United States: CFTC Proposes Sweeping Changes To Swap Execution Facilities And Trade Execution Requirement

The Commodity Futures Trading Commission (CFTC or Commission) on November 5, 2018, in a 4-1 vote, proposed to fundamentally redesign the regulatory framework governing swap execution facilities (“SEFs”) and the trade execution requirement. If promulgated, these proposed rules will affect virtually all market participants and market infrastructure providers. In a companion release, the Commission also requested comment on the practice of post-trade name give-up for anonymously executed swap transactions that are intended to be cleared.

Major Impacts of the Proposed Amendments 

The proposal would revamp the regulatory framework for executing swaps by 1) scrapping the current “Made Available to Trade” process and requiring that all transactions for cleared swaps that are listed on a SEF or a Designated Contract Market (“DCM”) be traded on a SEF or DCM, absent an explicit exemption; 2) requiring that all broking activities—activities of entities, including interdealer brokers that facilitate swaps trading between multiple market participants through non-registered voice or electronic platforms—be performed by a registered SEF and its “trading specialist” employees; 3) removing restrictions on SEF execution rules or trading protocols, such as the current Order Book and RFQ requirements in favor of disclosure-based trading and execution rules that apply to any execution method offered by a SEF; 4) prohibiting pre-trade communications and certain forms of off-facility swap transactions; and 5) permitting SEFs to establish eligibility requirements that enable a SEF to serve particular market segments or participants. The overall effect of the proposed changes is to substantially broaden the number of transactions required to be traded on a SEF (or DCM) while at the same time removing many of the substantive restrictions on the trading mechanics under which SEFs now operate. 

Cross-Border Impact 

The proposed rules would require non-US trading facilities meeting the SEF registration requirements, including non-US broking entities (particularly those operating as “foreign multi-lateral swaps facilities.), either to register as a SEF or to qualify for exemption based on comparable and comprehensive regulation in their home jurisdiction. Aside from noting that non-US trading platforms and brokers may “fall within the Commission’s jurisdiction,” the Commission did not clearly outline the criteria used to determine when their activities would trigger registration nor were criteria for the exemption included in the proposal. The Commission addresses these complications by delaying the compliance date for non-US trading platforms and broking entities for two years, presumably during which time detailed criteria will be crafted and non-US jurisdictions currently without a comparable regulatory framework will have the opportunity to establish one. 

Additional Proposed Amendments

In addition to fundamentally restructuring the regulatory framework for swap transactions, the Commission is proposing to codify several staff interpretive and no-action letters and to streamline several processes and compliance requirements. These proposed amendments would:

  • simplify the registration process by streamlining Form SEF; 
  • require a SEF to establish proficiency testing, ethics training and trading conduct requirements, and create a duty of supervision for a SEF in respect of its trading specialists; 
  • in place of the current operationally difficult confirmation requirement, enable a SEF to provide a “trade evidence” record for uncleared swaps that may be supplemented by previously negotiated underlying documents; 
  • provide a SEF with the ability to, among other things, (i) tailor its rule enforcement program and disciplinary procedures and sanctions to the characteristics of its trading operations and market; (ii) develop an audit trail surveillance system that is appropriate to the types of available execution methods it offers; and (iii) choose other additional types of regulatory service providers to assist with fulfilling its oversight duties; 
  • provide additional guidance for a SEF to demonstrate that the swaps it lists for trading are not readily susceptible to manipulation; 
  • clarify the straight through processing requirements to reflect existing practices; 
  • amend the existing financial resource requirements and cost calculation methodology; and 
  • streamline existing requirements for the chief compliance officer (“CCO”) including simplifying the preparation and submission of the required annual compliance report.

Comment Period

Comments on this proposed rule must be received on or before February 13, 2019.

Post Trade Name Give Up Practices

In a companion release, the Commission, without proposing actual rule language, requested comment on the necessity or utility of post-trade name give-up practices in facilitating anonymously executed swap transactions that are intended to be cleared. “Post-trade name give-up” refers to the practice of disclosing the identity of each swap counterparty to the other after a trade has been matched anonymously. Post-trade name give-up originated in OTC markets for uncleared swaps as a means to verify the creditworthiness of the counterparties. The Commission requests comment on the rationale for post-trade name give-up for swaps that are cleared (i.e., have no credit exposure) and whether the practice of post-trade name give-up continues to serve a valid industry purpose in facilitating swaps trading in a cleared environment.

Comment Period 

Comments on this proposed rule must be received on or before January 29, 2019.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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