Clearing, Swaps Rules, Data Quality Top CFTC Agenda

The Commodity Futures Trading Commission will focus on clearinghouse resiliency, swaps data quality, swaps trading rules and adopting regulations on automated trading and cybersecurity in 2016, sources told Bloomberg BNA.

Senate Agriculture Committee members, meanwhile, expect to advance a bill reauthorizing the CFTC at the beginning of the year that will focus on protecting end-users of derivatives from burdensome regulation and futures customers from their intermediaries, Chairman Pat Roberts (R-Kan.) said. A Senate-passed measure would then have to be reconciled with a bill passed by the House in 2015. Until that happens, the House Agriculture Committee will focus on tracking how the CFTC spends its money, Chairman K. Michael Conaway (R-Texas) said in an interview.

International Focus on Clearing.

At the commission, CFTC Chairman Timothy Massad told reporters at an open meeting in December that there will be a worldwide effort throughout 2016 to help ensure that clearinghouses can withstand a member default. “It’s one of the most important things we have on our plate,” he said. “Having made clearinghouses more important” through Dodd-Frank and international resolutions on swaps regulations, “we really have to make sure they are resilient.”

Massad said that working with U.S. clearinghouses, the CFTC will focus on skin-in-the-game requirements, stress testing, resolution planning and—should all else fail at keeping a clearinghouse afloat after a default—recovery planning. “There’s intense focus around the world, and cooperation among regulators,” the chairman said.

Regarding swaps trading, Massad said the CFTC hopes to begin permanently registering swap execution facilities (SEFs) in the early months of the year. Of 23 provisionally registered SEFs—including Bloomberg SEF, which is owned by Bloomberg BNA’s parent company, Bloomberg—none has been permanently registered.

Once the CFTC begins to register SEFs, Massad said the agency will turn its attention to codifying certain staff no-action letters issued in the past several years. The chairman said he wants to make SEF trading “work better” and said error trade and confirmation policies are among the topics he would like to revisit. Average daily volume on SEFs has been volatile. Volume has been as high as almost $500 billion in February 2015 and as low as approximately $280 billion in August 2014, according to data from the Futures Industry Association. It was at $370.2 billion in November, the last month for which data is available.

“SEFs have been accused, as a general proposition, of not working so well,” Ken Kopelman, a partner at Sidley Austin, New York, told Bloomberg BNA. “I think SEF trading rules are going to be changed over the near term.”

Specifically, Kopelman predicted that the CFTC will make changes to the made-available-to-trade process, in which swaps are mandated to be traded on a regulated platform. Changes to package trade rules and a clarification of how anonymity will work in swaps trading execution also are possibilities, Kopelman said.

Meanwhile, with the bulk of Dodd-Frank rules now in effect, Kopelman said he was concerned that the CFTC might use enforcement “as a way of making its views known” on certain matters, rather than through regulatory guidance.

Harmonize Rules.

In other swaps-trading developments, Massad said there will be an effort in 2016 to harmonize swaps trading rules with those in the E.U., which will include efforts to crease substituted compliance for swaps trading platforms on both sides of the ocean.

On that topic, CFTC Commissioner J. Christopher Giancarlo said the U.S. has made itself an “outlier” with respect to its swaps execution rules—specifically, the requirement that trades must be executed either through a central limit order book or through a request for quotes. “This will be the basis for another equivalence fight with the Europeans” in 2016, similar to the current standoff over clearinghouse margin requirements, Giancarlo predicted to Bloomberg BNA. “Why should the CFTC tell a registered swaps platform what type of technology to use?” he asked.

2015 Proposals Carry Over.

In other 2016 action, a number of rules proposed by the CFTC in 2015 are awaiting final action, including proposals to regulate automated trading and establish cybersecurity-testing standards for clearinghouses, exchanges and data repositories. The agency also will consider comments on draft standards for improving the quality of swaps data.

According to Massad, the agency is working on measures to enhance “the quality and consistency” of swap data reporting. Global regulators are frustrated that the data they are receiving isn’t standardized and varies substantially in terms of quality. The agency formally began the effort by seeking comment—due Feb. 22—on draft technical specifications for certain prioritized swap data elements. The comments will help determine whether and how staff proceeds the rest of the year with efforts to improve swap data repositories’ approaches to transmitting certain swaps data elements to the commission. The commission’s Technology Advisory Committee also was scheduled to meet Jan. 26 to discuss data quality.

Futures Industry Association President and Chief Executive Officer Walter Lukken said in a telephone interview that the CFTC at first was content with allowing industry participants to decide how to present their data. “As a result, not unexpectedly, people gave it in several forms and formats. So I think the commission is going to have to go back and in greater detail tell people how to provide the information and clean up some of this stuff over the next year,” he said. Lukken added, however, “it’s a heavy slog. I don’t think it will be a simple fix.”

Susan Ervin, a former partner at Davis Polk & Wardwell LLP, Washington, said in a telephone conversation that while the data issue is key for regulators, it also is important for market participants. “There have been concerns about inaccurate reporting—a swap dealer might input data that a counterparty didn’t think was right” for instance, she said. While the industry is seeking better data, it also will keep a close eye on any new standards or regulations, Ervin said. If dealers are required to change their internal reporting systems, “that would be a concern.”

Meanwhile, the CFTC proposed a rule Nov. 24 that would implement a new registration requirement for automated trading firms, as well as require system safeguards and other controls. A few weeks later on Dec. 16, it proposed two rules that would require the “core infrastructures” of the derivatives industry to conduct cybersecurity testing on their systems. Industry watchers told Bloomberg BNA that the cybersecurity proposal has a much better chance of being adopted in 2016 than automated trading, which could play out beyond the next 12 months.

AT Timing.

“I would be surprised if anything like Regulation AT was implemented prior to 2017,” Gary DeWaal, an attorney at Katten Muchin Rosenman LLP, New York, told Bloomberg BNA. “Under the best of circumstances, I think it’s unlikely to be [adopted] prior to the end of 2016, and I think that given the complexity, it’s unlikely to be made effective until sometime in 2017.”

One possible sticking point in the proposal is the requirement that AT firms store the proprietary source codes that run their systems and make them available to the CFTC if asked. Circumstantial evidence in spoofing cases and other enforcement actions could include how the source code was designed. “That’s the reason [the CFTC] likely wants the source code,” DeWaal said. “But the problem is, it’s the secret sauce for many firms.”

DeWaal said firms have two primary problems with giving up the codes: concern that the CFTC can’t protect them from hackers and that it may leak proprietary information. The proposal “lowers the threshold on how the government can get access [to proprietary information], and people are very upset about that,” he said. In the end, DeWaal predicted, there will be a regulation “that reflects compromise to some extent.”

Lukken, however, thinks the proposal could be adopted by the end of June. Once the comment period closes March 16, “they’ll take a few months, but you might see it at the end of the second quarter or maybe even sooner,” he predicted.

National Futures Association President and CEO Dan Roth told Bloomberg BNA that while the CFTC may or may not adopt a final AT rule in 2016, the process of doing so “is certainly going to be a focal point of attention for everyone in the industry, because the [proposed] rules are pretty significant.”

The cybersecurity comment period closes several weeks before that for automated trading, putting it on a quicker timetable, Lukken noted. Also, because the rules would come in the form of principles-based guidance, the proposal could prove to be less contentious, he said. “It may be an easier lift and happen quicker” than automated trading, he said.

Reauthorization Anticipated.

In Congress, meanwhile, Senate Agriculture Chairman Roberts told Bloomberg BNA that the panel is focused on producing a CFTC reauthorization bill that can pass the chamber and also be reconciled with legislation already passed by the House 111 DER 111, 6/10/15, 47 SRLR 1194, 6/15/15, 111 SLD, 6/10/15. The committee’s first order of business is to advance legislation on child nutrition, but it hopes to recommend a reauthorization bill early in the year.

Roberts told Bloomberg BNA in an e-mail that he has made CFTC reauthorization “a priority for the committee,” and that he “look[s] forward to marking up a bill soon that addresses regulatory overreach and protects farmers, ranchers and end-users.” The bill is expected to lean heavily on protecting nonfinancial end-users of swaps from excessive regulation and customers of futures commission merchants from the kinds of problems that resulted from the collapse of MF Global Inc. in 2011 and Peregrine Financial Group in 2012.

While the House Agriculture Committee already has approved two reauthorization bills that later were passed by the House, Senate rules and dynamics make it more difficult to move a bill without the assent of the minority. As such, the committee wants to produce a bill that comes to the floor with bipartisan support. Significant opposition from Democrats on the committee would make Senate passage much more difficult.

Funding Issues.

According to a futures industry attorney who follows Congress closely, the Senate committee minority, led by ranking member Debbie Stabenow (D-Mich.), is concerned with fully funding the CFTC and wants that issue addressed. Democratic officials on the committee didn’t return messages seeking comment.

On the House side, Agriculture Committee Chairman Conaway said in a telephone interview that he has had “good conversations” with Massad about the need to get the CFTC reauthorized, despite reports about tension between the two over the House bill 106 SLD, 6/3/15, 106 DER EE-16, 6/3/15, 47 SRLR 1154, 6/8/15. “The funding issue—he believes he needs more money; I believe they need to be reauthorized” before the agency’s budget can be increased, Conaway said. “Between those two tensions we’ll be able to come to an agreement, I think, on what that ought to look like.”

Conaway acknowledged that there probably are details in the sweeping House reauthorization bill that might have to be negotiated with the Senate, but said he is looking forward to beginning that process. “We’re anxious for that to move forward and are ready to come together,” he said.

Conaway Following the Money.

Meanwhile, Conaway said he plans to hold an oversight hearing to “get an understanding” of how the CFTC spent the money it received in fiscal year 2015—approximately $250 million, including a $35 million increase from the previous year 46 SRLR 2382, 12/15/14, 238 DER AA-3, 12/11/14, 238 Securities Law Daily, 12/11/14. Massad “has asked for new money, and I think it’s appropriate for us to have a pretty good understanding of where that money would go,” Conaway said. In addition, the chairman said he intends to have a more general oversight hearing at which Massad will testify about “the state of affairs” at the CFTC.

House Agriculture Commodity Exchanges Subcommittee Chairman Austin Scott (R-Ga.), told Bloomberg BNA that his panel “will take a very serious look” at the quality and reporting of swaps data. “There’s a tremendous amount of information coming in that serves no purpose” because its quality makes it unusable, he said. Scott also said he has an interest this year in ensuring that the CFTC takes bona fide hedging into consideration if it adopts a position limits rule.

Position limits were proposed for 28 physical commodity agricultural, energy and metals futures contracts and their “economically equivalent” swaps in 2013 but haven’t been adopted 215 DER EE-14, 11/6/13, 215 Securities Law Daily, 11/6/13, 45 SRLR 2087, 11/11/13. Sources inside and outside the commission indicate that a major snag has to do with how the commission will treat positions meant to hedge a commercial risk—market participants would like their hedging positions exempted from limits, but commission staff is struggling with how to define such positions.

SRO Increasing Activity.

NFA’s Roth told Bloomberg BNA that the self-regulatory organization (SRO) will take on several new responsibilities in both futures and swaps regulation in 2016. New initiatives will include helping the CFTC implement and monitor new rules on uncleared swaps margin—including helping approve internal models used by swap dealers to calculate counterparty margin requirements. “It’s going to be a big deal,” Roth said.

Other new swaps efforts will focus on overseeing valuation disputes and monitoring dealers’ compliance with capital rules, should the CFTC adopt them this year, Roth said. NFA also will have a major role in overseeing compliance with CFTC cybersecurity rules once they’re adopted, as expected, in 2016, as well as educating members on new responsibilities. “We’re not going to go out and do exams and just try to catch people” violating the rules, Roth said.

The SRO also is planning an overall evaluation of reporting rules it has implemented in the last several years, including futures commission merchants risk-exposure reports, chief compliance officer reports and commodity pool operator reports. “We need to talk with the commission, step back and say, what’s our experience with these rules,” Roth said. “How are these reports working? Are they giving us useful information? Do the rules need to be changed at all?”

“It’s not going to be a boring year,” Roth said. “There’s a lot going on.”

To contact the reporter on this story: Richard Hill in Washington at rhill@bna.com

To contact the editor responsible for this story: Phyllis Diamond at pdiamond@bna.com