On May 16, the Commodity Futures Trading Commission approved a new regulatory framework applicable to swap execution facilities (SEFs). The regulatory framework governs the registration and operation of SEFs, and is largely based on the Core Principles and other requirements contained in Section 5h of the Commodity Exchange Act (CEA). At its May 16 meeting, the CFTC also adopted final rules relating to minimum block sizes for certain swaps and the process by which designated contract markets (DCMs) and SEFs may make a swap “available to trade.”
The CFTC’s final rules applicable to SEFs make clear that any person operating a trading system in which multiple market participants have the ability to trade swaps by accepting bids and offers made by multiple participants (a “multiple-to-multiple” system) must register as a SEF. On the other hand, a person offering a trading system in which only one market participant has the ability to trade with other market participants (a “one-to-many” system) is not required to register as a SEF.
A SEF must, at a minimum, offer market participants an “order book,” which is defined as (i) an electronic trading facility, (ii) a trading facility or (iii) a trading system in which all market participants have the ability to enter orders, observe or receive orders and transact on such orders. For swaps subject to the trade execution requirement in Section 2(h)(8) of the CEA (i.e., swaps that are subject to mandatory clearing which have been made “available to trade” on a SEF or a DCM), a SEF additionally may allow its participants to execute trades in such swaps as block trades or through requests for quotes (RFQs). In contrast, swaps that are not subject to the Section 2(h)(8) trade execution requirement may be executed on a SEF by any means of interstate commerce.
The CFTC has established a temporary registration process that is designed to allow an applicant to operate a SEF while the CFTC’s determination on the applicant’s application for full registration is pending. The temporary registration process is available to applicants who file a complete application within the 60 days following publication of the final rules in the Federal Register, but is effective only after notice from the CFTC granting temporary registration. Temporary registration is not required for exempt commercial markets, electronic boards of trade and other facilities that have operated in reliance on CFTC no-action relief, provided that they submit a complete application by the compliance date for the final rules (120 days after publication of the final rules in the Federal Register).
The adopting release relating to the Core Principles and other requirements for SEFs is available here.
The CFTC also adopted final rules establishing minimum block sizes for swaps. Swap transactions that fall into one of the five following asset classes are subject to minimum block size standards set by the CFTC: (i) interest rate; (ii) credit; (iii) equity; (iv) foreign exchange and (v) other commodity. The appropriate block sizes will be established by the CFTC in accordance with a two-phase approach based on asset class. Minimum block sizes in interest rate and credit swaps will be determined using a 50% notional amount calculation in the first phase and a 67% notional amount calculation in the second phase, with the notional amount in each case representing a trimmed average of publicly reportable transactions over the preceding three years. Block trades in foreign exchange swaps that are economically related to a futures contract will initially have minimum thresholds based upon the block sizes set by the relevant DCMs, with a 67% notional amount calculation for most foreign exchange swaps in the second phase. The principles that apply to foreign exchange swaps will generally also apply to other commodity swaps. Equity swaps will not qualify as block trades, regardless of size.
The adopting release relating to minimum block sizes is available here.
Lastly, the CFTC issued final rules that prescribe the process by which DCMs and SEFs make a swap available to trade. CEA Section 2(h)(8) requires all swaps subject to mandatory clearing under CEA Section 2(h)(7) to be traded on a DCM or SEF, unless no DCM or SEF has made such swap available to trade. If a swap subject to mandatory clearing is listed on a DCM or SEF, the DCM or SEF may submit an available-to-trade determination to the CFTC pursuant to either the CFTC Regulation 40.5 rule approval process or CFTC Regulation 40.6 certification process. The determination must consider one or more of the following factors: (i) whether there are ready and willing buyers and sellers; (ii) the frequency or size of transactions; (iii) the trading volume; (iv) the number and types of market participants; (v) the bid/ask spread; and (vi) the usual number of resting firm or indicative bids and offers. The CFTC noted that it is not necessary for a SEF or DCM to consider more than one factor in making an available to trade determination, and that satisfying any one of the factors set forth above would sufficiently indicate that a swap is available to trade.
The adopting release relating to the trade execution requirement is available here.