The Commodity Futures Trading Commission’s (CFTC) latest proposals mandating compliance with the Dodd-Frank Wall Street Reform Act, which the agency voted out earlier this month, lack the detailed direction and guidance that traders need to make the transition to a regulated derivatives market, said CFTC Commissioner Scott O’Malia last Tuesday.
While the CFTC has issued 57 advance notices of proposed rulemaking or notices of proposed rulemaking, two interim final rules, 13 final rules and one proposed interpretative order, only on Sept. 8 “did the Commission finally turn its attention in its last open meeting to addressing how industry will be required to comply with the various implementation requirements for the numerous, intertwined rulemaking initiatives,” he said at the annual North America conference of the International Swap and Derivatives Association (see NGI, Sept. 12).
CFTC Chairman Gary Gensler “has frequently used the word ‘mosaic’ to describe our proposed regulatory framework…I looked up the word in the Merriam-Webster Dictionary…The definition notes that, in general, mosaics are highly detailed. Unfortunately, the implementation proposals that the Commission approved [in early September] are anything but detailed. Rather than setting forth a guide to understanding how the different rulemaking implementation, or effective date, sections should be pieced together to form a mosaic, the implementation proposals themselves more resembled a Jackson Pollack painting from the abstract expressionist movement,” he noted.
“We can no longer continue to provide the market with broad abstractions. The Commission is in the process of approving final rulemakings. Now is the time for the Commission to give the market concrete direction on how and when to translate the Dodd-Frank rulemakings into operational reality,” O’Malia said.
The CFTC earlier this month took its first step toward mandating compliance with Dodd-Frank. It voted out a proposal establishing a schedule to phase in compliance with the new clearing and trade execution requirements of Dodd-Frank, and a schedule to phase in compliance with the new trading documentation and margining requirements of the year-old derivatives law. The two implementation proposals have a 45-day comment period.
O’Malia voted against both implementation proposals. “You may have been surprised because since the beginning of the year, I have continually called for the Commission to present the market with an implementation schedule for notice and comment. I had hoped that an implementation schedule would give market participants the certainty that they need to begin an orderly transition to regulation…[But] the two proposals that the Commission took up for consideration raised more questions than they answered.”
To begin with, “the proposals only addressed a handful of the rulemakings that we have proposed and finalized. Second, the proposals failed to do several key things. The proposals did not provide market participants with reasoned estimates of beginning and end dates. The proposals did not explain their rationale for determining that 90-, 180- and 270-day time frames were appropriate, rather than the longer time frames that some commenters had sought when they provided feedback after the Commission’s roundtable on implementation issues. They did not quantify the costs and benefits of the 90-, 180- and 270-day time frames in comparison with alternatives. Finally, the proposals failed to define, or even acknowledge that the Commission intends to define, key triggering terms, such as ‘made available for trading,'” O’Malia said.
The CFTC proposals “simply did not set forth the clear transition milestones that market participants have repeatedly requested. I hope that the final rulemakings will better demonstrate that the Commission is clear on: 1) how all of its proposals work in concert together; 2) how market participants can comply with all such proposals; and 3) when market participants need to be in compliance.”
O’Malia offered what he believes will be the “rough time line” for implementation of the Dodd-Frank rules. “I believe that entities that the implementation proposals deem ‘Category 1’ (i.e., swap dealers, major swap participants, and active funds) will not become subject to mandatory clearing until approximately the third quarter of 2012. Entities that the proposals deem ‘Category 2’ or ‘Category 3’ will not become subject to mandatory clearing until 90 or 180 days later.
“To resolve any lingering ambiguity, the Commission may determine that a swap is subject to mandatory clearing before the third quarter of 2012, but the implementation proposals clarify that entities need not be in compliance at the time of such determination. As I noted [previously] the criteria that the Commission will use to make mandatory clearing determinations are still unclear. Therefore, I would continue to encourage market participants, as well as the public, to comment on the [July 28] letter that I have circulated regarding the need for more guidance on such criteria,” he said.
In related action, a coalition of energy and agriculture associations called on the CFTC to look at the full term of a swap and evaluate the liquidity of the transaction based on that term to determine whether it should be subject to mandatory clearing.
“If sufficient liquidity is not present for the full term, the swap should not be subject to mandatory clearing,” said Jenny Fordham, vice president of market for the Natural Gas Supply Association (NGSA), a coalition member that represents natural gas producers.
“[We’re] asking for regulatory certainty on how liquidity will be evaluated for swaps,” she said. This is a “pretty important” issue when it comes to making long-term investments in the energy industry, such as energy infrastructure projects that could take years to build, Fordham said. “Right now we really don’t know” which direction the CFTC is leaning.
“To make certain long-term investment decisions, market participants need confidence in the availability and cost of risk management tools. Where swaps are illiquid by virtue of their long terms, even greater reason exists to not subject them to mandatory clearing because doing so would create a disincentive for long-term investment in the economy,” wrote the coalition in a letter to the CFTC last Wednesday.
“While the [Dodd Frank] statute is clear that trading liquidity is a factor that the Commission must consider in determining swaps subject to mandatory clearing, regulatory uncertainty regarding the manner in which liquidity will be considered in this process persists and must be resolved,” it said.
The coalition’s letter is in response to O’Malia’s July 28 request for the public to comment on how the CFTC should determine which swaps to subject to the mandatory clearing requirement.
In addition to the , other members of the coalition are the American Gas Association, American Public Power Association, Commodity Markets Council, Edison Electric Institute, the Electric Power Supply Association, National Rural Electric Cooperative Association, the Fertilizer, the National Corn Growers Association and Agriculture Retailers Association.
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