CFTC Holds Roundtable on Core Principle 9 for DCMs
AT TODAY’S CFTC ROUNDTABLE, market participants discussed proposed regulations implementing Core Principle 9 for Designated Contract Markets (DCMs). Last month, the CFTC approved final rules implementing Section 735 of the Dodd-Frank Act which codifies regulations, guidance, and acceptable practices applicable to DCMs and DCM applicants. Core Principle 9, which requires that DCMs provide a competitive open market and mechanism for executing transactions, was not finalized in this rulemaking after staff suggested the rule be taken up when the Commission considers final rules for Swap Execution Facilities (SEFs).
The roundtable focused on three issues related to Core Principle 9, including the proposed minimum centralized market trading requirement; the proposed minimum requirements for exchange of derivatives for related positions (EDRP) transactions; and the proposed requirements for reporting block transactions. Rick Shilts, Director of the CFTC’s Division of Market Oversight; Ananda Radhakrishnan, Director of the CFTC’s Division of Clearing and Risk, and staff from both divisions were in attendance.
Staff began the roundtable by asking the participants how a contract that does not come onto a centralized market would comply with Core Principle 9. Many participants took the opportunity to raise concerns with the proposed provision that would require 85 percent of total trading volume of contracts on DCMs to consist of centralized trading or be mandatorily de-listed. The participants said such a requirement would have a chilling market effect, noting that the artificial threshold may drive currently cleared contracts into bilateral markets.
Participants also said the provision would threaten the ability of new and innovative products to come to the market and noted that the Commodity Exchange Act has never been so prescriptive before with regard to imposing a specific threshold number. Participants said this move away from a principles-based approach would be counterproductive.
Staff asked specifically whether a contract that does not trade on a centralized market would comply with Core Principle 9. Participants said such contracts could comply with the provision because the Dodd-Frank Act provides flexibility for DCMs to bring contracts under the auspices of the exchange.
Staff questioned what activities would constitute a violation of Core Principle 9 by an exchange. Participants responded that if a Board of Trade did not offer a competitive and efficient central market place, or did not provide fair access to market participants, then it would be in violation of the rule.
Staff asked the participants how the CFTC could ensure pre-execution transparency if it allowed futures contracts to be executed off an exchange. Specifically, staff wanted to know how market participants would be able to see bids and offers on these contracts.
One participant noted that the Dodd-Frank Act does not require pre-trade price transparency, stating that such a situation would be appropriate for products with deep liquidity and where parties are able to post bids and offers. Another participant noted that during the launch of new products, market participants will establish initial positions via blocks, stating that the 85 percent threshold proposal would greatly increase uncertainty for customers in these trades regarding when certain regulations would be triggered. The participant said this uncertainty could drive market participants away from these contracts. Participants noted that highly liquid contracts migrate to central clearing overtime and that flexibility must be afforded to DCMs to nurture this movement.
Staff wanted to know what the appropriate length of time would be for a noncompliant contract to be de-listed and have its open positions transferred to a SEF as required in the proposed rule.
Participants stated their hope that the CFTC looks at all the principles-based factors when finalizing the rule. Participants said that DCMs implement mechanisms to incentivize central limit order book trading and if contracts are still not trading in this way then “there is probably a good reason for that.” Participants noted the difficulty in answering the question because there is still uncertainty over what the rules of execution are for SEFs. They said de-listing is a “disruptive regulatory practice” and that forcing a futures contract to transform into a swap is contrary to the statutory language of Dodd-Frank. Another participant stated the CFTC does not have the unilateral right to change listing standards, and that it must instead be done bilaterally with the SEC as it relates to security futures.
Staff questioned whether the CFTC should take additional measures to address new products with low liquidity. Participants said new contracts should not be subject to de-listing, noting that such a requirement would risk balkanizing certain contracts that should be traded together. The participants also noted that market forces will cause the de-listing of contracts if necessary and said there are other ways to incentivize central limit order book trading.
Staff asked how companies utilize EDRPs. Participants said EDRPs are used across a number of different markets and are sometimes used as a way for customers to access certain trading methods.
Staff called for participants’ thoughts on prohibiting EDRP contingent transactions. Participants said prohibiting contingent swaps would be very disruptive and asked staff what they were envisioning with regard to the SEF rules.
Staff responded by noting that the SEF rules are still being “fleshed out” and remarked that the “elephant in the room” was CME’s ClearPort, noting how a variety of requirements, including real-time reporting, flow from the Congressional mandate to promulgate rules for mandatory clearing and exchange trading requirements.
Participants said that the CFTC must focus on answering whether contingent swaps would be required to be traded on a SEF as well as whether such swaps would be offered by and reported to a SEF and whether such swaps would count toward the “swap dealer” definition.
With regard to the proposed block transaction reporting requirements, staff asked what the challenges would be for market participants to report block trades within five minutes of agreeing to the terms of the trade. All of the participants agreed on the need to have flexibility for reporting time requirements, noting how all markets and contracts are different and that a one-size-fits-all approach would not be appropriate, especially for complex trades. Participants said that flexibility should also be given to new contracts to give market participants time to hedge that position.
For more information on the roundtable, please click here.
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AT TODAY’S CFTC ROUNDTABLE, market participants discussed proposed regulations implementing Core Principle 9 for Designated Contract Markets (DCMs). Last month, the CFTC approved final rules implementing Section 735 of the Dodd-Frank Act which codifies regulations, guidance, and acceptable practices applicable to DCMs and DCM applicants. Core Principle 9, which requires that DCMs provide a competitive open market and mechanism for executing transactions, was not finalized in this rulemaking after staff suggested the rule be taken up when the Commission considers final rules for Swap Execution Facilities (SEFs).
The roundtable focused on three issues related to Core Principle 9, including the proposed minimum centralized market trading requirement; the proposed minimum requirements for exchange of derivatives for related positions (EDRP) transactions; and the proposed requirements for reporting block transactions. Rick Shilts, Director of the CFTC’s Division of Market Oversight; Ananda Radhakrishnan, Director of the CFTC’s Division of Clearing and Risk, and staff from both divisions were in attendance.
Staff began the roundtable by asking the participants how a contract that does not come onto a centralized market would comply with Core Principle 9. Many participants took the opportunity to raise concerns with the proposed provision that would require 85 percent of total trading volume of contracts on DCMs to consist of centralized trading or be mandatorily de-listed. The participants said such a requirement would have a chilling market effect, noting that the artificial threshold may drive currently cleared contracts into bilateral markets.
Participants also said the provision would threaten the ability of new and innovative products to come to the market and noted that the Commodity Exchange Act has never been so prescriptive before with regard to imposing a specific threshold number. Participants said this move away from a principles-based approach would be counterproductive.
Staff asked specifically whether a contract that does not trade on a centralized market would comply with Core Principle 9. Participants said such contracts could comply with the provision because the Dodd-Frank Act provides flexibility for DCMs to bring contracts under the auspices of the exchange.
Staff questioned what activities would constitute a violation of Core Principle 9 by an exchange. Participants responded that if a Board of Trade did not offer a competitive and efficient central market place, or did not provide fair access to market participants, then it would be in violation of the rule.
Staff asked the participants how the CFTC could ensure pre-execution transparency if it allowed futures contracts to be executed off an exchange. Specifically, staff wanted to know how market participants would be able to see bids and offers on these contracts.
One participant noted that the Dodd-Frank Act does not require pre-trade price transparency, stating that such a situation would be appropriate for products with deep liquidity and where parties are able to post bids and offers. Another participant noted that during the launch of new products, market participants will establish initial positions via blocks, stating that the 85 percent threshold proposal would greatly increase uncertainty for customers in these trades regarding when certain regulations would be triggered. The participant said this uncertainty could drive market participants away from these contracts. Participants noted that highly liquid contracts migrate to central clearing overtime and that flexibility must be afforded to DCMs to nurture this movement.
Staff wanted to know what the appropriate length of time would be for a noncompliant contract to be de-listed and have its open positions transferred to a SEF as required in the proposed rule.
Participants stated their hope that the CFTC looks at all the principles-based factors when finalizing the rule. Participants said that DCMs implement mechanisms to incentivize central limit order book trading and if contracts are still not trading in this way then “there is probably a good reason for that.” Participants noted the difficulty in answering the question because there is still uncertainty over what the rules of execution are for SEFs. They said de-listing is a “disruptive regulatory practice” and that forcing a futures contract to transform into a swap is contrary to the statutory language of Dodd-Frank. Another participant stated the CFTC does not have the unilateral right to change listing standards, and that it must instead be done bilaterally with the SEC as it relates to security futures.
Staff questioned whether the CFTC should take additional measures to address new products with low liquidity. Participants said new contracts should not be subject to de-listing, noting that such a requirement would risk balkanizing certain contracts that should be traded together. The participants also noted that market forces will cause the de-listing of contracts if necessary and said there are other ways to incentivize central limit order book trading.
Staff asked how companies utilize EDRPs. Participants said EDRPs are used across a number of different markets and are sometimes used as a way for customers to access certain trading methods.
Staff called for participants’ thoughts on prohibiting EDRP contingent transactions. Participants said prohibiting contingent swaps would be very disruptive and asked staff what they were envisioning with regard to the SEF rules.
Staff responded by noting that the SEF rules are still being “fleshed out” and remarked that the “elephant in the room” was CME’s ClearPort, noting how a variety of requirements, including real-time reporting, flow from the Congressional mandate to promulgate rules for mandatory clearing and exchange trading requirements.
Participants said that the CFTC must focus on answering whether contingent swaps would be required to be traded on a SEF as well as whether such swaps would be offered by and reported to a SEF and whether such swaps would count toward the “swap dealer” definition.
With regard to the proposed block transaction reporting requirements, staff asked what the challenges would be for market participants to report block trades within five minutes of agreeing to the terms of the trade. All of the participants agreed on the need to have flexibility for reporting time requirements, noting how all markets and contracts are different and that a one-size-fits-all approach would not be appropriate, especially for complex trades. Participants said that flexibility should also be given to new contracts to give market participants time to hedge that position.
For more information on the roundtable, please click here.