The Commodity Futures Trading Commission (CFTC) might struggle to implement recently proposed changes to the Swap Execution Facility (SEF) rules in their current format, said Justin Slaughter, a partner at Mercury Strategies, and counsel to the Foreign Exchange Professionals Association (FXPA) on a webinar hosted by the FX trade association.

On November 5, 2018, CFTC Commissioners voted in favor of proposed amendments to the rules governing SEFs and the trade execution requirement, with Chairman Christopher Giancarlo signaling his intention to finalize revised rules next year. In a detailed release issued by the CFTC, a number of significant changes to the SEF rules were proposed.

The Commission aims to increase the number of swaps being traded on these platforms by expanding the number of swap execution platforms that must register as SEFs, allowing a SEF to offer any means of execution for swaps and by requiring all swaps that must be cleared under the CFTC’s clearing mandate to be executed on a SEF. In addition, the Commission is proposing to allow SEFs more flexibility to choose which types of market participants may access each SEF.

The CFTC is seeking to increase the number of SEF registrants by proposing that swaps broking entities that facilitate multiple-to-multiple swaps trading that does not occur on SEFs and trading systems or single-dealer platforms that aggregate one-to-many systems have to register as SEFs.

The Commission is also proposing that a swap can be executed on a SEF via any means of interstate commerce. This is a significant change from the current requirement that swaps subject to the trade execution mandate be traded through a central limit order book (CLOB) or by sending a request for quote (RFQ) to at least three unaffiliated market participants. This change could pave the way for more voice broking in the swaps market.

Another proposed change is to the trade execution mandate. The CFTC wants to remove the current Made Available to Trade (MAT) determination for swaps to become subject to the trade execution mandate, a process that requires CFTC review. Instead, it is proposing that any swap that is subject to the clearing mandate would automatically be required to be traded on a SEF or designated contract market (DCM) if the swap is listed for trading on at least one CFTC-registered SEF or DCM. The impact of this is likely to be that many more swaps products will be forced onto these platforms.

The Commission is advocating for changes to the requirement of SEFs to offer impartial access to market participants, instead stating that they must offer “fair and non-discriminatory” access to “all or similarly situated market participants”. What this means in practice is that SEFs will be able to deny access to specific classes of market participants, so they could, for example, decide to only allow bank dealers onto their platform.

Elsewhere, the CFTC proposes to facilitate a broader range of swaps trading activity on SEFs and promote pre-trade price transparency by limiting pre-arranged trading and pre-execution communications that occur outside of SEFs and has requested comments regarding the use of the “post-trade name give-up” practice on SEFs for swaps that are intended to be cleared.

During the FXPA webinar, Slaughter claimed that the reaction to these proposed rules from the financial services industry has this far been “fairly tepid” because, as he put it, everyone “has something to love about this rule, something to hate about this rule, something to fear about this rule”.

Interestingly, he highlighted that since the proposed rule changes were released, there have been some conversations amongst the banks about possibly creating SEFs themselves in the form of single-dealer aggregation platforms in a bid to disintermediate the existing SEFs.

“That’s going to be a continued point of conflict going forward,” said Slaughter.

However, love it or loathe it, Slaughter also suggested that will be challenging for the Commission to implement these rules in their current form. Part of this comes down to timing, he explained.

There’s a 75-day comment period for the rule changes proposed, and Slaughter said that while Giancarlo’s office is strenuously opposed to any extension of this comment period, there are already rumblings from market participants that they need more time to digest what is a long and complex piece of text. 

“[Giancarlo’s office] are on a very tight schedule. They want to get this done as early as late spring, which strikes me is unrealistic, but at the very latest by early fall of next year,” said Slaughter.

He continued: “Once the comment period ends, the CFTC’s process for actually dealing with the comments and moving forward is, in a word, Byzantine. Unlike popular belief, there is no automated process for reviewing comments, it’s all done manually often by only one or two people inside the building. They have to read every comment together and summarize them internally and then they have to respond to the comments one-by-one or be at risk of violating the Administrative Procedure Act.”

As such, Slaughter predicted that it will take months for the CFTC to provide a comment summary, even if they allocate a substantial amount of what he described as already overtaxed staff to the task. Once this is done, then there are internal negotiations that take place between the Commissioners, with Slaughter estimating that there will be at least one month of negotiations and edits to the proposed rule changes at this point in the process.

The reason why this timeline is particularly significant is because Giancarlo, who has been the driving force behind these possible swaps market reforms, is due to end his term as Chairman and as a Commissioner in next year with Heath Tarbert, who currently serves as assistant secretary for international markets at Treasury, set to be nominated as his replacement.

“The timeline we’re operating under to get this rule done, with a Chairman who wants to leave as soon as it’s done and maybe an administration that wants to replace him is very, very fraught,” said Slaughter. “[Giancarlo’s] going to move as fast as he can, but it’s not clear you can get this entire thing done. That leads to my belief that what’s going to end up happening is that this rule is going to get cut into pieces and a large chunk of it is going to get finished, but not all of it, and what gets included is going to be key.”

Even beyond this, Slaughter highlighted other possible challenges to the implementation of the rule changes.

For example, he said that they could be vulnerable to legal challenges because the proposal is required to go through a cost-benefit analysis before it can be introduced, and the CFTC says that it actually can’t estimate the cost of this proposal because it doesn’t have enough data. This, according to Slaughter, is “a big red flag” that will see the proposal potentially attacked by a variety of opponents to it.

In addition, he pointed to broader political trends in the US that might make it more difficult to implement the rule changes at speed.

“Mercury Strategies is anticipating there will be several funding lapses potentially in the next 12 months. Under the current Federal rules and laws, the CFTC does not get to continue to have much of its staff working in the event of a funding lapse. In 2013, 97% of the staff had to go home during the government shutdown,” said Slaughter. 

He added: “Every time there’s a shutdown it basically it makes it harder to finish this rule.” 

The FXPA presentation can be found here.