Financial industry anxious for clarity on swap-facility rules; business conduct a key compliance issue

June 11, 2013

By Emmanuel Olaoye, Compliance Complete

WASHINGTON/NEW YORK, June 11 (Thomson Reuters Accelus) – The financial industry is scrambling to understand the Commodity Futures Trading Commission’s final rules for firms trading derivatives on an electronic platform.

Representatives say several aspects of the rules adopted in May remain unclear, including which trades have to be traded electronically, how to adequately disclose risks in swaps, and the time frames for complying with the rules. 

Firms trading on electronic platforms known as swap execution facilities (SEFs) face a number of tough decisions on day one: multiple SEFs, building a request for quote system in a way that will not drive the market against them, and understanding which trades will be executed on a SEF.

Experts say their ability to make the right decisions will have a big say on regulators’ efforts to increase transparency in the $650 trillion over-the-counter derivatives market.

“Let’s say that on day one there is a lot of SEFs. How do customers know where to go or where there will be a good market? The number of SEFs that start up will likely not be sustainable; at first, the market will be heavily fragmented,” said Steven D. Lofchie, co-chair of the financial services department at Cadwalader Wickersham & Taft LLP.

For compliance professionals working in buy-side and sell-side firms, adapting to the new regime will mean complying with the CFTC’s business conduct standards as well as the SEF rulebook.

The business conduct rules will be a major concern for compliance officers, said Robert Pickel, chief executive of the International Swaps and Derivatives Association.

For years, firms in the over-the-counter derivatives market traded swaps over the phone. They often relied on their trading partners to voluntarily disclose the risks in the instruments they were trading. With swaps being traded on SEFs, firms will have to provide extensive disclosures on the “material risks” of a swap to their trading partner.

“That is a particular challenge for dealers and customers and also for SEFs as well,” he said.

The final rule was published in the Federal Register on Tuesday. The effective date is in 60 days (August 5). The compliance date of October 5 is 120 days after the rule is published in the federal register.

The rule says that swaps that are made “available to trade” must be executed on a SEF.

A SEF can select a number of swaps that should be made available for trade, then submit the list to the CFTC. After reviewing the list, the CFTC will publish the swaps that meet its criteria on its website. It will also list the SEFs and exchanges that offer those swaps.

But the financial industry is uncertain about how long it will take the CFTC to review the products that are submitted for review. The CFTC’s timeframe for reviewing the products was also not clear, Pickel said.

“If you’re an asset manager and a contract becomes available for trade and needs to be traded electronically, how are you going to know it needs to be executed and where it is going to be available?,” said Ricardo Martinez, a principal at Deloitte & Touche LLP.

He said asset managers have the difficult job of figuring out which products are “available for trade” or can be traded electronically.

With 120 days left before the compliance date, he said there was a lot of uncertain about the “available-to-trade” requirement.

A large part of the focus for asset managers is central clearing, said Matt Nevins, a managing Director and associate general counsel at the Securities Industry and Financial Markets Association.

In December, the CFTC identified six classes of credit default swaps and interest rates as eligible for central clearing. The effective date for clearing those swaps is June 10.

With the CFTC finalizing the rules for executing swaps on SEFs, it will take up to six months before trades can be executed on SEFs.

Nevins said asset managers have to figure out how to interact with firms that are registered as SEFs. “There are questions as to who all the SEFs will be, how many there will be, and what number of SEFs firms need to be connected with.”

The final rule poses operational challenges for SEFs too, especially smaller ones. One such SEF said he was surprised that the CFTC requires an “order book” (or a platform that allows buyers and sellers to make multiple bids and offers) for transactions such as foreign exchange options, which tend to be illiquid.

The SEF said the CFTC had given no indication that it would request an order book during the proposal stage. The change means the SEF will have to build a technology platform that can handle multiple bids and offers on its products.

“That is a real surprise and it will be quite costly,” he said.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

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