At the agency’s first meeting following the one-year anniversary of the sweeping Dodd-Frank Wall Street Reform Act, the Commodity Futures Trading Commission (CFTC) Tuesday overwhelmingly voted out three final rules aimed at reviewing swaps for mandatory clearing and removing references to credit agencies in CFTC regulations. Chairman Gary Gensler said end-users, which are exempt from clearing swaps, will not have to meet capital margin requirements.
The final rules easily cleared the Commission by 5-0, but not before Commissioners Jill Sommers and Scott O’Malia expressed concern over the piecemeal approach the CFTC is taking in issuing the rules. The Republican commissioners voted against two proposed rules, but those nevertheless passed by a 3-2 vote.
“Although the final rules that we have been considering thus far deal with discrete stand-alone issues, complex issues dealing with market structure and business conduct standards” are on the horizon, said Sommers. “We are beginning [a] difficult uphill climb without a plan, and I believe that’s a mistake…We run the risk of unnecessarily increasing uncertainty among market participants by continuing to put out final rules in a piecemeal fashion.”
O’Malia echoed similar sentiments, and renewed his call for the Commission to issue a rule schedule and implementation plan at the CFTC’s next scheduled meeting on Aug. 4.
Of the three final rules voted out, the one on review of swaps for mandatory clearing was probably the most significant. Under the rule, a derivatives clearing organization (DCO) — which provides clearing and settlement services for financial and commodities derivatives — would be presumed eligible to accept for clearing any swap that is within a group, category, type or class of swaps that the DCO already clears.
A DCO that plans to accept for clearing a swap that does not meet this requirement would have to seek a determination from the CFTC on its eligibility to clear the swap. Moreover, Dodd-Frank requires a DCO that plans to accept swaps for clearing to first submit the swaps to the CFTC for a determination as to whether the swaps are required to be cleared.
The rule is not likely to go into effect until the CFTC issues a final rule on defining swaps. “I think it’s going to be into the fall,” said Chairman Gary Gensler.
O’Malia called on the Commission to issue further guidance on the swap clearing rule. He said he plans to send a letter out to market participants seeking their input on defining various thresholds and standards that the Commission should consider in determining which swaps should be subjected to mandatory clearing. He said he was especially concerned the rule leaves open the possibility that the Commission will impose capital margin requirements on end-users. Under Dodd-Frank, end-users are exempt from clearing swaps that are used to reduce commercial risk.
Gensler said dealers will not be required to collect margin from end-users. “I don’t think there [is] any difference between you [O’Malia] and me” on this issue, he said.
Also approved was a final rule that amends the CFTC’s existing regulations by removing certain references to — and reliance on — credit agencies. It replaced the references with alternative standards: it adjusts the minimum qualifications that foreign banks are required to satisfy — must have in excess of $1 billion of regulatory capital — before futures commission merchants (FCM) and DCOs may deposit customer funds into them; and it requires commodity pool operators to provide greater disclosure to their customers to enhance their understanding of how pool operators use customer money.
The proposed rules drew immediate opposition from Sommers and O’Malia. “I would like to see this Commission finish the job of implementing the requirements of Dodd-Frank before we turn our attention to these discretionary items,” Sommers said. The proposed rules “are not required by Dodd-Frank” and involve “complicated issues that market participants spent countless hours addressing.”
Like Sommers, O’Malia said he supported the final rules because they are non-controversial process rules, but he had “serious concerns” with the proposed rules because “they rely on weak statutory authority” and are “neither justified [nor] required under Dodd-Frank.”
One of the proposed rules involved clearing member risk management. It would require each swap dealer, major swap participant and FCM that is a clearing member to establish credit and market risk-based limits based on position size, order size, margin requirements or similar factors. The proposed rule would require monitoring for adherence to the risk-based limits intraday and oversight.
Gensler said he supported these “pre-trade risk filters,” saying they would help secure the financial integrity of the markets and the clearing system and protect customers funds.
The other proposed rule seeks to enhance customer access to clearing and minimize the time between submission and acceptance or rejection of trades for clearing by DCOs and clearing members. “This proposal will foster bilateral clearing arrangements between customers and their futures commission merchants,” Gensler said.
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