described in Sec. 43.4(f) and
appendix A to this part. Such unique product identifier may combine the
information from one or more of the data fields described in appendix
A.
Widely published means to publish and make available through
electronic means in a manner that is freely available and readily
accessible to the public.
Issued in Washington, DC, on February 6, 2020, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
NOTE: The following appendices will not appear in the Code of
Federal Regulations.
Appendices To Swap Execution Facility Requirements and Real-Time
Reporting Requirements--Commission Voting Summary and Commissioners'
Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Support of Commissioner Brian D. Quintenz
I support today's proposal that seeks to resolve through
rulemaking three issues currently addressed in staff no-action
letters. I believe this proposal is an important first step to
provide market participants with much needed regulatory certainty
while also promoting swap execution facility (SEF) participation,
though regulatory certainty over additional current market practices
is necessary as well.
Staff initially granted these requests for relief in 2013 and
2014, as SEFs were first coming into compliance with the
Commission's then-new SEF regulatory framework. With the benefit of
six-plus years of implementation experience, and multiple extensions
of each of these no-action letters, it is long overdue for the
Commission to codify and clarify its policy on each of these
important issues.
First, the proposal would amend part 37 regulations to permit
the swap components of certain categories of package transactions to
be executed on-SEF through flexible means of execution, rather than
via the required methods of execution under Rule 37.9.\1\ In
addition, the proposal would also include an exemption from the
trade execution requirement for swap transactions that are executed
as a component of a new issuance bond package transaction. These
amendments recognize the need to provide flexible means of execution
for swaps that are negotiated and executed concurrently with other
components of a larger, integrated transaction.
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\1\ These amendments address the relief currently provided by
CFTC No-Action Letter 17-55 (Oct. 31, 2017).
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Second, the proposal adopts a principles-based approach
regarding SEF policies to correct operational or clerical errors.\2\
The proposal directs SEFs to adopt fair, transparent, and consistent
policies and procedures that allow for the timely resolution of
error trades. SEFs would be permitted to allow market participants
to execute offsetting or correcting trades through any method of
execution offered by the SEF. I believe these amendments will
facilitate the prompt identification and correction of error trades,
thereby minimizing market participants' exposure to market, credit,
and operational risks.
---------------------------------------------------------------------------
\2\ These amendments address the relief currently provided by
CFTC No-Action Letters 17-27 (May 30, 2017) and 20-01 (Jan. 8,
2020).
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Thirdly, the proposal recognizes the difficulties associated
with performing a pre-trade execution credit check on block trades
occurring away from a SEF's trading system or platforms.\3\
Accordingly, it would permit block trades to be executed on a
trading system of the SEF that is not an order book, thereby
allowing FCMs to conduct pre-execution credit screenings. The
proposal also continues to allow block trades to be executed away
from the SEF.
---------------------------------------------------------------------------
\3\ These amendments address the relief currently provided by
CFTC No-Action Letter 17-60 (Nov. 14, 2017).
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This proposal should in no way preclude the Commission from
considering additional SEF no-action letters and policy issues
through rulemaking. For example, codifying the current no-action
letter providing relief from the trade execution requirement for
inter-affiliate swaps, or providing greater clarity about
permissible methods of execution and minimum SEF trading
functionality are prime examples. In order to truly foster and
promote market liquidity, transparency, innovation, and competition
in the SEF marketplace, I believe these outstanding issues should be
addressed. I will support today's proposal but remain hopeful that
these and other important areas can be addressed through rulemaking
in the near future.
Appendix 3--Statement of Concurrence of Commissioner Rostin Behnam
I respectfully concur in the Commission's proposal to amend
certain swap execution facility (SEF) requirements and real-time
reporting requirements. A little more than a year ago, the
Commission issued a proposal that would have constituted a complete
overhaul of the existing regulatory framework for SEFs.\1\ As I
stated in my concurrence to the 2018 SEF proposal, I do not believe
that such an overhaul is necessary.\2\ However, despite my
opposition to the overhaul, I supported issuing the SEF proposal for
public comment because it contained several policy changes which
separately warranted further consideration. Market participants have
spent a great deal of resources to build systems and businesses that
comply with our existing SEF rules. Fundamental changes amounting to
an overhaul of the entire system should only be done in
circumstances where there is a regulatory concern that necessitates
action.\3\ Accordingly, in the past I have suggested we should focus
on targeted reforms, such as codifying existing no-action relief for
SEFs.\4\ I warned that we should not allow issues with the broader
vision of the 2018 SEF proposal to distract us from making targeted
changes.\5\
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\1\ Swap Execution Facilities and Trade Execution Requirement,
83 FR 61946 (proposed Nov. 30, 2018).
\2\ Rostin Behnam, Statement of Concurrence of Commissioner
Rostin Behnam Regarding Swap Execution Facilities and Trade
Execution Requirement (Nov. 5, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement110518a.
\3\ Rostin Behnam, Sowing the Seeds of Success in 2020, Remarks
of CFTC Commissioner Rostin Behnam at the 2019 ISDA Annual General
Meeting, Grand Hyatt Hong Kong, Hong Kong (Apr. 9, 2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam13.
\4\ Id.
\5\ Id.
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Today, the Commission proposes to limit changes to our existing
SEF rules, specifically focusing on the codification of long-
standing no-action relief regarding package transactions, error
trades, and block trades. While I support today's proposal, I do
have some concerns where I think we deviate from the path of
targeted codification. The provisions in today's proposal regarding
package transactions and block trades basically mirror the existing
no-action relief.\6\ However, the proposal regarding error trades
does not.\7\
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\6\ See CFTC No-Action Letter No. 17-55, Re: Extension of No-
Action Relief from Sections 2(h)(8) and 5(d)(9) of the Commodity
Exchange Act and from Commission Regulations 37.3(a)(2) and 37.9 for
Swaps Executed as Part of Certain Package Transactions (Oct. 31,
2017); CFTC No-Action Letter No. 17-60, Re: Extension of No-Action
Relief for Swap Execution Facilities from Certain ``Block Trade''
Requirements in Commission Regulation 43.2 (Nov. 14, 2017).
\7\ See CFTC No-Action Letter No. 17-27, Re: No-Action Relief
for Swap Execution Facilities and Designated Contract Markets in
Connection with Swaps with Operational or Clerical Errors Executed
on a Swap Execution Facility or Designated Contract Market (May 30,
2017); CFTC No-Action Letter No. 20-01 (``NAL No. 20-01''), Re:
Supplemental No-Action Relief for Swap Execution Facilities and
Designated Contract Markets in Connection with Swaps with
Operational or Clerical Errors Executed on a Swap Execution Facility
or Designated Contract Market (Jan. 8, 2020).
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DMO currently provides no-action relief from the required
methods of execution under Sec. 37.9 for trades intended to resolve
error trades.\8\ The existing relief provides a number of
conditions, including a requirement that a SEF determine (either
prior to execution or within 24 hours after) that an error has
occurred. Among other things, the no-action relief requires that a
SEF have error trade rules that account for whether a transaction
cancellation or price adjustment will adversely impact market
integrity or facilitate market manipulation or other illegitimate
activity.\9\ None of these
[[Page 9430]]
conditions appear in the error trade rules proposed today, and under
the proposal SEFs will no longer have any obligation to determine
whether a trade is an error trade--the determination can instead be
left entirely to the parties to the trade. I look forward to
comments regarding whether this ``principles-based'' approach goes
too far and fails to give market participants sufficient clarity
regarding error trades.
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\8\ NAL 17-27.
\9\ Id.
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I support targeted, thoughtful reform of our SEF regulations,
and I particularly applaud staff's efforts to provide market
participants with greater legal certainty through the codification
of our existing no-action relief. I look forward to the comments.
Appendix 4--Statement of Commissioner Dan M. Berkovitz
I am voting in favor of today's proposed rule that would amend
certain Commission rules in parts 36, 37, and 43 relating to package
transactions, block trades, and error transactions on swap execution
facilities (``SEFs'') (``Proposal''). Today's amendments largely
codify longstanding no-action letters for limited categories of
swaps transactions regarding the required methods of execution.
Generally, I support the codification of no-action letters where,
based on experience, doing so is consistent with our statutory
mandate, protects customers, provides market participants with a
greater level of certainty, and promotes market integrity.
Package Transactions
This Proposal would amend part 37 to allow the swap components
of certain package transactions--including those that are illiquid
and bespoke and therefore not suitable for trading on-SEF--to be
executed on-SEF but through flexible methods of execution. In
addition, the Proposal amends part 36 to exempt from the trade
execution requirement a swap in a package transaction involving a
bond sold in the primary market (``new issuance bond transaction''),
which also is not conducive to trading on-SEF.
Beginning in 2014, the Commission issued a series of no-action
letters specifying permissible methods of execution for certain
package transactions, which have enabled market participants and the
agency to apply the trading mandate to these transactions in a
phased manner. As the market infrastructure for the trading and
clearing of swaps has improved, the trading mandate has been applied
to the packages involving more liquid and standardized swap
components.\1\ The remaining package transactions that would be
covered by today's Proposal represent a small percentage of swaps
trading on the most active SEFs.
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\1\ For example, U.S. Dollar Spreadover package transactions
account for nearly seventy percent of interest rate swaps trading in
the inter-dealer swap market. No-action letters for these package
transactions have expired and market participants now actively trade
the swap component of these packages through required methods of
trading. See Proposed Rule, Sect. II.A.1 and n.33.
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I encourage the industry to continue to develop systems that
allow for increased execution of package trade swap components on-
SEF. I also appreciate the Staff's commitment, if this rule is
finalized, to continue to evaluate the categories of package
transactions subject to the rule and revise the rule as necessary in
the future to reflect developments in trading methodologies.
Error Trades
The Proposal also would amend part 37 to enable SEFs to permit
market participants to use flexible methods of execution to correct
error trades, and would require a SEF to establish error trade
policies that largely track the conditions set forth in prior no-
action letters. Notably, the Proposal would require market
participants to provide prompt notice of an error trade to the SEF,
enabling the SEF to fulfill its self-regulatory obligations. It
would not alter the requirement that SEFs must adopt rules declaring
that trades rejected from clearing are deemed void ab initio. The
Proposal also includes the requirement under CFTC No-Action Letter
No. 17-27 that after submitting one error trade, market participants
will not be able to submit a second new trade with the original
terms. These conditions facilitate a SEF's direct supervision of its
markets, protect against abuse, and promote fair competition.
Block Trades
The Proposal would revise the definition of ``block trade'' in
Commission Regulation 43.2 to permit SEFs to offer non-Order Book
methods of execution for market participants to execute swap block
trades on-SEF. Like package transactions, block trades encompassed
within the Proposal are a small percentage of the number of swaps
traded. A significant benefit of this Proposal is that it would
facilitate pre-trade credit checks by SEFs for block trades, in
accordance with the SEF core principles.
It is my preliminary view that this Proposal would provide
certainty to market participants and increase trading efficiencies,
while not compromising the Congressional goal of moving standardized
OTC derivative contracts to exchanges or electronic trading
platforms. I look forward to public comments on the anticipated
effects of these amendments, and I thank the staff of the Division
of Market Oversight for their work on this Proposal.
[FR Doc. 2020-02721 Filed 2-18-20; 8:45 am]
BILLING CODE 6351-01-P