Special Report: CFTC moves forward on three rulemakings

18 December 2019

The U.S. Commodity Futures Trading Commission held an open meeting on Dec. 18 to discuss several rulemakings related to the regulation of swaps trading and the oversight of clearinghouses. The CFTC agreed to issue a proposal related to cross-border swaps trading by a vote of 3-2; agreed to issue a proposal to ensure fully anonymous trading on swap execution facilities by a vote of 5-0; and approved a final rule on core principles and general provisions for clearinghouses by a vote of 5-0. 

CFTC chairman withdraws bid to restrict use of EU collateral

One of the items on the CFTC meeting agenda was a "request for comment" on whether U.S. clearinghouses should be allowed to continue accepting euros and European government bonds from their members as collateral. This item was not discussed, however, because CFTC Chairman Heath Tarbert announced that it would be withdrawn "for the time being" pending the outcome of discussions with European regulators.

Tarbert explained that the EMIR 2.2 legislation recently approved by the European Commission gives European regulators authority over non-EU clearinghouses if they are determined to be systemically important. That determination in part is based on the amounts of collateral denominated in euros that non-EU clearinghouses hold as margin or guarantee fund deposits. Tarbert said that he had "no problem" with the use of EU collateral in U.S. clearinghouses, but he warned that if this triggered the application of EMIR 2.2 to U.S. clearinghouses, it could result in them becoming subject to duplicative regulation by EU regulators, and he vowed to use the CFTC's authority to prevent this from happening.

"The CFTC … has the unilateral authority to address these things and we will not hesitate to do so to avoid our clearinghouses being subject to an EU law that on its face would purport to override our own laws and regulations," Tarbert said. He also threatened to revoke Part 30 exemptions granted to European exchanges, which allow foreign firms to provide US customers with access to those exchanges without having to register with the CFTC, if the CFTC does not get "deference" from its European counterparts.

"I hope we don't have to take drastic measures so to that end I've decided at this point I think we're going to withdraw that proposal…for the time being." He added that the CFTC has had a "constructive dialogue" with the European Commission on this issue over the last three months and said that he remains "hopeful" that the final Delegated Acts, which specify how EMIR 2.2 will be implemented, will lead to "strong coordination and information sharing" rather than "burdensome, duplicative and uncertain supervision."

Commissioners clash on cross-border rule

During the meeting, the CFTC agreed to issue a proposed rule governing the cross-border application of swap dealer registration requirements and certain other swap dealer requirements. If approved, the rule would replace guidance issued in 2013 that has been criticized by market participants for its extraterritorial reach. The agency's two Democratic commissioners dissented, however, and criticized the proposal for pulling back too far on the CFTC's oversight of swap dealing activity.

Joshua Sterling, the director of the swap dealer and intermediary oversight division, described the proposed rule as a "smart, effective and practical approach" that builds on the agency's 2013 guidance but takes into account seven years of "real world experience" as well as a "prudent dose of comity" with foreign regulators. Sterling commented that the U.S. was a "first mover" on G20 reforms, but now that other regulators have developed their rules for swap dealer regulation, the proposed rule would allow the CFTC to rely more heavily on "substituted compliance" with rules in foreign jurisdictions that are comparable to the U.S. rules.

The text of the proposed rule has not been made public yet, but comments from Sterling and other CFTC staff indicated two important changes compared to the 2013 guidance. First, it would not apply U.S. requirements to non-U.S. transactions that are "arranged, negotiated or executed" in the U.S. This would have the effect of reducing the range of transactions covered by CFTC rules and allowing non-U.S. swap dealers to rely on personnel in the U.S. without triggering the registration requirement. Second, the proposed rule would narrow the definition of a guarantee extended by a U.S. bank to an overseas affiliate or subsidiary, which is one of the tests for determining the potential risk that overseas swap dealers pose for the U.S. financial system.

In addition, Tarbert commented that the proposed rule's definition of a U.S. person matches the definition developed by the U.S. Securities and Exchange Commission. On the other hand, the proposed rule's treatment of "arranged, negotiated and executed" is not the same as the SEC's treatment.

During the discussion, CFTC Commissioner Dan Berkovitz framed the proposal as an attempt to "get the balance right" between the need to protect the U.S. financial system from risk flowing back from overseas activities with the need to avoid putting U.S. banks at a "significant competitive disadvantage" in their overseas business. He raised several concerns about the technical details of the proposal, however, and in particular the degree to which the CFTC would rely on prudential supervision by U.S. banking regulators.

"I have a fundamental problem with deference to U.S. prudential regulators," said Berkovitz. "I have respect for the prudential regulators but the only reason we're all in the room debating this is because they got it wrong. There was a crisis because the prudential regulators got it wrong."

Berkovitz also said he was very concerned about "relaxing" the definition of guarantee in context of assessing the relationship between U.S. banks and their foreign subsidiaries and affiliates, and he warned that this provision will allow banks to conduct a significant amount of swap dealing activity in non-U.S. entities that are currently registered but would no longer need to be registered under the proposed rule.

CFTC Commissioner Dawn Stump, who supported the proposal, emphasized that the CFTC would gain new enforcement powers if the 2013 guidance is codified into a rule. "Some might have us believe we're abandoning our charge in rolling back in regulatory oversight," she said. "I suggest the opposite. We're actually transitioning from non-binding guidance to a rule that for the first time would find obligations with respect to cross-border activities and major swap participants. if the rules are violated, I expect we would bring enforcement action."

Tarbert stressed that his goal is to protect the "national interest" and protect U.S. taxpayers from having to bail out a U.S. financial institution, but he also said that it would not be a good use of taxpayer money to regulate activity overseas that does not pose risk to the U.S. He also said that one of his guiding principles is to cooperate with other regulators and recognize their authority in their home jurisdictions, rather than attempting to regulate all activity everywhere. "My view is we afford comity to other regulators," said Tarbert. "If their institutions are here in the United States, they play by our rules. If our institutions are over there, they play by their rules, assuming they have those rules. If they don't have rules comparable to us, if [the risk] rises to the level of being significant and our fellow regulators are not looking at it, we'll focus on that." 

The discussion was also notable for a disagreement on process. Tarbert sought to limit the discussion on this rulemaking to an hour to "keep the process moving," but Berkovitz objected vociferously, and Tarbert subsequently agreed to extend the discussion.

The proposal will be open for public comment for 60 days. CFTC Commissioner Rostin Behnam noted that this was originally set at 90 days and asked Tarbert and the staff to consider going back to the longer comment period, given the importance of this rulemaking.

Unanimous support for anonymous trading on SEFs

The five commissioners unanimously agreed to issue a proposed rule that would prohibit post-trade name give-up on swap execution facilities. The proposal was issued with a 60-day comment period.

In contrast to the discussion on cross-border, Tarbert joined with Behnam and Berkovitz in issuing a joint statement of support for this proposal. In his comments during the discussion, Tarbert emphasized that the proposed rule would increase "fair competition" in the swaps markets. The proposed rule would apply to all cleared swaps that trade on SEFs, with the exception of cleared swaps that are traded as part of a package that includes uncleared swaps.

Final rule approved on clearinghouse requirements

The five commissioners voted unanimously to approve a final rule amending Part 39 of its rules, which implements core principles for derivatives clearing organizations. The CFTC staff explained that this rulemaking was meant to "clean up" the regulations and fix provisions that needed further interpretation or clarification. Those areas include:

  • "carving out" DCOs that clear fully collateralized positions from requirements that do not apply to that type of business;
  • requiring DCOs to have "enterprise-wide" risk management programs and an enterprise risk officer; requiring DCOs to calculate their largest financial exposure, net of required margin on deposit rather than total margin on deposit including excess, which will bring CFTC regulations into line with international standards on this issue;
  • the incorporation into the rules of interpretative guidance on the amount of initial margin that clearing firms must collect from their customers; and
  • several changes to default management that were drafted in response to the September 2018 default at Nasdaq's clearinghouse in Stockholm.

The final rule did not include, however, certain requirements that were put forward at an earlier stage of the rulemaking, such as requiring DCOs to have a default committee with member participation. The staff explained that given the divergence of views among commenters, they decided to give the industry more time to consider this issue and move toward consensus.

CFTC staff grant Libor relief

At the end of the meeting, Tarbert announced the issuance of three no-action letters by CFTC staff that provide relief to swap dealers and other market participants related to the transition away from LIBOR. The letters outline the conditions under which counterparties will qualify for relief from certain CFTC requirements when they amend existing swaps to update the provisions that reference Libor. Tarbert commented that the CFTC was one of the first U.S. regulators to provide this type of relief and said others will soon follow.

Additional information

Click here for a recording of the CFTC meeting

Click here for statements of CFTC commissioners

  • FIA
  • Clearing
  • Cross Border
  • Swaps