By Eric Berman, Senior Legal Editor, Practical Law Finance
In keynote remarks at the Futures Industry Association (FIA) Futures and Options Expo on November 4, 2015, Commodity Futures Training Commission (CFTC) Chairman, Timothy Massad, outlined a packed CFTC agenda including rulemaking on important issues, such as:
- Uncleared swaps margin. Automated trading. Cybersecurity. Reducing the de minimis swap dealer threshold. Data reporting. Other matters, including Swap Execution Facility (SEF) registration, commodity position limits, and more.
The chairman also emphasized enforcement, as the CFTC shifts focus, having completed much of its rulemaking under Title VII of the Dodd Frank. The chairman emphasized enforcement in the areas of data reporting violations and market manipulation. The latter was highlighted in a recent high-profile "spoofing" case, decided on November 4, 2015, the first US prosecution under the Dodd-Frank anti-spoofing law (7 U.S.C. § 6c(a)(5)).
The following is a top 10 practical summary of the chairman's remarks.
1. Margin for Uncleared Swaps
The chairman acknowledged the uncleared swaps bank margin rules released in late October by US prudential bank regulators and confirmed (as expected) that corollary CFTC rules on uncleared swaps margin for nonbanks are likely to be finalized by the CFTC late this year. He noted that while certain minor differences between the rules will remain, similarity on the following issues can be expected:
- Material swaps exposure threshold, which triggers margin requirements. Timetable of implementation. Acceptable types of collateral, including for variation margin. Currency of payment. Certain other matters.
According to the chairman, the CFTC remains committed to harmonizing these rules with the bank margin rules, as well as internationally, as much as possible.
2. Automated Trading
The chairman confirmed that the CFTC was expected to consider proposed rulemaking on automated trading, designed primarily to address the potential for market disruptions. Since the FIA Expo, the CFTC issued these proposed new rules on automated trading, which include risk controls, transparency measures, and other safeguards designed to enhance the regulatory regime for automating trading on US designated contract markets (DCMs). For details on the proposed CFTC rules for automated trading, see Legal Update, CFTC Proposes Rules for Automated Trading.
3. Cybersecurity
Chairman Massad also mentioned that he expected the CFTC to take action shortly in the area of cybersecurity. The chairman noted the CFTC's focus on disruptive cyberattacks and cited recent approval of National Futures Association's (NFA's) cybersecurity guidance that will require NFA members to adopt - and enforce - policies and procedures to secure customer data and protect their electronic systems.
The CFTC is also considering proposals to ensure that major exchanges, clearinghouses, and swap data repositories (SDRs) are conducting adequate evaluation and testing of their own cybersecurity and operational risk protections.
These are also expected to be principles-based standards. A proposal can be expected in 2016.
4. Reducing the De Minimis Swap Dealer Threshold
Chairman Massad noted that when the CFTC and the SEC originally wrote the de minimis swap dealer threshold exemption, they did so without the benefit of much data. Now, Massad asserted, the CFTC is in a much better position to estimate the impact of setting different threshold levels, with data to inform the discussion.
Since the FIA Expo, the CFTC published a preliminary report mandated under Title VII of the Dodd-Frank Act on the de minimis swap dealer exemption. The CFTC is currently seeking public comment on the report and on lowering the threshold, which is currently $8 billion. This is the amount of aggregate notional swap dealing activity that requires an entity to register with the CFTC as a swap dealer. This threshold is currently scheduled to fall to $3 billion in about two years.
The CFTC will estimate the number of participants that might be subject to registration under a lower threshold and the percentage of the market that might be captured. For details on the preliminary report, see Legal Update, CFTC Seeks Public Comment on Lowering Swap Dealer Threshold.
5. SEF Registration
Chairman Massad stated that the CFTC is working to make swap execution facility (SEF) registrations permanent. Twenty-two platforms are temporarily registered. The CFTC expects to make determinations of permanent registrations by early 2016 for the platforms that have provided complete information.
6. Finalizing No-action Rules
Over the last 18 months, the CFTC has issued no-action letters and guidance on several rules which Chairman Massad expects the CFTC to "formalize" through rulemaking proposals. CFTC staff members have recently noted the following no-action relief that the CFTC is looking to make permanent through rulemaking:
- No-action relief from Title VII swap dealer external business conduct (EBC) rules for so-called "intended-to-be-cleared" swaps. No-action relief from the swap dealer EBC rules in connection with certain prime brokerage swaps.
7. Commodity Position Limits
The chairman noted that the CFTC was unlikely to finalize rules on position limits for certain physical commodities. These rules remain in the re-proposal stage after being struck down in federal court in 2012.
8. Improving Data Reporting
Chairman Massad had extensive remarks in this area, touching on a number of subtopics.
Making sure the data is complete. The chairman noted first that many dealers were leaving certain data fields incomplete in their Dodd-Frank data reports, and that there has been a high rate of incomplete data reporting fields. He noted that after consulting with SDRs and with these parties that completeness has made a dramatic improvement across a number of data fields.
However, in addition to encouraging SDRs to continue to use "heat maps" and similar tools to improve the quality of data reporting, Massad suggested the following further improvements that could be made to the data collection and dissemination process. These may be the subject of proposed rulemaking in 2016:
- Empower SDRs to validate not only the completeness, but also the accuracy of data before it is passed along to the CFTC. If the SDR rejects a participant's submission, then the participant should be considered out of compliance with CFTC requirements. Hold SDRs accountable for the manner in which they collect, compile and report data they receive.
Making sure data is consistent and high quality. The chairman also pointed to a lack of standardization in how many data fields are reported. There is considerable variation in how the same information is reported to the SDRs, and in how the SDRs themselves transmit the same information to the CFTC.
Massad noted that in its final rulemaking on data reporting under Title VII of the Dodd-Frank Act, the CFTC purposely did not prescribe exactly how each field should be reported - the CFTC felt that industry standards might develop, which did not occur. Therefore, the chairman explained, the CFTC is currently developing proposals to refine how data should be reported, and the proposals will specify the form, manner, and the allowable values that each data element can have. According to the chairman, the CFTC will publish proposals on about 100 fields before the end of 2015, and solicit public comment.
The chairman noted that the CFTC is also focused on international data reporting harmonization. The CFTC co-chairs an international task force that is leading the effort to harmonize data reporting standards. This has been formed under the auspices of Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), which include representatives from regulators in the G-20 countries.
One of its projects is to standardize the reporting of data fields by proposing definitions and formats for each. This group recently published its first consultative document containing a batch of data fields and the CFTC is working on standardizing its data fields according to the international recommendations.
Refining swap identifiers. The CFTC is working to develop effective means to identify swaps and swap activity by participant, transaction and product type throughout the swap life cycle. These include the Legal Entity Identifier (LEI), as well as the Unique Transaction Identifier (UTI) and Unique Product Identifier (UPI).
The LEI is the most advanced way to identify a specific entity and its activities, with over 400,000 LEIs in existence. The chairman advocated for the expanded use of the LEI so that it can be used to identify affiliated entities - and aggregate positions or transactions among them - something the chairman asserts cannot be done today.
Clarifying reporting obligations and eliminating unnecessary reporting obligations. Another issue pertains to clarifying which party has the obligation to report data and what data must be reported, as well as eliminating reporting obligations that are unnecessary.
In connection with this, the chairman noted a couple of recent measures that have provided some limited progress in this area, including amendments to Part 45 cleared-swap-data reporting proposed by the CFTC and rules exempting SEFs from reporting certain data in master agreements not in their possession.
Enforcing reporting obligations. Chairman Massad emphasized the need to enforce reporting obligations. He noted that the CFTC "will not hesitate to carry out enforcement actions for industry participants who do not make timely, complete and accurate reporting."
The chairman noted that the CFTC fined a major global bank $2.5 million for repeated failures to comply with swap reporting obligations, including failing to report swaps and failing to correct errors in its reporting, and that since the beginning of 2014, the CFTC has brought actions against six other institutions, including other major banks and an exchange, for various reporting violations. Massad emphasized that the CFTC "will continue to promote compliance in recordkeeping and reporting - and hold those who are not in compliance accountable."
9. Warning on Spoofing and Market Manipulation
Though not part of his keynote remarks, as reported by Reuters, Chairman Massad spoke to reporters at the conference and warned traders that the CFTC will aggressively pursue cases of market manipulation.
These remarks highlighted the significance of the conviction of high-frequency trader Michael Coscia in the first US prosecution under a new "anti-spoofing" law on November 4, 2015. Coscia, owner of New Jersey-based Panther Energy Trading, was found guilty of six counts of commodities fraud and six counts of spoofing after a seven-day trial.
According to Reuters, lawyers and analysts say the verdict clarifies the definition of spoofing, in which traders place orders without intending to execute them to create the illusion of market demand. As a result, the government may become more aggressive in pursuing such cases against traders.
Coscia was accused of entering large orders that he never intended to execute into futures markets in 2011. He canceled most of the large orders and made money executing smaller trades, prosecutors said. Coscia spoofed markets run by exchange operators CME Group Inc and Intercontinental Exchange Inc.
Coscia's prosecution was the first under an anti-spoofing provision that was added to the Commodity Exchange Act (CEA) by the Dodd-Frank Act.
According to Reuters, Chairman Massad noted that the CFTC has "been very aggressive in going after situations that we feel are violations of the law and implementing our new authority," and that the CFTC "will continue to do that."
10. Other Issues
The CFTC will consider additional matters, such as:
- The "made available for trade" (MAT) exchange-trading determination process. CFTC staff have noted that the CFTC may look to tweak the MAT process so that the CFTC is more involved - currently the exchanges are charged with making a swap available to trade. Clearinghouse equivalence and recognition, and cross-border harmonization. Now that ESMA has published the MiFiD II technical standards, the CFTC is working to understand differences between US and EU rules on swaps trading. The chairman has begun to indicate recently that perhaps harmonization may face obstacles. The fact that Chairman Massad declined to discuss this issue in depth may be further evidence of CFTC gravitation away from cross-border harmonization efforts, though as noted above, the chairman reiterated the Commission's commitment to harmonization.
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