The CFTC will hold a meeting on 12_10_2013 at 9:30 a.m. to discuss its version of the Volcker Rule, as well as other commission business. One other topic on the list...block trading of futures contracts.
The press release, inclusive of meeting information, is available here.
Good day. Good developments. TSR
On November 19th, the CME issued its Market Regulation Advisory Notice 1308-5, relating to CME Group Rule 534 ("Wash Trades Prohibited"). The notice itself is relatively short and sets forth the text of the rule - this posting is intended to provide our readers with a brief overview of the particular "questions and answers" ("Q & As") that relate to unintentional and incidental crossing (or self-match) situations.
A "wash trade" is a trade that gives the appearance of a bona fide purchase and sale of an exchange-traded contract, but for the fact that the trades had been entered into without the intent to i) take a bona fide market position; or ii) executed bona fide transactions subject to market risk or price competition. In essence, a wash trade can result from the simultaneous purchase and sale of the same instrument at the same price for commonly owned trading accounts.
A violation of the wash trade prohibitions requires "intent" to not enter into a bona fide trade, although market participants do from time to time receive inquiry from exchanges about unintentional "self-matches" that occur due to trading in the same contract across different desks, in different jurisdictions, through different commonly-owned affiliates, or as a result of a combination of some or all of these factors. In short, this can happen when traders in the same firm (or at different commonly-owned affiliates) end up on both sides of the same trade (which is likely to be more common in relatively illiquid markets). Ultimately, a market participant may well be able to demonstrate that they intended to enter into a bona fide trade and, as a result, the matching of the buy and the sell was incidental (assuming, of course, that these trades were limited and the circumstances were isolated relative to the trading program and activity as a whole). However, in our experience, responding to these sorts of exchange inquries make the legal, compliance, and trading functions very nervous.
Therefore, we have prepared this posting to provide our readers with a summary of the Q&As that relate to incidental matching. In particular, for a discussion of these types of self-match scenarios and the use of CME’s Self-Match Prevention functionality, see the following Q&As:
Q&A 10, p. 4 of the Advisory Notice - Identifying the fact that a coincidental cross of trades in the market, may not rise to the level of a wash trade, but may "draw additional regulatory scrutiny"
Q&A 12, p. 4 of the Advisory Notice - Wash trade prohibitions not necessarily implicated if multiple traders of the same firm make fully independent trading decisions, subject to demonstration of a bona-fide trades being entered into without prearrangement or knowledge of other positions
Q&A 15, p. 4 of the Advisory Notice - Market participants are to monitor trading and minimize both the potential and occurrence for self-match events; and
Q&A 16 and 17, pp. 5 and 6 of the Advisory Notice - Highlighting the availability of the CME Group’s Self-Match Prevention functionality as a tool to manage self-match risk.
The notice is available here. Good morning. Good reminder. TSR
On November 12, 2013, the Securities and Exchange Commission published its final municipal advisor registration rule. Information about this rule is available here.
Investment advisers that provide advice to municipalities should pay particular attention to this rule, especially if a particular investment mandate may involve swaps or security based swaps. These particular types of derivatives may constitute "muncipal derivatives" and any advice provided by a registered investment adviser to a municipality in respect of these derivatives may subject that adviser to registration as a muncipal advisor.
Good day. Good day to give thanks for all things, even the new muncipal advisor registration rule. TSR
By Todd Zerega and Cátia Kossovsky
Beginning on Tuesday, November 19, the Open Market Trading Desk of the Federal Reserve Bank of New York (FRBNY) increased the fixed rate offered in its overnight fixed-rate reverse repurchase operations exercise again, this time, from 4 basis points to 5 basis points. All other terms of the exercise remain the same. You can see the latest FRBNY statement here.
These exercises are intended to improve the FRBNY's ability to manage short-term interest rates. The Financial Stability Board, is also seeking comment letters on repurchase reform and additional recommendations. The deadline for the comments is November 28, 2013.
Good day. Good overnight. TSR
By Todd Zerega and Cátia Kossovsky
The Federal Reserve Bank of NY released their monthly statistics of the U.S. tri-party repo market for October.
For the month ending October 9, 2013, the total collateral in the U.S. tri-party repo market increased by $51 billion, an increase of 0.3%. The amount of collateral increased for almost every asset class, with Money Market leading the increase by $7 billion, or 41.3%.
Haircuts remained relatively stable with the median haircut remaining constant for all collateral types except for ABS Investment Grade, which grew from 5% to 6%.
The statistics are available here.
Good Day. Good Statistics. TSR
By Todd Zerega and Tom Watterson
In December of 2012, the European Securities and Markets Authority (“ESMA”) adopted Guidelines on ETFs and other UCITS issues (the “Guidelines”) that included a requirement regarding the diversification of collateral held for derivatives and repos. Section 43 e) of the Guidelines requires that UCITS diversify the collateral held under “financial derivative transactions,” including repos, by issuer and country. The maximum exposure to an issuer of collateral received from its repo counterparties (on an aggregate basis across counterparties) cannot exceed 20% of the UCITS’ NAV. However, the Guidelines do not include an exclusion from the collateral diversification requirement for governmental or sovereign issuers.
The Guidelines became effective in February of 2013, and, following the expiration of a transitional period, UCITS must comply with the collateral diversification requirements of the Guidelines by February 18, 2014.
Government money market funds (“Government MMFs”) principally hold obligations of governmental issuers as well as repurchase agreements collateralized by such securities. Government MMFs may limit their obligations to those issued by an individual country, such as the United Kingdom, Germany or United States. Repos are vital to the operation of most Government MMFs. Government MMFs use repos to provide liquidity for the fund that it then uses to facilitate shareholder redemptions. Repos are also used to generate attractive returns for Government MMFs.
Under the ESMA Guidelines, Government MMFs (particularly those limiting investments to an individual country) would likely be required to limit investing in repos to 20% of their NAVs or change their investment policies to permit the fund to take other securities as collateral. As a result, those Government MMFs would likely increase their investment in direct holdings of obligations of the government issuer. Therefore, the ESMA collateral diversification requirements would have the counter-intuitive effect of increasing a Government MMF’s exposure to direct holdings of obligations of the particular governmental issuer.
The European Commission’s recently released Proposal of the European Parliament and of the Council on Money Market Funds (the “MMF Reform”) presents diversification rules for MMFs with respect to collateral and direct holdings of securities. The MMF Reform, however, includes an exemption from the diversification rules with respect to holding treasuries and government bonds both directly and as collateral to repos, permitting MMFs to hold up to 100% of their assets in treasuries or government bonds from one issuer. A common sense solution would be for ESMA to implement a similar exception to its collateral diversification rules.
Good day. Good diversification? TSR
By Andrew Cross and Tom Watterson
We wanted to raise awareness on a point that has not received much attention to date: increased recordkeeping requirements for SEF members. At the outset, many SEFs use the term "participant" synonymously with "member." So, if you are one of the many swap market participants who have received a "Participant Agreement" in the past month, then this posting applies to you.
In December 2012, The CFTC amended Rule 1.35(a)(1) to include SEFs and SEF members. Now that the SEF rules have been finalized, and SEFs are operating, the recordkeeping requirements are beginning to apply to many end users. CFTC Rule 1.35(a)(1) details recordkeeping requirements for both written and oral records, but the CFTC exempted many entities from maintaining oral records (i.e., recording phone lines). The written recordkeeping requirement remains for all SEF members. These written recordkeeping requirements exceed what is required for OTC swaps.
Written Records
All SEF members are subject to the recordkeeping requirements of CFTC Rule 1.35(a)(1) for written records. The general recordkeeping requirement of CFTC Rule 1.35(a)(1) uses language similar to the swap recordkeeping requirements, but provides further detail as to what records must be kept. In addition to the OTC swap recordkeeping rules, a SEF member must also keep:
Significantly for energy companies, commodity trading firms, corporate entities, and anyone using swaps as hedging instruments, the recordkeeping requirements will apply to cash commodity transactions hedged by a swap or a future.
As a related side note, these written recordkeeping requirements also apply to any member of a futures exchange, including any non-clearing member.
Oral Records/Phone Recording
CFTC Rule 1.35 also obligates SEF members to maintain oral records (i.e., recorded line requirements), but it provides exemptions from maintaining oral records to the following types of entities:
Notably absent from the exempted entities are stand alone (i.e., non-CPO) registered commodity trading advisors.
Additionally, oral records do not have to be kept for communication that lead solely to the execution of a related cash or forward transaction.
Oral records include: communications provided or received concerning quotes, solicitations, bids, offers, instructions, trading, and prices that lead to the execution of a transaction in a commodity interest and related cash or forward transactions, whether communicated by telephone, voicemail, facsimile, instant messaging, chat rooms, electronic mail, mobile device, or other digital or electronic media. It is worth noting that for certain media (i.e., instant messaging and e-mail) that the nature of the communication, rather than the medium, will determine whether it is an oral or written communication. (Query what happens if a voicemail is attached to an e-mail as a .wav file?)
Retention Periods
Records kept under CFTC Rule 1.35(a)(1) must be kept pursuant to Rule 1.31. As with OTC swap recordkeeping, the written records required to be kept under CFTC Rule 1.35(a)(1) must be kept for the life of the transaction plus five years, or if not related to a transaction then for five years. Oral records must be kept for one year.
What to do Now
Now that SEFs are registered and operating, many people are beginning to become SEF members (i.e., "participants"). Moreover, SEFs have begun to make submissions to the CFTC to determine that certain interest rate swaps and credit default index swaps are available to trade and should be required to be traded on a SEF (see a summary of the first such submission here). Compliance managers should review the regulatory status of their firms to determine if they will have to keep oral records as a SEF member. Moreover, compliance policies should be updated, as needed, to ensure that all email, IM’s, text messages and other electronic communications are being captured with respect to swaps, futures and related cash commodity transactions. In particular, we note that in the final rule, the CFTC explicitly rejected limiting the recording to firm provided mobile devices, so this would include communications sent on an employee's personal devices to the extent that such communication would otherwise fall under CFTC Rule 1.35(a)(1) requirements.
As a final note, given the choice between using a voice broker and a SEF, CFTC Rule 1.35(a)(1) places a larger recordkeeping burden on using a SEF (a consequence that we doubt was intended).
Good day. Good recording. TSR
By Crystal Travanti and Tom Watterson
In April of this year, the NFA issued a notice to its members introducing a new quarterly filing requirement for CTAs, Form NFA-PR. Each registered CTA with a reporting requirement under CFTC Regulation 4.27 must file NFA Form PR on a quarterly basis with the NFA within 45 days after the end of each quarter. The first calendar quarter triggered by the rules is September 30, 2013, and there is an upcoming NFA-PR filing date of November 14, 2013 (45 days after the close of the calendar quarter).
Form NFA-PR will require general information about the CTA, its trading programs, the pool assets directed by the CTA and the identity of the CPOs that operate those pools, as well as information about certain trading programs being offered by the CTA, including the monthly rates of return and the assets under management of those programs.
An example of Form NFA-PR can be found here.
NFA-PR is based off of the CFTC’s form (CTA-PR), which is required to be filed annually with the NFA. The filing of NFA-PR will satisfy a CTA’s obligation to file Form CTA-PR.
Good day. Good filing. TSR
By Todd Zerega and Cátia Kossovsky
Effective Monday, October 21, 2013, the Federal Reserve Bank of New York (FRBNY) revised the terms of its daily, overnight fixed-rate reverse repurchase operational exercise, to increase the fixed rate from 1 basis point to 2 basis points. All other terms of the exercise will remain the same.
Since 2009, the Open Market Trading Desk (the Desk) of the FRBNY has been working with market participants on operational aspects of tri-party reverse repurchase agreements (RRPs) to ensure that this tool will be ready to support the monetary policy objectives of the Federal Open Market Committee (Committee). In September, the Committee instructed the Desk to further examine how a potential overnight, fixed-rate full-allotment RRP facility might affect short-term interest rates. As a result, the Desk will conduct a series of daily overnight, fixed-rate RRP operations through the end of January 2014.
The FRBNY is interested in running these exercises with larger transactional flows to view what effect such operations would have on interest rate control. The FRBNY has stated that this is only intended as an operational exercise as part of advance planning and is not intended to materially affect the current level of short-term interest rates.
A link to this notice can be found here.
Good day. Good Exercise. TSR
By Andrew Cross and Tom Watterson
On Friday, Javelin SEF made the first "Made Available to Trade" submission (an "MAT Submission") to the CFTC for certain interest rate swaps. Javelin's submission, if not objected to by the CFTC, would cause those interest rate swaps come under the trading requirement, and those swaps would then be required to be executed on a swap execution facility ("SEF") or a designated contract market (unless they fall under the end-user exception).
Javelin's MAT Submission would cover USD LIBOR, Sterling LIBOR, & EURIBOR interest rate swaps.
The CFTC determined that Javelin's MAT Submission presented novel or complex issues, providing the CFTC with 90 days to review the MAT Submission. The CFTC also opened the MAT Submission up to public comment. The comment period will end on November 19, 2013.
The SEF rules only became effective on October 2, 2013, and since then 17 SEFs have provisionally registered with the CFTC. However, the CFTC has commented that it has not had enough time to review the SEF registrations, or even to review each SEF's rule book.
The factors to consider if a swap is "available to trade" and should be subject to the trading requirement are:
Given the extensive number of counterparties that use interest rate swaps, and the very brief operating period for SEFs, many market participants would have to undergo significant changes if this MAT Submission became effective.
The CFTC Press Release is available here. The Javelin MAT Submission is available here.
Good day. Good commenting. TSR
Thanks to author Abbey Mansfield, who originally posted the piece at The Lending Law Report on October 10th. In the posting, Abbey discusses ECP qualification and market trends from the perspective of a lending lawyer. The full posting is available here.
Good day. Good posting - thanks Abbey. TSR
By Todd Zerega and Cátia Kossovsky
The Federal Reserve Bank of NY released their monthly statistics of the U.S. tri-party repo market for September.
For the month ending September 11, 2013, the total collateral in the U.S. tri-party repo market decreased by $68 billion, a decrease of 0.4%. The amount of collateral decreased for almost every asset class, with Corporates Non Investment Grade leading the decrease by $1.5 billion, or 8.6%.
Haircuts remained relatively stable with the median haircut remaining constant for all collateral types in September.
The statistics are available here.
Good day. Good statistics. TSR
By Andrew Cross and Tom Watterson
Last week ISDA announced that, in the event of a default by the U.S. on its debt following the failure to raise the debt ceiling, the sellers of CDS on U.S. debt would pay-out, at most, only $3.6 billion.
The potential default, however, is also impacting the interest rate swap market. Anticipating market moves related to the debt ceiling and a related increased tail risk, the CME increased the margin on cleared interest rate swaps. The increase will be 12% across interest rate swap portfolios and the CME will implement the increase across four days beginning at the close of business today. Note the paradox: given the prominent use of Treasuries as collateral, a default on U.S. debt - all things being equal - would seem to increase the demand for U.S. debt. Ha!
The CME notice of the margin increase can be found here.
News articles on the margin hike can be found:
Good day. Good-ness. TSR
By Patricia Dondanville, James A. Rolfes, and Sarah R. Wolff
In a reversal of course, the Division of Enforcement of the Commodities Futures Trading Commission ("CFTC"), has confirmed that it will no longer pursue omnibus orders of investigation by means of an "absent objection" procedure, and instead will seek Commission approval before extending such orders. In a September 26th speech, CFTC Commissioner Scott O'Malia discussed this reversal in greater detail. That speech is available here.
Last month, CFTC Commissioner Scott O'Malia, issued a sharply worded objection to the Division's use of the procedure. Commissioner O'Malia warned that, by using the "absent objection" process, the Enforcement Division could initiate and extend a broadly scoped examination indefinitely, and avoid a full Commission discussion and review of the legal and factual basis for the investigation. See RS Client Alert: CFTC Takes an Aggressive Enforcement Tack, which is available here. "It is imperative for the Commission to issue formal orders of investigation that are consistent with Congressional intent and that reflect the Commission's collective opinion, based upon each Commissioner's independent review of the merits of each request to authorize or extend investigations," said O'Malia.
Seeking the omnibus order of investigation via such an absent procedure was one indication of the more aggressive enforcement stance the CFTC has taken since the Dodd Frank Wall Street Reform and Consumer Protection Act passed in 2010. Its retreat from this practice signals that the CFTC will follow a more deliberative investigatory approach where the Commissioners take an active role in assessing the legal and factual basis for bringing an investigation, controlling the scope of the investigation, and considering the potentially significant ramifications to the Enforcement Division's announcement. Commissioner O'Malia reiterated his support of Division's efforts to "promptly and effectively investigate potential violations of the Commodity Exchange Act," and promised to act swiftly when considering Enforcement Division investigatory requests.
Good day. Good reversal. TSR
By Andrew Cross and Tom Watterson
Last night the CFTC Division of Market Oversight (“DMO”) released CFTC Letters 13-55, 13-56, and 13-57. CFTC Letters 13-56 and 13-57 are particularly relevant for market participants other than SEFs.
CFTC Letter 13-55 provides no-action relief to the SEFs for compliance with the Part 43 reporting obligations and the obligation to report creation data in Part 45, each for swaps in FX, other commodity and equity asset classes. The relief is conditioned on either the reporting counterparty reporting the data, or the SEF back-loading the data when it is able. In addition, the SEFs must submit a notice to the DMO and comply with all recordkeeping requirements. The relief expires on October 30, 2013 for FX swaps and on December 2, 2013 for other commodity and equity swaps.
CFTC Letter 13-55 is available here.
CFTC Letter 13-56 provides no-action relief to a reporting counterparty for failing to report required swap continuation data under Part 45 or for errors and omissions in swap continuation data for equity, FX and other commodity asset classes that are executed on, or pursuant to, the rules of a SEF. A reporting counterparty’s ability to report continuation data may depend on the SEF's fulfillment of its obligations under section 45.3(a) to report swap creation data. As described above, those obligations have been delayed under CFTC Letter 13-55. The reporting counterparty must inform the SEF of circumstances causing a failure to report and must retain records of the transactions. CFTC Letter 13-56 expires on October 29, 2013 with respect to FX swaps and December 1, 2013 with respect to other commodity and equity swaps.
CFTC Letter 13-56 is available here.
CFTC Letter 13-57 provides no-action relief to the enforcement of certain rules against SEFs, with respect to market participants trading on those SEFs until November 1, 2013. The relief covers: 37.200(a), 37.200(b), 37.201(b)(1), 37.201(b)(3), 37.201(b)(5), 37.202(b) and 37.203. The rules covered by CFTC Letter 13-57 would require SEFs to enforce their own rulebooks and compel participants to consent to the jurisdiction of the SEF. As a practical result, this means that market participants would have to agree to each SEFs rulebook, many of which have just been released or have not yet been released.
The relief will be welcome news to buy-side participants, who were being forced into agreeing to terms and rulebooks with very little time to review and negotiate. SEFs must still create rulebooks, but they will not have to enforce them against market participants.
CFTC Letter 13-57 is available here.
Good day. Good delay. TSR
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