Swap Execution Facilities and Trade Execution Requirement, 61946-62149 [2018-24642]
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Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Parts 9, 36, 37, 38, 39, and 43
RIN 3038–AE25
Swap Execution Facilities and Trade
Execution Requirement
Commodity Futures Trading
Commission.
ACTION: Proposed rule.
AGENCY:
The Commodity Futures
Trading Commission (‘‘Commission’’ or
‘‘CFTC’’) is proposing amendments to
regulations relating to the trade
execution requirement under the
Commodity Exchange Act (‘‘CEA’’ or
‘‘Act’’) and amendments to existing
regulations relating to swap execution
facilities (‘‘SEFs’’) and designated
contract markets (‘‘DCMs’’). Among
other amendments, the proposed rules
apply the SEF registration requirement
to certain swaps broking entities and
aggregators of single-dealer platforms;
broaden the scope of the trade execution
requirement to include all swaps subject
to the clearing requirement under the
Act that a SEF or a DCM lists for
trading; allow SEFs to offer flexible
execution methods for all swaps that
they list for trading; amend straightthrough processing requirements; and
amend the block trade definition. The
proposed rules, which also include nonsubstantive amendments and various
conforming changes to other
Commission regulations, reflect the
Commission’s enhanced knowledge and
experience with swaps trading
characteristics and would further the
Dodd-Frank Act’s statutory goals for
SEFs, i.e., promote more SEF trading
and pre-trade price transparency in the
swaps market. Further, the proposed
rules are intended to strengthen the
existing swaps regulatory framework by
reducing unnecessary complexity, costs,
and other burdens that impede SEF
development, innovation, and growth.
DATES: Comments must be received on
or before February 13, 2019.
ADDRESSES: You may submit comments,
identified by ‘‘Swap Execution Facilities
and Trade Execution Requirement’’ and
RIN 3038–AE25, by any of the following
methods:
• CFTC Comments Portal: https://
comments.cftc.gov. Select the ‘‘Submit
Comments’’ link for this rulemaking and
follow the instructions on the Public
Comment Form.
• Mail: Send to Christopher
Kirkpatrick, Secretary of the
Commission, Commodity Futures
Trading Commission, Three Lafayette
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Centre, 1155 21st Street NW,
Washington, DC 20581.
• Hand Delivery/Courier: Follow the
same instructions as for Mail, above.
Please submit your comments using
only one of these methods. To avoid
possible delays with mail or in-person
deliveries, submissions through the
CFTC Comments Portal are encouraged.
All comments must be submitted in
English, or if not, be accompanied by an
English translation. Comments will be
posted as received to https://
comments.cftc.gov. You should submit
only information that you wish to make
available publicly. If you wish the
Commission to consider information
that you believe is exempt from
disclosure under the Freedom of
Information Act (‘‘FOIA’’), a petition for
confidential treatment of the exempt
information may be submitted according
to the procedures established under
§ 145.9 of the Commission’s
regulations.1
The Commission reserves the right,
but shall have no obligation, to review,
pre-screen, filter, redact, refuse or
remove any or all submissions from
https://comments.cftc.gov that it may
deem to be inappropriate for
publication, such as obscene language.
All submissions that have been redacted
or removed that contain comments on
the merits of the rulemaking will be
retained in the public comment file and
will be considered as required under the
Administrative Procedure Act and other
applicable laws, and may be accessible
under the FOIA.
FOR FURTHER INFORMATION CONTACT:
Nhan Nguyen, Special Counsel, (202)
418–5932, nnguyen@cftc.gov; Roger
Smith, Special Counsel, (202) 418–5344,
rsmith@cftc.gov; or David Van Wagner,
Chief Counsel, (202) 418–5481,
dvanwagner@cftc.gov, Division of
Market Oversight; Michael Penick,
Senior Economist, (202) 418–5279,
mpenick@cftc.gov, Office of the Chief
Economist, Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street NW, Washington, DC
20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background and Introduction
A. Statutory Background: The Dodd-Frank
Act
B. Regulatory History: The Part 37 Rules
1. Challenges of Existing Regulatory
Approach
a. Lack of MAT Determinations
b. Swaps Market Characteristics
c. Operational Complexities and Costs
C. Proposed Approach
1 17
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D. Summary of Proposed Revisions
E. Consultation With Other U.S. Financial
Regulators
II. Part 9—Rules Relating To Review of
Exchange Disciplinary, Access Denial or
Other Adverse Actions
III. Part 36—Trade Execution Requirement
IV. Part 37—Subpart A: General Provisions
A. § 37.1—Scope
B. § 37.2—Applicable Provisions and
Definitions
1. § 37.2(a)—Applicable Provisions
2. § 37.2(b)—Definition of ‘‘Market
Participant’’
a. Applicability of § 37.404(b) to Market
Participants
b. SEF Jurisdiction Over Clients of Market
Participants
C. § 37.3—Requirements and Procedures
for Registration
1. § 37.3(a)—Requirements for Registration
a. Footnote 88
b. Single-Dealer Aggregator Platforms
c. Swaps Broking Entities, Including
Interdealer Brokers
(1) Structure and Operations of Swaps
Broking Entities, Including Interdealer
Brokers
(2) SEF Registration Requirement for
Swaps Broking Entities, Including
Interdealer Brokers
d. Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps
Trading Facilities
(1) Proposed Delay of SEF Registration
Requirement
(2) Proposed Conditions for Delay of SEF
Registration Requirement
2. § 37.3(a)(2) Through (3)—Minimum
Trading Functionality and Order Book
Definition
3. § 37.3(b)—Procedures for Registration
a. Elimination of Temporary Registration
b. § 37.3(b)(1)—Application for
Registration
(1) Form SEF Exhibits—Business
Organization
(2) Form SEF Exhibits—Financial
Information
(3) Form SEF Exhibits—Compliance
(4) Form SEF Exhibits—Operational
Capability
(5) Other Form SEF Amendments
(6) Request for Legal Entity Identifier
c. § 37.2(b)(2)—Request for Confidential
Treatment
d. § 37.3(b)(3)—Amendment of Application
for Registration
e. § 37.3(b)(4)—Effect of Incomplete
Application
f. § 37.3(b)(5)—Commission Review Period
g. § 37.3(b)(6)—Commission Determination
4. § 37.3(c)—Amendment to an Order of
Registration
5. § 37.3(d)—Reinstatement of Dormant
Registration
6. § 37.3(e)—Request for Transfer of
Registration
7. § 37.3(f)—Request for Withdrawal of
Application for Registration
8. § 37.3(g)—Request for Vacation of
Registration
9. § 37.3(h)—Delegation of Authority
D. § 37.4—Procedures for Implementing
Rules
E. § 37.5—Provision of Information
Relating to a Swap Execution Facility
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1. § 37.5(a)—Request for Information
2. § 37.5(b)—Demonstration of Compliance
3. § 37.5(c)—Equity Interest Transfer
4. § 37.5(d)—Delegation of Authority
F. § 37.6—Enforceability
1. § 37.6(a)—Enforceability of Transactions
2. § 37.6(b)—Swap Documentation
a. § 37.6(b)(1)—Legally Binding
Documentation
b. § 37.6(b)(2)—Requirements for Swap
Documentation
G. § 37.7—Prohibited Use of Data Collected
for Regulatory Purposes
H. § 37.8—Boards of Trade Operating Both
a Designated Contract Market and a
Swap Execution Facility
I. § 37.9—Methods of Execution for
Required and Permitted Transactions;
§ 37.10—Process for a Swap Execution
Facility To Make a Swap Available to
Trade; § 37.12—Trade Execution
Compliance Schedule; § 38.11—Trade
Execution Compliance Schedule;
§ 38.12—Process for a Designated
Contract Market To Make a Swap
Available to Trade
1. Trade Execution Requirement and MAT
Process
2. Execution Method Requirements
3. Implementation of Existing
Requirements
4. Proposed Approach
a. § 36.1(a)—Trade Execution Requirement
b. Elimination of Required Execution
Methods
V. Part 37—Subpart B: Core Principle 1
(Compliance With Core Principles)
VI. Part 37 Regulations Related to SEF
Execution Methods—Subpart C: Core
Principle 2 (Compliance With Rules)
A. § 37.201—Requirements for Swap
Execution Facility Execution Methods
1. § 37.201(a)—Required Swap Execution
Facility Rules
a. § 37.201(a)(1)—Trading and Execution
Protocols and Procedures
b. § 37.201(a)(2)—Discretion
c. § 37.201(a)(3)—Market Pricing
Information
2. § 37.203(a)—Pre-Arranged Trading
Prohibition; § 37.9(b)—Time Delay
Requirement
a. § 37.201(b)—Pre-Execution
Communications
(1) Exception for Swaps Not Subject to the
Trade Execution Requirement
(2) § 37.201(b)(1)—Exception for Package
Transactions
3. § 37.201(c)—SEF Trading Specialists
a. § 37.201(c)(1)—Definition of ‘‘SEF
Trading Specialist’’
b. § 37.201(c)(2)—Fitness
c. § 37.201(c)(3)—Proficiency
Requirements
d. § 37.201(c)(4)—Ethics Training
(1) Guidance to Core Principle 2 in
Appendix B—Ethics Training
e. § 37.201(c)(5)—Standards of Conduct
f. § 37.201(c)(6)—Duty To Supervise
g. § 37.201(c)(7)—Additional Sources for
Compliance
VII. Additional Part 37 Regulations—Subpart
C: Core Principle 2 (Compliance With
Rules)
A. § 37.202—Access Requirements
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1. § 37.202(a)—Impartial Access to
Markets, Market Services, and Execution
Methods
a. § 37.202(a)(1)—Impartial Access Criteria
(1) Application of Impartial Access
Requirement
(i) Eligibility and Onboarding Criteria
(ii) Access to Execution Methods
(iii) Use of Discretion
b. § 37.202(a)(2)—Fees
2. § 37.202(b)—Limitations on Access
3. § 37.202(c)—Eligibility
4. § 37.202(d)—Jurisdiction
B. § 37.203—Rule Enforcement Program
1. § 37.203(a)—Abusive Trading Practices
Prohibited
2. § 37.203(b)—Authority To Collect
Information
3. § 37.203(c)—Compliance Staff and
Resources
4. § 37.203(d)—Automated Trade
Surveillance System
5. § 37.203(e)—Error Trade Policy
a. Error Trades—Swaps Submitted for
Clearing
b. Current SEF Error Trade Policies
c. § 37.203(e)—Error Trade Policy
6. § 37.203(f)—Investigations
7. § 37.203(g)—Additional Sources for
Compliance
C. § 37.204—Regulatory Services Provided
by a Third Party
1. § 37.204(a)—Use of Regulatory Service
Provider Permitted
2. § 37.204(b)—Duty To Supervise
Regulatory Service Provider
3. § 37.204(c)—Delegation of Authority
D. § 37.205—Audit Trail
1. § 37.205(a)—Audit Trail Required
2. § 37.205(b)—Elements of an Acceptable
Audit Trail Program
a. § 37.205(b)(1)—Original Source
Documents; § 37.205(b)(2)—Transaction
History Database; § 37.205(b)(3)—
Electronic Analysis Capability
3. § 37.205(c)—Audit Trail Reconstruction
E. § 37.206—Disciplinary Procedures and
Sanctions
1. § 37.206(a)—Enforcement Staff
2. § 37.206(b)—Disciplinary Program
3. § 37.206(c)—Hearings
4. § 37.206(d)—Decisions
5. § 37.206(e)—Disciplinary Sanctions
6. § 37.206(f)—Warning Letters
7. § 37.206(g)—Additional Sources for
Compliance
F. Part 9—Rules Relating To Review of
Exchange Disciplinary, Access Denial or
Other Adverse Actions
VIII. Part 37—Subpart D: Core Principle 3
(Swaps Not Readily Susceptible to
Manipulation)
A. § 37.301—General Requirements
1. Appendix C—Demonstration of
Compliance That a Swap Contract Is Not
Readily Susceptible to Manipulation
IX. Part 37—Subpart E: Core Principle 4
(Monitoring of Trading and Trade
Processing)
A. § 37.401—General Requirements
B. § 37.402—Additional Requirements for
Physical-Delivery Swaps
C. § 37.403—Additional Requirements for
Cash-Settled Swaps
D. § 37.404—Ability To Obtain Information
E. § 37.405—Risk Controls for Trading
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F. § 37.406—Trade Reconstruction
G. § 37.407—Regulatory Service Provider;
§ 37.408—Additional Sources for
Compliance
X. Part 37—Subpart F: Core Principle 5
(Ability To Obtain Information)
A. § 37.501—Establish and Enforce Rules
B. § 37.502—Provide Information to the
Commission
C. § 37.503—Information-Sharing
D. § 37.504—Prohibited Use of Data
Collected for Regulatory Purposes
XI. Part 37—Subpart G: Core Principle 6
(Position Limits or Accountability)
A. § 37.601—Additional Sources for
Compliance; Guidance to Core Principle
6 in Appendix B
XII. Part 37—Subpart H: Core Principle 7
(Financial Integrity of Transactions);
§ 39.12—Participant and Product
Eligibility
A. § 37.701—Required Clearing
B. § 37.702—General Financial Integrity
1. § 37.702(a)—Minimum Financial
Standards
2. § 37.702(b) and § 39.12(b)(7)—Time
Frame for Clearing
a. ‘‘Prompt and Efficient’’ Standard and
AQATP Standard
b. Proposed Approach to Straight-Through
Processing
(1) § 37.702(b)(1) and § 39.12(b)(7)(i)(A)—
‘‘Prompt, Efficient, and Accurate’’
Standard
(2) § 39.12(b)(7)(ii)—AQATP Standard for
Registered DCOs
(3) § 37.702(b)(2) Through (3)—PreExecution Credit Screening
3. Applicability of § 37.702(b) to SEFs That
Do Not Facilitate Clearing
C. § 37.703—Monitoring for Financial
Soundness
XIII. Part 37—Subpart I: Core Principle 8
(Emergency Authority)
A. § 37.801—Additional Sources for
Compliance
XIV. Part 37—Subpart J: Core Principle 9
(Timely Publication of Trading
Information)
XV. Part 37—Subpart K: Core Principle 10
(Recordkeeping and Reporting)
XVI. Part 37—Subpart L: Core Principle 11
(Antitrust Considerations)
XVII. Part 37—Subpart M: Core Principle 12
(Conflicts of Interest)
XVIII. Part 37—Subpart N: Core Principle 13
(Financial Resources)
A. § 37.1301—General Requirements
1. § 37.1301(a)
2. § 37.1301(b)
3. § 37.1301(c)
B. § 37.1302—Types of Financial Resources
C. § 37.1303—Liquidity of Financial
Resources
D. § 37.1304—Computation of Costs To
Meet Financial Resources Requirement
1. Acceptable Practices to Core Principle
13 in Appendix B
E. § 37.1305—Valuation of Financial
Resources
F. § 37.1306—Reporting to the Commission
1. § 37.1306(a)
2. § 37.1306(b)
3. § 37.1306(c)
4. § 37.1306(d)
5. § 37.1306(e)
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G. § 37.1307—Delegation of Authority
XIX. Part 37—Subpart O: Core Principle 14
(System Safeguards)
A. § 37.1401(c)
B. § 37.1401(g)—Program of Risk Analysis
and Oversight Technology Questionnaire
C. § 37.1401(j)
XX. Part 37—Subpart P: Core Principle 15
(Designation of Chief Compliance
Officer)
A. § 37.1501—Chief Compliance Officer
1. § 37.1501(a)—Definitions
2. § 37.1501(b)—Chief Compliance Officer
a. Acceptable Practices to Core Principle 15
in Appendix B
3. § 37.1501(c)—Duties of Chief
Compliance Officer
4. § 37.1501(d)—Preparation of Annual
Compliance Report
5. § 37.1501(e)—Submission of Annual
Compliance Report and Related Matters
6. § 37.1501(f)—Recordkeeping
7. § 37.1501(g)—Delegation of Authority
XXI. Part 36—Trade Execution Requirement
A. § 36.1—Trade Execution Requirement
1. § 36.1(a)—Trade Execution Requirement
2. § 36.1(b)—Exemption for Certain Swaps
Listed Only by Exempt SEFs
a. Discussion of CEA Section 4(c)
Enumerated Factors
3. § 36.1(c)—Exemption for Swap
Transactions Excepted or Exempted
From the Clearing Requirement Under
Part 50
a. Discussion of CEA Section 4(c)
Enumerated Factors
4. § 36.1(d)—Exemption for Swaps
Executed With Bond Issuance
a. Discussion of CEA Section 4(c)
Enumerated Factors
5. § 36.1(e)—Exemption for Swaps
Executed Between Affiliates That Elect
To Clear
a. Discussion of CEA Section 4(c)
Enumerated Factors
B. § 36.2—Registry of Registered Entities
Listing Swaps Subject to the Trade
Execution Requirement; Appendix A to
Part 36—Form TER
C. § 36.3—Trade Execution Requirement
Compliance Schedule
1. § 36.3(c)(1)—Category 1 Entities
2. § 36.3(c)(2)—Category 2 Entities
3. § 36.3(c)(3)—Other Counterparties
4. § 36.3(e)—Future Compliance Schedules
XXII. Part 43—§ 43.2—Definition of ‘‘Block
Trade’’
A. § 43.2—Definition—Block Trade;
§ 37.203(a)—Elimination of Block Trade
Exception to Pre-Arranged Trading
XXIII. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Information Provided by Reporting
Entities/Persons
a. § 37.3(a)—Requirements for Registration
b. § 37.3(b)—Procedures for Registration
c. § 37.3(c)—Amendment to an Order of
Registration
d. § 37.5(c)—Provision of Information
Relating to a Swap Execution Facility
e. § 37.6(b)(1)—Legally Binding
Documentation
f. § 37.203(d)—Automated Trade
Surveillance System
g. § 37.203(e)—Error Trade Policy
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h. § 37.205(a)—Audit Trail Required
i. § 37.205(b)—Elements of an Acceptable
Audit Trail Program
j. § 37.205(c)—Audit Trail Reconstruction
k. §§ 37.206(b)–(d)—Disciplinary Program
l. § 37.401—General Requirements for
Monitoring of Trading and Trade
Processing
m. § 37.1301(b)—General Requirements for
Financial Resources
n. § 37.1306—Financial Reporting to the
Commission
o. § 37.1401(g)—Program of Risk Analysis
and Oversight Technology Questionnaire
p. § 37.1501(d)—Preparation of Annual
Compliance Report
q. Part 36—Trade Execution Requirement
2. Information Collection Comments
C. Cost-Benefit Considerations
1. Introduction
2. Baseline
3. SEF Registration
a. Overview
(1) Application of SEF Registration
Requirement
(2) SEF Registration Process and Related
Forms
b. Benefits
(1) Application of SEF Registration
Requirement
(2) SEF Registration Process and Related
Forms
c. Costs
(1) Application of SEF Registration
Requirement
(2) SEF Registration Process and Related
Forms
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
4. Market Structure and Trade Execution
a. Overview
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
(2) Trade Execution Requirement and
Elimination of MAT Process
(3) Pre-Execution Communications and
Block Trades
(4) Impartial Access
b. Benefits
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
(2) Trade Execution Requirement and
Elimination of MAT Process
(3) Pre-Execution Communications and
Block Trades
(4) Impartial Access
c. Costs
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
(2) Trade Execution Requirement and
Elimination of MAT Process
(3) Pre-Execution Communications and
Block Trades
(4) Impartial Access
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
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(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
5. Compliance and SRO Responsibilities
a. Overview
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ‘‘Market Participant’’
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and
Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence
Record
(iii) Information-Sharing
(6) System Safeguards
b. Benefits
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ‘‘Market Participant’’
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and
Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence
Record
(iii) Information-Sharing
(6) System Safeguards
c. Costs
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ‘‘Market Participant’’
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and
Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence
Record
(iii) Information-Sharing
(6) System Safeguards
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
6. Design and Monitoring of Swaps
a. Overview
(1) Swaps Not Readily Susceptible to
Manipulation
(2) Monitoring of Trading and Trade
Processing
b. Benefits
(1) Swaps Not Readily Susceptible to
Manipulation
(2) Monitoring of Trading and Trade
Processing
c. Costs
(1) Swaps Not Readily Susceptible to
Manipulation
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(2) Monitoring of Trading and Trade
Processing
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
7. Financial Integrity of Transactions
a. Overview
b. Benefits
c. Costs
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
8. Financial Resources
a. Overview
b. Benefits
c. Costs
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
D. Antitrust Considerations
registration requirement, which requires
an entity to register as a SEF prior to
operating a facility for the trading or
processing of swaps.6 CEA section 5h(f)
requires registered SEFs to comply with
fifteen core principles.7 Further, the
trade execution requirement in CEA
section 2(h)(8) provides that swap
transactions that are subject to the
clearing requirement in CEA section
2(h)(1)(A) 8 must be executed on a DCM,
SEF, or a SEF that is exempt from
registration pursuant to CEA section
5h(g) (‘‘Exempt SEF’’),9 unless no DCM
or SEF 10 ‘‘makes the swap available to
trade’’ or the related transaction is
subject to a clearing requirement
exception pursuant to CEA section
2(h)(7).
B. Regulatory History: The Part 37 Rules
Pursuant to its discretionary
rulemaking authority in CEA sections
5h(f)(1) and 8a(5), the Commission
identified the relevant areas in which
the statutory SEF framework would
benefit from additional rules or
regulations.11 Accordingly, the
I. Background and Introduction
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A. Statutory Background: The DoddFrank Act
Title VII of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (‘‘Dodd-Frank Act’’) 2 amended the
Commodity Exchange Act (‘‘CEA’’ or
‘‘Act’’) 3 to establish a comprehensive
new swaps regulatory framework that
includes the registration and the
oversight of swap execution facilities
(‘‘SEFs’’).4 As amended, CEA section
1a(50) defines a SEF as a trading system
or platform that allows multiple
participants to execute or trade swaps
with multiple participants through any
means of interstate commerce.5 CEA
section 5h(a)(1) establishes the SEF
2 See Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111–203, tit.
VII, 124 Stat. 1376 (2010) (codified as amended in
various sections of 7 U.S.C.), available at https://
www.cftc.gov/sites/default/files/idc/groups/public/
@lrfederalregister/documents/file/2013-12242a.pdf.
3 7 U.S.C. 1 et seq.
4 7 U.S.C. 7b–3 (adding a new CEA section 5h to
establish a registration requirement and regulatory
regime for SEFs).
5 As amended by the Dodd-Frank Act, CEA
section 1a(50) specifically defines a ‘‘swap
execution facility’’ as a trading system or platform
in which multiple participants have the ability to
execute or trade swaps by accepting bids and offers
made by multiple participants in the facility or
system, through any means of interstate commerce,
including any trading facility, that facilitates the
execution of swaps between persons; and is not a
designated contract market. 7 U.S.C. 1a(50).
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6 CEA section 5h(a)(1) states that no person may
operate a facility for the trading or processing of
swaps unless the facility is registered as a SEF or
as a DCM under section 5h. 7 U.S.C. 7b–3(a)(1).
7 7 U.S.C. 7b–3(f).
8 Section 723(a)(3) of the Dodd-Frank Act added
a new CEA section 2(h) to establish the clearing
requirement for swaps. 7 U.S.C. 2(h). CEA section
2(h)(1)(A) provides that it is unlawful for any
person to engage in a swap unless that person
submits such swap for clearing to a derivatives
clearing organization that is registered under the
Act or a derivatives clearing organization that is
exempt from registration under this Act if the swap
is required to be cleared. 7 U.S.C. 2(h)(1)(A). CEA
section 2(h)(2) specifies the process for the
Commission to review and determine whether a
swap, group, category, type or class of swap should
be subject to the clearing requirement. 7 U.S.C.
2(h)(2). The Commission further implemented the
clearing determination process under part 50,
which also specifies the swaps that are currently
subject to the requirement. 17 CFR part 50.
9 The Commission notes that CEA section
2(h)(8)(A)(ii) contains a typographical error that
specifies CEA section 5h(f), rather than CEA section
5h(g), as the provision that allows the Commission
to exempt a SEF from registration. Where
appropriate, the Commission corrects this reference
in the discussion herein.
10 CEA sections 2(h)(8)(A)(i)–(ii) provide that with
respect to transactions involving swaps subject to
the clearing requirement, counterparties shall
execute the transaction on a board of trade
designated as a contract market under section 5; or
execute the transaction on a swap execution facility
registered under 5h or a swap execution facility that
is exempt from registration under section 5h(g) of
the Act. Given this reference in CEA section
2(h)(8)(A)(ii), the Commission accordingly
interprets ‘‘swap execution facility’’ in CEA section
2(h)(8)(B) to include a swap execution facility that
is exempt from registration pursuant to CEA section
5h(g).
11 To implement the SEF core principles, Core
Principle 1 provides that the Commission may, in
its discretion, determine by rule or regulation the
manner in which SEFs comply with the core
principles. 7 U.S.C. 7b–3(f)(1)(B).
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61949
Commission adopted the part 37 rules to
implement a regulatory framework for
SEFs and for the trading and execution
of swaps 12 on such facilities.13 Among
other provisions, subpart A to part 37
applies the SEF registration requirement
to facilities that meet the statutory SEF
definition; specifies a minimum trading
functionality that a SEF must offer to
participants for all listed swaps, i.e., an
‘‘Order Book’’; 14 and specifies the
process for a SEF to make a swap
‘‘available to trade’’ (‘‘MAT’’), i.e.,
required to be executed on a SEF or
DCM pursuant to the trade execution
requirement.15 Subpart A also defines
swaps subject to the trade execution
requirement as ‘‘Required Transactions’’
and requires a SEF to offer either (i) an
Order Book or (ii) a request-for-quote
system that sends a request-for-quote to
no less than three unaffiliated market
participants and operates in conjunction
with an Order Book (‘‘RFQ System’’) for
the execution of these transactions.16
Swaps that are not subject to the trade
execution requirement are defined as
‘‘Permitted Transactions,’’ for which a
SEF may offer any execution method
and for which market participants may
voluntarily trade on a SEF.17 The
Commission’s regulations specify
additional requirements that correspond
to the use of an Order Book or RFQ
System to execute Required
Transactions.18 Subparts B through O
12 The Commission notes that, unless otherwise
stated, the terms ‘‘trades,’’ ‘‘transactions,’’ and
‘‘swaps’’ are used interchangeably in the discussion
herein.
13 Core Principles and Other Requirements for
Swap Execution Facilities, 78 FR 33476 (Jun. 4,
2013) (‘‘SEF Core Principles Final Rule’’); Process
for a Designated Contract Market or Swap Execution
Facility To Make a Swap Available to Trade, Swap
Transaction Compliance and Implementation
Schedule, and Trade Execution Requirement Under
the Commodity Exchange Act, 78 FR 33606 (Jun. 4,
2013) (‘‘MAT Final Rule’’).
14 17 CFR 37.3(a)(2). An Order Book is defined as
(i) an ‘‘electronic trading facility,’’ as that term is
defined in CEA section 1a(16); (ii) a ‘‘trading
facility,’’ as that term is defined in CEA section
1a(51); or (iii) a trading system or platform in which
all market participants have the ability to enter
multiple bids and offers, observe or receive bids
and offers entered by other market participants, and
transact on such bids and offers. 17 CFR 37.3(a)(3).
15 17 CFR 37.10. Given that swaps subject to the
trade execution requirement may also be executed
on a DCM, the Commission adopted the same
process for a registered DCM to make a swap
‘‘available to trade’’ in part 38. 17 CFR 38.12.
Accordingly, discussion in this notice with respect
to the application of the trade execution
requirement or the MAT process to SEFs should be
interpreted to also apply to DCMs.
16 17 CFR 37.9(a). With the exception of block
trades, as defined under § 43.2, Required
Transactions must be executed on a SEF’s Order
Book or RFQ System. 17 CFR 37.9(a)(2)(i).
17 17 CFR 37.9(c).
18 See infra notes 85 (15-second time delay for the
entry of pre-arranged or pre-negotiated transactions
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set forth regulations that further
implement each of the fifteen SEF core
principles in CEA section 5h(f).
Appendix B provides further guidance
and acceptable practices associated with
the SEF core principles.19
These rules reflect a more limited and
prescriptive regulatory approach to
implementing the statutory provisions
and promoting the statutory goals of
section 5h of the Act, i.e., promoting the
trading of swaps on SEFs and promoting
pre-trade price transparency in the
swaps market.20 In particular, the
Commission focused on achieving pretrade price transparency by mandating a
minimum trading functionality
requirement for all swaps listed on a
SEF and two specific, limited execution
methods for Required Transactions. The
Commission adopted the Order Book
requirement both as a minimum trading
functionality for SEF registration and as
an execution method for Required
Transactions.21 To provide some
execution flexibility for Required
Transactions,22 the Commission also
allowed SEFs to offer an RFQ System,
as described above.23 To further the goal
of pre-trade price transparency with
respect to trading via an RFQ System,
however, the Commission required that
an RFQ must be submitted to three
unaffiliated market participants and that
a requester receive applicable firm bids
and offers from the Order Book in
addition to any RFQ responses.24
Recognizing that only certain swaps are
well-suited to be traded and executed
through an Order Book or RFQ System,
the Commission interpreted the trade
execution requirement in CEA section
2(h)(8), in particular the phrase ‘‘makes
the swap available to trade,’’ to have a
scope of application that is consistent
with the use of these methods.
Accordingly, the Commission
interpreted the phrase, which the Act
does not otherwise define, to implement
a voluntary MAT process for
determining the swaps that must be
executed on a SEF; this process
primarily focuses on whether a swap
has ‘‘sufficient trading liquidity’’ to be
executed via an Order Book or RFQ
System.25
to an Order Book) and 242 (additional requirements
for RFQ Systems) and accompanying discussion.
19 17 CFR part 37 app. B.
20 7 U.S.C. 7b–3(e) (specifying the rule of
construction for CEA section 5h).
21 17 CFR 37.3(a)(2) (minimum trading
functionality requirement); 17 CFR 37.9(a)(2)(i)(A)
(Required Transactions requirement).
22 SEF Core Principles Final Rule at 33564–65.
23 17 CFR 37.9(a)(3).
24 SEF Core Principles Final Rule at 33497, 33499.
25 MAT Final Rule at 33609 (noting that a MAT
determination may focus on whether a swap is
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The Commission noted that the
prescribed trading methods, such as the
Order Book, are consistent with the SEF
definition in CEA section 1a(50) of the
Act as they allow multiple market
participants to post bids or offers and
accept bids and offers that are
transparent to multiple market
participants.26 The Commission stated
that the RFQ System is consistent with
the SEF definition because it requires
market participants to be able to access
multiple market participants, but not
necessarily the entire market.27 Further,
in response to commenters’ feedback
that the Commission’s approach is
inconsistent with the Act, the
Commission stated that the limited
execution methods for Required
Transactions are consistent with the
phrase ‘‘through any means of interstate
commerce’’ in the SEF definition
because a SEF ‘‘may for purposes of
execution and communication use ‘any
means of interstate commerce,’
including, but not limited to, the mail,
internet, email, and telephone, provided
that the chosen execution method
satisfies the requirements . . . for Order
Books or . . . for [RFQ Systems].’’ 28
The Commission also noted that a SEF
may provide any method of execution
for Permitted Transactions as further
justification for its approach under the
Act.29
In adopting a regulatory framework
that would effectuate the statutory SEF
provisions and goals, the Commission
relied in part upon its experience with
the futures market, including DCM
oversight and DCM core principles
implementation.30 While the
Commission did provide flexibility for
certain swap requirements relative to
the DCM rules,31 the Commission
sought, where possible, to harmonize
SEF regulations with DCM regulations
based on the similarities in the statutory
core principles between SEFs and
DCMs, and the ability of both types of
entities to offer swaps for trading and
execution.32
sufficiently liquid to be subject to the trade
execution requirement).
26 SEF Core Principles Final Rule at 33501.
27 Id. at 33496.
28 Id. at 33501.
29 Id. at 33484.
30 Id. at 33477.
31 For example, the RFQ System requirement for
Required Transactions on SEFs is less restrictive
than the RFQ-to-all approach that is used by some
DCMs. The Commission decided that the former
approach was more appropriate for SEFs due to the
less standardized nature of the swaps market. SEF
Core Principles Final Rule at 33497 n.270.
32 Id. at 33478, 33553 (noting the similarities
between the statutory requirements for SEFs and
DCMs).
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1. Challenges of Existing Regulatory
Approach
The Commission’s existing regulatory
approach has transitioned some degree
of swaps trading and market
participants to SEFs, but has also
created several challenges for swaps
trading on SEFs, as described below.
a. Lack of MAT Determinations
The voluntary, SEF-driven MAT
determination process has resulted in a
limited set of products that are required
to be executed on SEFs. Since 2014,
SEFs have submitted a limited number
of swaps, relative to the scope of swaps
subject to the clearing requirement, as
‘‘available to trade’’ to the
Commission.33 The swaps that SEFs
have submitted—‘‘on-the-run’’ index
credit default swaps (‘‘CDS’’) and fixedto-floating interest rate swaps (‘‘IRS’’) in
benchmark tenors—are generally the
most standardized and liquid swaps
contracts.34 Beyond this initial set of
MAT determinations, the Commission
has not received any filings for
additional swaps despite the subsequent
expansion of the clearing requirement.35
33 For a list of MAT determinations that have
been submitted to the Commission, see CFTC,
Industry Oversight, Industry Filings, Swaps Made
Available to Trade Determination, https://
sirt.cftc.gov/sirt/sirt.aspx?Topic=%20Swaps
MadeAvailableToTradeDetermination. For a
current list of swaps that have been made ‘‘available
to trade’’ and are subject to the trade execution
requirement, see CFTC, Industry Oversight,
Industry Filings, Swaps Made Available to Trade,
https://www.cftc.gov/sites/default/files/idc/groups/
public/@otherif/documents/file/swapsmade
availablechart.pdf. For a list of swaps subject to the
clearing requirement, see 17 CFR 50.4; see also
CFTC, Industry Oversight, Industry Filings, Swaps
Subject to Clearing Requirement, https://
www.cftc.gov/sites/default/files/idc/groups/public/
@otherif/documents/ifdocs/clearing
requirementcharts9-16.pdf.
34 See, e.g., Bloomberg SEF, Submission No.
2013–R–9, Bloomberg SEF LLC—Made Available to
Trade (‘‘MAT’’) Submission of Certain Credit
Default Swaps (‘‘CDS’’) and Interest Rate Swaps
(‘‘IRS’’) pursuant to [CFTC] Regulation 40.6 at 3
(Dec. 5, 2013) (stating that its MAT determination
consists of only the most standardized and liquid
swaps, which represent a majority of market traded
volume), https://www.cftc.gov/sites/default/files/
stellent/groups/public/@otherif/documents/ifdocs/
bsefmatdetermltr120513.pdf; ‘‘TW SEF,TW SEF
LLC—Clarification and Amendment to SelfCertification for Swaps to be Made Available to
Trade’’ at 8 (Nov. 29, 2013) (stating that its MAT
determinations with respect to IRS represent the
‘‘standard benchmarks, which are the most
standard, liquid, and transparent of the IRS market,
and trade with market-accepted, standard, plain
vanilla dates), https://www.cftc.gov/sites/default/
files/stellent/groups/public/@otherif/documents/
ifdocs/twsefamendmatltr112913.pdf.
35 In 2016, the Commission expanded the clearing
requirement for IRS in the four classes (fixed-tofloating swaps, basis swaps, forward rate
agreements, overnight index swaps) to additional
currencies. CFTC, Press Releases, Release No. 7457–
16, CFTC Expands Interest Rate Swap Clearing
Requirement, https://www.cftc.gov/PressRoom/
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The lack of additional determinations is
partly attributable to market
participants’ concerns over the
Commission’s required methods of
execution for Required Transactions.36
Based on those concerns, SEFs have not
pursued making additional swaps
subject to the trade execution
requirement. This lack of additional
submissions has effectively limited the
number of swaps that must be executed
on SEFs which has limited the amount
of trading and liquidity formation
occurring on SEFs.
b. Swaps Market Characteristics
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Over the course of the part 37
implementation process, the
Commission has gained greater
familiarity with the swaps markets, in
particular the nature of the products and
how market participants trade and
execute those products. Based on what
it has learned, the Commission believes
that the existing regulatory framework
has contributed to the limited amount of
swaps that are subject to the trade
execution requirement, and therefore,
the limited scope of swaps trading that
occurs on SEFs.
Swaps consist of many highly variable
terms and conditions beyond price and
size that can be negotiated and tailored
to suit a market participant’s specific
and unique needs. While some swaps
are relatively standardized, others are
customized and consist of innumerable
permutations, making them generally
less standardized and more bespoke
than futures contracts. Given the ability
to customize swaps to address specific
and often large risks that cannot be
offset through more standardized
instruments, the swaps market is
generally comprised of a relatively
concentrated number of sophisticated
market participants in contrast to the
futures market. In this regard, the
Commission notes that CEA section 2(e)
limits swaps trading on SEFs to
‘‘eligible contract participants’’
(‘‘ECPs’’), as defined by CEA section
1a(18).37 These swaps market
characteristics contribute to varying
liquidity profiles for swaps that range
PressReleases/pr7457-16 (Sept. 28, 2016). See also
Clearing Requirement Determination Under Section
2(h) of the Commodity Exchange Act for Interest
Rate Swaps, 81 FR 71202 (Oct. 14, 2016) (‘‘Second
Clearing Determination Final Rule’’).
36 See CFTC Public Roundtable: The Made
Available to Trade Process, 151–152, 192–193 (July
15, 2015), https://www.cftc.gov/idc/groups/public/
%40newsroom/documents/file/transcript071515
.pdf (‘‘2015 MAT Roundtable’’) (discussing the
prescriptive nature of the required methods of
execution and noting the relationship to the MAT
determination process).
37 7 U.S.C. 2(e); 7 U.S.C. 1a(18).
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from relatively illiquid to episodic to
relatively liquid.
Historically, these particular
characteristics have contributed to the
use of a variety of execution methods—
electronic, voice-based, or a hybrid of
both (‘‘voice-assisted’’)—by market
participants. Utilizing one execution
method or another depends on
considerations such as the type of swap,
transaction size, complexity, the swap’s
liquidity at a given time, the number of
potential liquidity providers, and the
associated desire to minimize potential
information leakage and front-running
risks. For swaps with standard tenors
that are relatively liquid, market
participants may utilize a method of
trading and execution, such as an
electronic order book platform, that
disseminates trading interests to all
other market participants on the
platform. Trading and execution in less
standardized products, however,
generally occur on systems or platforms
that are more discreet in disseminating
trading interests, such as auction
platforms. The Commission’s existing
approach to required execution
methods, as described above, creates a
tension with swaps market
characteristics that necessitate flexible
execution methods. This tension has
otherwise hindered the expansion of the
trade execution requirement.
c. Operational Complexities and Costs
The Commission has learned that its
approach to other part 37 rules may
have imposed certain burdens on SEFs,
including operating complexities and
costs that have impeded development,
innovation, and growth in the swaps
market. SEFs have indicated that they
are unable to comply with some of these
requirements because they are
impractical or unachievable due to
technology limitations or incompatible
with existing market practices. For
example, as discussed further below,
SEFs have informed the Commission
that the confirmation requirement for
uncleared swaps under § 37.6(b) and the
electronic analysis capability
requirements with respect to audit trail
data for voice orders under § 37.205
have been operationally difficult and
impractical to implement.38 Even where
SEFs have been able to comply with
some of the requirements, they have
asserted that the compliance costs are
high and compliance is unnecessary in
helping them satisfy their self-regulatory
obligations and the SEF core principles.
38 See infra Section IV.F.—§ 37.6—Enforceability
(discussion of SEF confirmation requirements);
Section VII.D.—§ 37.205—Audit Trail (discussion of
SEF audit trail requirements).
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61951
For example, SEFs have noted the high
costs of the financial resources
requirements imposed by the Core
Principle 13 regulations.39 SEFs and
market participants have attributed the
limited development, innovation, and
growth of SEFs to these ongoing
burdens.
As a result of these burdens, the
Commission believes that a significant
amount of swaps liquidity formation
activity occurs away from registered
SEFs in a manner similar to the preDodd-Frank Act swaps trading
environment. These examples include
(i) entities that aggregate single-dealer
platforms to allow market participants
to obtain indicative or firm pricing and
execute swaps with multiple singledealer liquidity providers away from
SEFs; and (ii) swaps broking entities,
including interdealer brokers 40 that
facilitate swaps trading between
multiple market participants through
non-registered voice or electronic
platforms. While some of these
interdealer brokers are affiliated with
registered SEFs, the Commission
understands that they have nevertheless
maintained a bifurcated operating
structure under which a SEF primarily
executes and processes orders that have
already been negotiated or arranged on
an affiliated broker platform, in effect
limiting a SEF’s role to a swaps
transaction booking and processing
engine.41 By operating in this manner,
the Commission believes that many
entities have been able to avoid the
burdens arising from SEF registration
and compliance under part 37.
When necessary or appropriate to
mitigate these burdens in the course of
implementing part 37, Commission staff
has issued various guidance and timelimited no-action relief to SEFs and
market participants. The no-action relief
has afforded additional time for
compliance with certain part 37
regulations and related procedures or
has provided an opportunity to
39 See Letter from Wholesale Markets Brokers’
Association, Americas (‘‘WMBAA’’), Swap
Execution Facility Regulations, Made Available to
Trade Determinations, and Swap Trading
Requirements at 5 (Mar. 11, 2016) (‘‘2016 WMBAA
Letter’’); see also CFTC Letter No. 17–25, Division
of Market Oversight Guidance on Calculating
Projected Operating Costs By Designated Contract
Markets and Swap Execution Facilities (Apr. 28,
2017) (‘‘CFTC Letter No. 17–25’’).
40 The Commission believes that most of these
swaps broking entities are currently registered with
the Commission as introducing brokers (‘‘IBs’’). See
infra note 340 and accompanying discussion.
41 The Commission notes that these swaps
broking entities and their affiliated SEFs primarily
operate as part the ‘‘dealer-to-dealer’’ segment of the
swaps market, which primarily facilitates swaps
trading between swap dealers. See infra Section
VII.A.1.a.(1)(i).—Eligibility and Onboarding Criteria
(discussion of impartial access requirements).
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determine whether a longer-term
regulatory solution—such as those
proposed in this notice—is warranted.42
Where compliance could not be
achieved or impractical compliance
burdens arose from the existing part 37
rules, SEFs may have been impeded
from pursuing beneficial market
initiatives, such as developing new
trading systems and protocols to attract
greater swaps liquidity. The
Commission believes that it is
appropriate to address these issues as
part of the changes to the existing
regulations proposed in this notice.
C. Proposed Approach
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Given the challenges described above
and the Commission’s enhanced
knowledge and experience from
implementing part 37, the Commission
is proposing to strengthen its swaps
trading regulatory framework, while still
effectuating the statutory SEF provisions
and better promoting the statutory SEF
goals. The Commission’s proposed
approach also more appropriately
accounts for swaps market
characteristics and should reduce
certain complexities and costs that have
contributed to a significant amount of
swaps liquidity formation occurring
away from SEFs; limited the scope of
swaps that are subject to the trade
execution requirement; and impeded
SEF development, innovation, and
growth. In this regard, the Commission
proposes a simple but comprehensive
approach that provides SEFs with
flexibility, where appropriate, to
calibrate their trading and compliance
functions based on their respective
trading operations and markets. The
Commission believes that this proposed
approach will attract greater liquidity
formation on SEFs.
First, the Commission aims to
effectuate the SEF registration
requirement to ensure that multiple-tomultiple trading of swaps occurs on a
SEF by requiring that swaps broking
entities and certain single-dealer
aggregator platforms register as SEFs
(emphasis added). In particular,
consistent with the statutory SEF
provisions and goals, this proposed
42 See infra notes 223 (no-action relief from
existing § 37.6(b) confirmation requirements for
uncleared swap transactions executed on a SEF),
433 (no-action relief from existing § 37.9 and
§ 37.203(a) with respect to the correction of error
trades on SEFs), 474 (no-action relief from existing
§ 37.205(a) with respect to capturing of trade
allocation information in a SEF transaction history
database), 822 (no-action relief from existing
§ 37.1501(f) with respect to SEF annual compliance
report filing requirements), 898 (no-action relief
from certain ‘‘block trade’’ definitional
requirements under existing § 43.2) and
accompanying discussion.
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rulemaking would apply the SEF
registration requirement in CEA section
5h(a)(1) and § 37.3(a) to swaps broking
entities, including interdealer brokers,
that are currently registered with the
Commission as IBs, and their personnel
currently facilitating swaps trading
away from SEFs. Based on its
experience and observation of market
developments since the adoption of part
37, the Commission has witnessed the
various ways in which swaps broking
entities, including interdealer brokers,
have structured themselves to facilitate
swaps trading, and therefore liquidity
formation, outside of the existing SEF
regulatory framework.
Second, the Commission aims to
facilitate increased trading and liquidity
on SEFs by proposing a revised
interpretation of the trade execution
requirement that is consistent with CEA
section 2(h)(8). The Commission’s
proposed interpretation would apply
the trade execution requirement to all
swaps that are both subject to the
clearing requirement under section
2(h)(1) of the Act and listed for trading
on a SEF. As a result of this approach,
the Commission would also withdraw
the existing voluntary MAT process.
The proposed expansion of the trade
execution requirement is expected to
capture a greater number of swaps with
different liquidity profiles, thereby
reinforcing the need to establish a more
flexible regulatory approach to swaps
trading and execution that would help
foster customer choice, promote
competition between and innovation by
SEFs, and better account for
fundamental swaps market
characteristics. Accordingly, the
Commission also proposes to allow a
SEF to offer any method of execution for
all swaps trading and execution, rather
than only an Order Book or RFQ
System.
Rather than dictating certain
execution methods for Required
Transactions, the Commission’s
proposed flexible approach would
enable SEFs to provide, and ultimately
allow market participants to choose,
execution methods that are appropriate
for the liquidity and other
characteristics of particular swaps. The
Commission’s approach should also
promote pre-trade price transparency in
the swaps market by allowing execution
methods that maximize participation
and concentrate liquidity during times
of episodic liquidity. The Commission
believes that providing flexibility in
execution methods will allow the swaps
market to continue to naturally evolve
and allow SEFs to innovate and provide
more efficient, transparent, and costeffective means of trading and
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execution. The Commission also
proposes to eliminate the minimum
trading functionality requirement,
which should reduce the costs incurred
by SEFs to operate and maintain order
books that have not attracted significant
volumes. In lieu of specific execution
method requirements, the Commission
is proposing general disclosure-based
trading and execution rules that would
apply to any execution method offered
by a SEF.
In conjunction with allowing SEFs to
offer more flexible execution methods,
the Commission is proposing new rules
for certain SEF personnel—‘‘SEF trading
specialists’’—that constitute part of a
SEF’s trading system or platform. The
proposed rules require SEFs to adopt
minimum proficiency testing and ethics
training requirements to ensure that
their trading specialists possess and
maintain an adequate level of technical
knowledge and understand their ethical
responsibilities in customer trading or
execution and fostering liquidity
formation. The proposed rules would
also require SEFs to adopt trading
conduct standards and a duty of
supervision. With the ability to offer
more flexible execution methods for all
swaps, in particular those that involve
discretion by trading specialists in
handling trading or execution, the
Commission believes that these
proposed requirements are necessary to
enhance professionalism in the swaps
market and to promote market integrity
and fairness. Further, the proposed
requirements would mandate requisite
levels of knowledge and competence
that are commensurate to other similar
requirements established for personnel
in major trading markets, such as
futures and equities.43
The Commission is also proposing a
series of amendments to additional part
37 regulations that implement the SEF
core principles. These proposed
amendments would allow a SEF to
better tailor its compliance and
regulatory oversight programs to its
trading operations and markets. The
Commission believes that these
proposed revisions are critical to the
ability of SEFs to offer the diverse types
of execution methods that would be
available to them under this proposal.
Further, the proposed rules would
streamline and refine some of the
existing prescriptive requirements
applicable to SEFs to better reflect
technological capabilities and existing
market practices in the swaps market.
The proposed rules would also seek to
reduce unnecessary compliance costs
while still maintaining robust
43 See
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compliance programs and consistency
with the SEF core principles. The ability
to tailor compliance and oversight
programs is consistent with the
‘‘reasonable discretion’’ that Core
Principle 1 provides SEFs to comply
with the core principles and mitigates
compliance challenges that SEFs have
encountered in implementing part 37.44
With respect to existing staff guidance
and staff no-action relief, the
Commission would adopt or codify such
guidance or relief where appropriate.
Providing a simple, but more
comprehensive regulatory approach
would help mitigate barriers for market
participants to trade and execute further
on SEFs, which would in turn better
promote the statutory SEF goals.
Finally, the proposed rules include
non-substantive amendments and
various conforming changes to relevant
provisions in the Commission’s
regulations.
The Commission believes that the
proposed revisions to the part 37
framework are consistent with the
statutory SEF provisions and should
serve to advance swaps trading on SEFs.
The proposed rules are designed to
more appropriately account for swaps
market characteristics, especially with
respect to the use of a wider array of
different execution methods to trade
and execute a broad scope of swaps
with varying liquidity characteristics.
Accordingly, the proposed rules are
expected to better promote the
development, innovation, and growth of
the swaps market, with the intent of
attracting liquidity formation onto SEFs.
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D. Summary of Proposed Revisions
As a general overview of the major
changes described in this notice, the
Commission is proposing:
• Registration: A proposed interpretation
to apply the statutory SEF registration
requirement and the definition of ‘‘swap
execution facility’’ in CEA sections 5h(a)(1)
and 1a(50), respectively, to certain swaps
broking entities, including interdealer
brokers, as well as aggregators of singledealer platforms. The proposed rules also
include revisions to simplify the registration
process by streamlining Form SEF.
• Trade Execution Requirement: A revised
interpretation of the trade execution
requirement in CEA section 2(h)(8) and new
rules based upon that interpretation that (i)
broaden the scope of the trade execution
requirement; (ii) create a compliance
schedule for the expanded requirement; and
(iii) provide exemptions from the
44 Core Principle 1 states that, unless otherwise
determined by the Commission by rule or
regulation, a SEF shall have reasonable discretion
in establishing the manner in which it complies
with the SEF core principles.’’ 7 U.S.C. 7b–
3(f)(1)(B).
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requirement for certain types of swap
transactions pursuant to CEA section 4(c).
Further, the Commission is proposing to
require each SEF to submit a Form TER that
specifies those swaps that it lists for trading
that are subject to the clearing requirement.
• Execution Methods: New general,
disclosure-based trading and execution rules
under Core Principle 2 that apply to any
execution method offered by a SEF. These
proposed rules would replace the § 37.3(a)(2)
minimum trading functionality requirement
and the execution methods prescribed under
§ 37.9 for Required Transactions, thereby
allowing a SEF to offer flexible methods of
execution for swaps subject to the trade
execution requirement. Further, the
Commission is also proposing to limit the
scope of trading-related communications that
SEF participants may conduct away from a
SEF’s trading system or platform.
• Proficiency: In conjunction with
allowing SEFs to offer more flexible methods
of execution for swaps subject to the trade
execution requirement, the Commission is
also proposing new rules under Core
Principle 2 for SEF trading specialists. The
proposed rules would benefit SEF
participants by strengthening market
integrity and fairness through requirements
for SEFs to establish proficiency testing and
ethics training, trading conduct standards,
and a duty of supervision.
• Swap Documentation: Amendments to
the existing § 37.6(b) confirmation
requirement that would allow a SEF to
provide a ‘‘trade evidence’’ record for an
uncleared swap that serves as evidence of a
legally binding swap transaction, but may be
supplemented by counterparties with
additional terms based on previously
negotiated underlying agreements.
• Impartial Access: Modifications to the
existing impartial access rules under § 37.202
that would allow a SEF to structure
participation criteria and trading practices in
a manner that aligns with the current swaps
market structure.
• Self-Regulatory Oversight: Amendments
to §§ 37.203–206 under Core Principle 2 that
provide a SEF with the ability to, among
other things, (i) tailor its rule enforcement
program and disciplinary procedures and
sanctions to the characteristics of its trading
operations and market; (ii) develop an audit
trail surveillance system that is appropriate
to the types of available execution methods
it offers; and (iii) choose other additional
types of regulatory service providers to assist
with fulfilling its oversight duties.
• Product Guidance: Additional guidance,
pursuant to Core Principle 3, for a SEF to
demonstrate that the swaps that it lists for
trading are not readily susceptible to
manipulation.
• Straight-Through Processing:
Amendments and clarifications to the SEF
straight-through processing requirements that
better reflect existing swaps market practices.
• Financial Resources: Amendments to
apply the existing Core Principle 13 financial
resource requirements in a more practical
manner to SEF operations. The proposed rule
changes include amendments to the existing
six-month liquidity requirement and the
addition of new acceptable practices that
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61953
provide further guidelines to SEFs for making
a reasonable calculation of their projected
operating costs.
• Chief Compliance Officer: Amendments
to Core Principle 15 regulations that
streamline existing requirements for the chief
compliance officer (‘‘CCO’’) position; allow
SEF management to exercise discretion in
CCO oversight; and simplify the preparation
and submission of the required annual
compliance report.
E. Consultation With Other U.S.
Financial Regulators
In developing these rules, the
Commission has consulted with the
Securities and Exchange Commission,
pursuant to section 712(a)(1) of the
Dodd-Frank Act.45
II. Part 9—Rules Relating To Review of
Exchange Disciplinary, Access Denial
or Other Adverse Actions
The Commission is proposing nonsubstantive amendments to part 9 of the
Commission’s regulations that conform
to proposed amendments to § 37.206—
Disciplinary procedures and sanctions.
Accordingly, the Commission discusses
those proposed amendments to part 9 in
Section VII.F. of this notice in
conjunction with its discussion of the
proposed amendments to § 37.206.
III. Part 36—Trade Execution
Requirement
The Commission is proposing new
rules under part 36 of the Commission’s
regulations to implement a proposed
revised interpretation of the trade
execution requirement in CEA section
2(h)(8), which would broaden the scope
of the requirement to include additional
swaps. The Commission discusses the
proposed implementing rules in Section
IV.I.4.a. of this notice in conjunction
with its discussion of (i) the proposed
adoption of flexible means of execution
and elimination of the minimum trading
functionality under § 37.3(a)(2); (ii) the
prescribed execution methods under
§ 37.9; and (iii) the MAT process (and
corresponding trade execution
compliance schedule) under § 37.10,
§ 37.12, and §§ 38.11–12.46 Further, the
Commission discusses the proposed
Form TER submission, the proposed
compliance schedule for the expanded
requirement, and proposed exemptions
from the requirement in Section XXI. of
this notice.
45 Dodd-Frank Act, Public Law 111–203, tit. VII,
§ 712(a)(1), 124 Stat. 1376 (2010).
46 See infra Section IV.I.4.a.—§ 36.1(a)—Trade
Execution Requirement.
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IV. Part 37—Subpart A: General
Provisions
A. § 37.1—Scope
Section 37.1 currently clarifies that
part 37 applies to every SEF that is
registered or is applying to become
registered as a SEF with the
Commission. Section 37.1 also clarifies
that part 37’s applicability does not
affect the eligibility of a registered SEF
or a SEF applicant to operate as either
a DCM under part 38 of the Commission
regulations or a swap data repository
(‘‘SDR’’) under part 49 of the
Commission’s regulations.
The Commission proposes a nonsubstantive amendment to § 37.1. The
Commission has not identified any
provisions in part 37 that would
preclude a registered SEF from being
eligible to operate as a DCM or an SDR;
accordingly, the clarifying language may
create unnecessary ambiguity.
Therefore, the Commission proposes a
non-substantive amendment to
eliminate the existing language to avoid
any potential confusion.
B. § 37.2—Applicable Provisions and
Definitions 47
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1. § 37.2(a)—Applicable Provisions
Section 37.2 states that a SEF must
comply with part 37 and all other
applicable Commission regulations,
including any related definitions and
cross-referenced sections. Section 37.2
also identifies certain specific pre-DoddFrank Act provisions whose
applicability to SEFs may otherwise not
be apparent—in particular, § 1.60 and
part 9 of the Commission’s
regulations.48 The Commission
proposes to adopt a non-substantive
amendment to eliminate the reference to
part 9; the Commission notes that it has
since adopted amendments to part 9 to
conform to the relevant part 37
regulations.49
47 The Commission proposes to retitle § 37.2 to
‘‘Applicable provisions and definitions’’ from
‘‘Applicable provisions’’ based on the proposed
addition of § 37.2(b) described below.
48 Section 1.60 sets forth requirements for futures
commission merchants (‘‘FCMs’’) and DCMs to
submit documents requested by the Commission
that have been filed in any material legal
proceeding in which the FCM or DCM is a party.
17 CFR 1.60. For a description of the Commission’s
part 9 regulations, see infra Section VII.F.—Part 9—
Rules Relating to Review of Exchange Disciplinary,
Access Denial or Other Adverse Actions.
49 Technical Amendments to Rules on
Registration and Review of Exchange Disciplinary,
Access Denial, or Other Adverse Actions, 83 FR
1538 (Jan. 12, 2018). The Commission notes that it
is also proposing additional amendments to part 9
in this notice that conform to the proposed
amendments to the Core Principle 2 regulations
discussed herein. The Commission also proposes to
renumber this provision to subsection (a) based on
the proposed addition of § 37.2(b) described below.
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2. § 37.2(b)—Definition of ‘‘Market
Participant’’
The Commission proposes a new
provision under § 37.2(b) to define
‘‘market participant,’’ as the term is
currently used in part 37, to clarify a
SEF’s jurisdiction over the various
participants that may be involved in
trading or executing swaps on its
facility. In the preamble to the SEF Core
Principles Final Rule, the Commission
specified that a ‘‘market participant’’
includes any ‘‘person that directly or
indirectly effects transactions on the
SEF. [The definition] includes persons
with trading privileges on the SEF and
persons whose trades are
intermediated.’’ 50 This term applies to
several part 37 rules and triggers certain
obligations under the Core Principle 2
regulations, which set forth a SEF’s selfregulatory responsibilities. For example,
§ 37.206 requires a SEF to establish
participation rules that broadly impose
a SEF’s disciplinary authority across
different categories of participants,
including market participants.51
In practice, SEFs have created various
participation categories, including
‘‘direct access,’’ ‘‘direct market access,’’
and ‘‘sponsored access’’ to describe how
persons connect to their trading systems
or platforms. For example, the
Commission understands that ‘‘direct
access’’ generally refers to participants
who have been granted trading
privileges by a SEF and utilize their
own proprietary means, e.g., trading
credentials and/or front-end interface, to
participate directly on the SEF.52 In
contrast, ‘‘direct market access’’ or
‘‘sponsored access’’ generally describe
arrangements in which a person uses a
SEF participant’s means, including
trading credentials and/or front-end
systems, to participate directly on the
SEF. For example, many SEFs allow
persons to access their systems or
platforms by using the credentials and/
or front-end functionality provided by a
SEF participant, such as a futures
commission merchant (‘‘FCM’’) serving
as a clearing member on the SEF or an
IB.53 Finally, some persons may
participate on a SEF via an agency
execution model by directing an
intermediary, e.g., an FCM or an IB, to
50 SEF Core Principles Final Rule at 33506. See
also Division of Market Oversight Guidance on
Swap Execution Facility Jurisdiction (Feb. 10, 2014)
(‘‘2014 Staff Jurisdiction Guidance’’).
51 17 CFR 37.206.
52 The Commission notes that ‘‘direct access’’ also
refers to participants who may onboard and utilize
a SEF’s own front-end application to trade swaps
on the SEF’s systems or platforms.
53 The Commission notes that some SEFs refer to
such persons as ‘‘customers’’ of a SEF trading
participant.
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submit orders or request quotes on their
behalf.
Notwithstanding these categories,
SEFs have generally relied on the
existing description of ‘‘market
participant’’ in the SEF Core Principles
Final Rule preamble to establish
jurisdiction over all of these participants
that access the SEF and trade swaps on
a direct or indirect basis. Given this
established reliance and the continued
use of this term under the proposed
rules, the Commission seeks to codify
the definition of ‘‘market participant’’ in
part 37. The Commission proposes to
define ‘‘market participant’’ as any
person who accesses a SEF (i) through
direct access provided by a SEF; (ii)
through access or functionality provided
by a third-party; or (iii) through
directing an intermediary that accesses
a SEF on behalf of such person to trade
on its behalf. As a threshold matter, the
Commission notes that since these
persons are currently considered
‘‘market participants,’’ they are already
subject to a SEF’s jurisdiction. The
Commission believes that persons
accessing a SEF through the various
means described above interact with
other market participants on the SEF
and have the ability to engage in abusive
trading practices. Therefore, they should
continue to be subject to a SEF’s
jurisdiction, including disciplinary
procedures and recordkeeping
obligations.54
a. Applicability of § 37.404(b) to Market
Participants
The Commission notes in particular
that this proposed definition of ‘‘market
participant’’ would apply to the
recordkeeping requirements under
§ 37.404(b). Section 37.404(b) requires a
SEF to adopt rules that require its
market participants to keep records of
their trading, including records of their
activity in any index or instrument used
as a reference price, the underlying
54 Although a person who directs an intermediary
to trade on its behalf does not interact with other
market participants in the same manner, the
Commission believes that such a person could
engage in abusive trading activity by using more
than one intermediary to place orders that result in
an abusive trading practice. For example, a person
seeking to achieve a wash result could structure a
transaction or a series of transactions through
separate intermediaries, which may give the
appearance of bona fide purchases and sales, but
where the trades have been entered into without the
intent to take a bona fide market position. While
persons do not typically access a SEF in this
manner, the Commission is mindful that the part 37
rules do not preclude this access method and notes
that some SEFs currently facilitate agency-based
trading. Accordingly, the Commission believes that
a SEF must continue to have jurisdiction and
disciplinary authority over these persons in order
to effectively investigate misconduct and prosecute
rule violations that occur on the SEF.
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commodity, and related derivatives
markets.55 Participants who trade on a
SEF via direct access and participants
who use the access or functionality of
another participant to trade on a SEF
have primary access to these types of
records of their own trading. Further,
the Commission believes persons who
direct an intermediary to trade on their
behalf are best situated to maintain the
records required by § 37.404(b). The
Commission understands that such
intermediaries would likely only have
access to records of swaps activity
occurring on the SEF, not necessarily
activity by their customers in the index
or instruments used as a reference price,
the underlying commodity, and related
derivatives markets. Consequently, the
Commission believes that as ‘‘market
participants’’ under the proposed
definition, they should be subject to the
recordkeeping requirements under
§ 37.404(b).56
b. SEF Jurisdiction Over Clients of
Market Participants
The proposed ‘‘market participant’’
definition would not capture clients of
asset managers who, as market
participants of a SEF, trade on a SEF on
their clients’ behalf.57 The Commission
recognizes that based on general
industry practice, these clients have
given their respective asset managers
broad discretion to execute transactions
in various financial products in
different markets, including swaps.
When asset managers trade on a client’s
behalf based on that discretion, such
trading typically occurs without specific
knowledge by the client as to whether
such transactions are occurring on a SEF
or the identity of the SEFs involved.
While the clients themselves ultimately
are the named counterparties to any
transactions executed on their behalf,
the asset managers are the participants
accessing the SEF, and as such, are
subject to the ‘‘market participant’’
definition and the obligations
thereunder, including the SEF’s
jurisdiction. The Commission notes that
asset managers—not their clients—
access the SEF and sign onboarding
documentation subjecting them to the
SEF’s jurisdiction. Since clients of asset
managers would not be captured under
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55 17
CFR 37.404(b).
Commission notes that the proposed
‘‘market participant’’ definition, or the discussion
herein, does not alter any person’s obligations
under § 1.35. 17 CFR 1.35.
57 The Commission notes that in the SEF Core
Principles Final Rule, one commenter expressed
concern that the vague use of the term ‘‘market
participant’’ could potentially subject dealers’
customers, and thus asset managers and their
clients, to onerous requirements. SEF Core
Principles Final Rule at 33506.
56 The
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the proposed market participant
definition, a SEF would not be required
to subject these clients to jurisdiction
under proposed § 37.202(d).
Given that these clients give broad
trading discretion to their asset
managers, the Commission believes that
requiring an asset manager who accesses
and conducts actual trading on a SEF to
submit to the SEF’s jurisdiction is
sufficient. This approach ensures that
SEFs have the ability to take
disciplinary action against the
individual or entity—the asset
manager—that could actually engage in
potentially abusive trading practices on
the SEF. The Commission notes that this
logic would apply in other
circumstances where a client gives
broad trading discretion to another
person to trade and execute swap
transactions on the client’s behalf.
Therefore, these situations would not
fall within the third prong of the
‘‘market participant’’ definition as
described above because the client is
not ‘‘directing’’ the intermediary to
trade on its behalf.
With respect to recordkeeping, the
Commission understands that asset
managers typically maintain records of
swap transactions on SEFs to which
their clients are named counterparties.
Although asset managers would likely
not have complete records of their
clients’ trading activity in the index or
instruments used as a reference price,
the underlying commodity, and related
derivatives markets under § 37.404(b),
the Commission does not believe that
SEFs would need these client records
for regulatory purposes to the extent
that the client is not directing the asset
manager to trade on its behalf, but rather
allowing the asset manager to exercise
discretion in trading swaps. Therefore,
the potential risks of manipulation,
price distortion, and disruptions of the
delivery or cash settlement process,
which a SEF is required to prevent
through trade monitoring under Core
Principle 4, may be less attributable to
such clients. To the extent that such
risks may exist, however, the
Commission believes it is sufficient for
SEFs to have access to records that
relate to the asset manager, who is
conducting the actual swaps trading
activity.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.2(b). The
Commission is particularly interested in
the impact of the scope of the proposed
‘‘market participant’’ definition on
various constituencies and, therefore,
requests comment on the following
questions:
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(1) Is the Commission’s proposed
definition of ‘‘market participant’’ clear
and complete? Please comment on any
aspect of the definition that you believe
is not clear or adequately addressed.
(2) Should the proposed definition of
‘‘market participant’’ distinguish
between clients that give up complete
trading discretion to an asset manager or
another SEF participant and clients that
do not so give up discretion or only give
up partial discretion? If so, on what
basis should the definition establish
such a distinction?
(3) Do customers currently access a
SEF through an intermediary, e.g., an
FCM or IB, and direct that intermediary
to trade on their behalf through an
agency-based approach? If this is not
common, could this method of
accessing a SEF become more common
in the future? If so, under what
circumstances would this occur? Is the
third prong of the proposed ‘‘market
participant’’ definition appropriate,
which would include a person who
directs an intermediary that accesses a
SEF to trade on its behalf? If not, then
why?
(4) Are there any other methods that
are either currently being used or could
be used to access a SEF? Are there any
other examples of how a person could
access a SEF through access or
functionality provided by a third party?
What type of abusive trading practices,
if any, could a customer attempt to
conduct if the customer directs its
trading through an intermediary such as
an FCM or an IB? Please provide
examples.
(5) What type of abusive trading
practices, if any, could a client of an
asset manager conduct if the client gives
up complete trading discretion to the
asset manager? Please provide
examples. If the client allows an asset
manager to exercise discretion in
trading swaps, what are the risks of
manipulation, price distortion, and
disruptions of the delivery or cash
settlement process that may be
attributable to the client?
(6) Does a SEF’s ability to monitor
trading to prevent such risks require it
to have access to client trading records
that include activity in the index or
instrument used as a reference price, the
underlying commodity, and related
derivatives markets? Are there any
trading records that are currently
created and maintained by clients of
asset managers that would not also be
retained by the asset managers? If so,
please describe such records. Should
SEFs receive such records for regulatory
purposes?
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C. § 37.3—Requirements and Procedures
for Registration
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1. § 37.3(a)—Requirements for
Registration 58
CEA section 5h(a)(1) establishes the
SEF registration requirement and
specifies that no person may operate a
facility for the trading or processing of
swaps unless the facility is registered as
a SEF or as a DCM.59 In adopting the
SEF Core Principles Final Rule, the
Commission affirmed its view under
existing § 37.3(a)(1) that the broad
registration requirement in CEA section
5h(a)(1) applies only to facilities that
meet the SEF definition in CEA section
1a(50).60 In furtherance of CEA section
5h(a)(1), existing § 37.3(a)(1) states that
any person operating a facility that
offers a trading system or platform in
which more than one market participant
has the ability to execute or trade swaps
with more than one other market
participant on the system or platform
shall register the facility as a SEF or as
a DCM.61 The Commission believed that
this interpretation of the statutory SEF
registration requirement would help
further the statutory SEF goals of
promoting swaps trading on SEFs and
promoting pre-trade price transparency
in the swaps market.62
As discussed further below, the
Commission is proposing to apply the
SEF registration requirement to several
types of entities. The Commission does
not intend for the discussion in this
notice to exhaustively address which
entities must register as a SEF. Rather,
a determination of whether an entity
must register as a SEF pursuant to CEA
section 5h(a)(1) would depend on an
evaluation of the operations of the
58 The Commission proposes to renumber
paragraph (a)(1) to subsection (a) based on the
proposed elimination of the minimum trading
functionality requirement under § 37.3(a)(2) and the
Order Book definition under § 37.3(a)(3) described
below.
59 CEA section 5h(a)(1) states that no person may
operate a facility for the trading or processing of
swaps unless the facility is registered as a swap
execution facility or as a designated contract
market. 7 U.S.C. 7b–3(a)(1).
60 SEF Core Principles Final Rule at 33481. The
statutory SEF definition in CEA section 1a(50)
provides that a SEF is a trading system or platform
in which multiple participants have the ability to
execute or trade swaps by accepting bids and offers
made by multiple participants in the facility or
system, through any means of interstate commerce,
including any trading facility, that facilitates the
execution of swaps between persons; and is not a
designated contract market. 7 U.S.C. 1a(50).
61 17 CFR 37.3(a)(1). In addition to SEFs, existing
§ 37.3(a)(1) also references registration as a DCM.
While the trading of swaps may occur through
either a SEF or a DCM, CEA section 2(e) limits the
trading of swaps on SEFs to ECPs. Both ECPs and
non-ECPs may trade swaps through a DCM. 7 U.S.C.
2(e).
62 SEF Core Principles Final Rule at 33481.
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entity, in particular whether it meets the
SEF definition under CEA section
1a(50).63
a. Footnote 88
As noted above, the Commission has
stated that the SEF registration
requirement in CEA section 5h(a)(1) 64
only applies to facilities that meet the
statutory SEF definition in CEA section
1a(50).65 In footnote 88 of the preamble
to the SEF Core Principles Final Rule,
the Commission specifically stated that
the SEF registration requirement is not
limited by the trade execution
requirement in CEA section 2(h)(8),
‘‘such that only facilities trading swaps
subject to the trade execution
requirement would be required to
register as a SEF.66 Therefore, a facility
is required to register as a SEF if it
operates in a manner that meets the
statutory SEF definition even though it
only executes or trades swaps that are
not subject to the trade execution
[requirement].’’ 67 The Commission
adopted this approach despite several
comments to the proposed part 37
regulations, stating that registration as a
SEF should only be required if an entity
both met the SEF definition and offered
swaps subject to the trade execution
requirement.68 The Commission stated
that its approach to this issue is
consistent with the statutory SEF
registration requirement, the statutory
SEF definition, and the trade execution
requirement; the Commission also held
that its approach promotes the statutory
SEF goals.69
The Commission proposes to codify
this existing approach to the SEF
registration requirement by amending
§ 37.3(a)(1) to state that a person
operating a facility that meets the
statutory SEF definition must register as
a SEF without regard to whether the
swaps that it lists for trading are subject
to the trade execution requirement. This
proposed amendment is intended to
clarify that the trade execution
requirement is not a determinant of
whether an entity must register as a SEF
63 The Commission notes that the preamble to the
SEF Core Principles Final Rule addresses the
applicability of the SEF registration requirement in
CEA section 5h(a)(1) to several types of entities that
facilitate swaps activity. SEF Core Principles Final
Rule at 33479–84. The Commission maintains its
approach to these types of entities with respect to
the registration requirement, except as discussed
herein. See infra Section IV.C.1.b.—Single-Dealer
Aggregator Platforms (addressing the SEF
registration requirement with respect to singledealer aggregator platforms).
64 7 U.S.C. 5h(a)(1).
65 7 U.S.C. 1a(50).
66 SEF Core Principles Final Rule at 33481 n.88.
67 Id.
68 Id. at 33479–80.
69 Id. at 33481–82.
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by codifying the requirement that an
entity must register as a SEF if it permits
trading or execution of any swap,
including swaps that are not subject to
the trade execution requirement, in a
manner consistent with the statutory
SEF definition, i.e., trading or execution
on a ‘‘multiple-to-multiple’’ basis among
market participants.
Request for Comment
The Commission requests comment
on all aspects of the proposed
amendment to § 37.3(a).
b. Single-Dealer Aggregator Platforms
In the preamble to the SEF Core
Principles Final Rule, the Commission
evaluated the application of the
statutory SEF registration requirement
to various swaps market entities,
including ‘‘aggregation services or
portals’’ (‘‘SEF Aggregator Portals’’) and
‘‘one-to-many systems or platforms’’
(‘‘Single-Dealer Platforms’’).70 The
Commission generally determined that
SEF Aggregator Portals and SingleDealer Platforms do not meet the
statutory SEF definition and therefore
are not required to register as SEFs.71
As the Commission has gained greater
knowledge and experience with the
swaps market, however, it has become
aware of a different type of a trading
system or platform that implicates the
SEF registration requirement—trading
systems or platforms that aggregate
Single-Dealer Platforms (‘‘Single-Dealer
Aggregator Platforms’’). Specifically, a
Single-Dealer Aggregator Platform
typically operates a trading system or
platform that aggregates multiple SingleDealer Platforms and, thus, enables
multiple dealer participants to provide
executable bids and offers, often via
two-way quotes, to multiple non-dealer
participants on the system or platform.
Those non-dealer participants are thus
able to view, execute, or trade swaps
posted to the Single-Dealer Aggregator
Platform’s system or platform from
multiple dealer participants. These
types of systems or platforms, however,
have not registered their operations as
SEFs.
The Commission believes that the
type of trading system or platform
provided by Single-Dealer Aggregator
Platforms should be subject to the SEF
registration requirement because it
meets the SEF definition in CEA section
1a(50) by allowing multiple participants
to trade swaps by accepting bids and
offers made by multiple participants in
the facility or system.72
70 SEF
Core Principles Final Rule at 33481–83.
id.
72 7 U.S.C. 1a(50).
71 See
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While a Single-Dealer Aggregator
Platform has elements that resemble a
Single-Dealer Platform, which is a type
of entity that does not trigger the SEF
registration requirement,73 the
Commission believes that both types of
platforms are distinguishable from one
another. In the preamble to the SEF Core
Principles Final Rule, the Commission
characterized Single-Dealer Platforms as
systems or platforms in which a single
dealer serves as a single liquidity
provider by exclusively providing all
bids and offers against which its
customers, i.e., participants, trade or
execute swaps.74 Accordingly, the
dealer serves as the counterparty to all
swaps executed on its trading system or
platform.75 Unlike the ‘‘one-to-many’’
nature of a Single-Dealer Platform,
however, a Single-Dealer Aggregator
Platform comports with the SEF
definition in CEA section 1a(50) by
providing a trading system or platform
where multiple dealers send or stream
bids and offers to multiple participants,
thereby subjecting them to SEF
registration.
The Commission also believes that
Single-Dealer Aggregator Platforms are
distinguishable from SEF Aggregator
Portals. SEF Aggregator Portals are
services or portals that enable market
participants to access multiple SEFs,
each of which provides a trading system
or platform that facilitates the trading or
execution of swaps between multiple
participants. In the preamble to the SEF
Core Principles Final Rule, the
Commission stated that a SEF
Aggregator Portal does not meet the
statutory SEF definition because it
merely provides a portal through which
its users may access multiple SEFs,
rather than providing a venue for the
trading or execution of swaps.76 A SEF
Aggregator Portal does not provide a
trading system or platform where
multiple participants have the ability to
execute or trade swaps with multiple
participants within its facility; rather,
the multiple-to-multiple participant
execution or trading occurs on the SEF
and not the SEF Aggregator Portal. A
Single-Dealer Aggregator Platform, in
contrast, acts as more than a mere portal
because it provides a system or platform
for multiple-to-multiple participant
73 SEF
Core Principles Final Rule at 33482.
74 Id.
75 See
id.
76 Although
the Commission maintains that a SEF
Aggregator Portal is generally not required to
register as a SEF, such a system or platform may
be subject to the Act and Commission regulations
as an IB, as defined in CEA section 1a(31), given
that its activity may constitute soliciting or
accepting orders to be routed to SEFs. 7 U.S.C.
1a(31).
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swaps trading or execution, thereby
subjecting it to the SEF registration
requirement.
Request for Comment
The Commission requests comment
on all aspects of the proposed
application of the SEF registration
requirement to Single-Dealer Aggregator
Platforms. The Commission may
consider alternatives to the proposed
application of the registration
requirement to Single-Dealer Aggregator
Platforms and requests comment on the
following questions:
(7) Is the Commission’s position that
Single-Dealer Aggregator Platforms meet
the SEF definition appropriate? Please
explain.
(8) Should the Commission apply the
SEF registration requirement to any
other type of entity or activity? If so,
please describe the type of entity and/
or activity at issue.
(9) What factors, if any, would
prevent a Single-Dealer Aggregator
Platform from complying with the SEF
registration requirement?
(10) Is the Commission’s existing
position that SEF Aggregator Portals and
Single-Dealer Platforms do not satisfy
the statutory SEF definition
appropriate? Please explain.
c. Swaps Broking Entities, Including
Interdealer Brokers
In the preamble to SEF Core
Principles Final Rule, the Commission
specified whether the SEF registration
requirement would apply to several
specific types of entities,77 but did not
address whether the requirement would
apply to swaps broking entities, i.e.,
interdealer brokers, most of whom are
registered with the Commission as IBs
and traditionally facilitate swaps trading
in the over-the-counter (‘‘OTC’’)
markets.78 As discussed below, the
77 As noted in the preamble to the SEF Core
Principles Final Rule, the Commission received
comments characterizing the SEF registration
requirement as ambiguous and requesting that the
Commission provide clarification with respect to
certain entities. SEF Core Principles Final Rule at
33479–81. In response, the Commission provided
examples of how the SEF registration requirement
would or would not apply to ‘‘certain categories of
better understood facilities.’’ Id. at 33482–84. These
categories included (i) one-to-many systems or
platforms; (ii) blind auction systems or platforms;
(iii) aggregation services or portals; (iv) services
facilitating portfolio compression and risk
mitigation transactions; and (v) swap processing
services. The Commission, however, emphasized
that these examples do not ‘‘comprehensively’’
address all entities that are subject to SEF
registration and urged participants to seek
clarification from the Commission as to how the
registration requirement applied to their particular
operations. Id. at 33482.
78 ‘‘Interdealer broker,’’ as used in this notice,
refers to an interdealer broker entity or operation in
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61957
Commission believes that the activities
of these entities—firms operating
trading systems or platforms that
facilitate swaps trading primarily
between swap dealers—trigger the SEF
registration requirement because they
allow multiple participants to trade
swaps with multiple participants in a
manner consistent with the language of
CEA sections 5h(a)(1) and 1a(50)
(emphasis added). In light of existing
market practices, the Commission
believes that it is necessary to apply the
SEF registration requirement to ensure
that the multiple-to-multiple ‘‘trading’’
that occurs on such trading systems or
platforms is subject to the Act and
Commission’s regulations as regulated
SEFs. This application is consistent
with Congressional intent, as evidenced
by the statutory SEF registration
requirement and SEF definition, and is
further consistent with the statutory SEF
goals.
The Commission understands that the
proposed interpretation may require
certain non-domestic operations—in
particular, foreign swaps broking
entities, such as foreign interdealer
broker operations—to seek SEF
registration or an exemption from SEF
registration pursuant to CEA section
5h(g), provided that they fall within the
Commission’s jurisdiction.79 Given the
potentially complex issues that may
arise for these entities from the
Commission’s proposed application of
the SEF registration requirement, the
Commission proposes below to delay
the compliance date of the requirement
with respect to such entities and their
operations. This proposed delay would
allow the Commission to further
develop its cross-border regulatory
regime, including the achievement of
additional comparability determinations
with foreign regulators regarding their
respective regulatory frameworks for
swap trading venues located within
their respective jurisdictions, i.e.,
foreign multilateral swaps trading
the aggregate and not to a particular individual, i.e.,
an associated person, who works as a broker within
the entity or operation. The Commission, however,
considers such individuals to constitute part of the
interdealer broker’s trading system or platform. See
infra Section VI.A.1.—§ 37.201(a)—Required Swap
Execution Facility Rules (specifying proposed rules
for SEF execution methods that apply to activities
of SEF trading specialists who facilitate swaps
trading or execution by, among other things,
conducting broking-like functions).
79 Pursuant to CEA section 5h(g), the Commission
may exempt a facility from SEF registration upon
a finding that it is subject to ‘‘comparable,
comprehensive supervision and regulation’’ under
the rules and regulations of the facility’s home
country. 7 U.S.C. 7b–3(g). See infra Section
IV.C.1.d.—Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading
Facilities.
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facilities, which would include foreign
swaps broking entities as described
below. Such a determination would
allow such operations to seek an
exemption from SEF registration. A
delay would also provide time to foreign
swaps broking entities to determine an
appropriate course of action for their
respective operations.80
(1) Structure and Operations of Swaps
Broking Entities, Including Interdealer
Brokers
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Since adopting part 37, the
Commission has developed a deeper
understanding of the swaps market and
has observed how swaps broking
entities, including interdealer brokers,
have structured themselves in relation
to the current SEF regulatory
framework. Interdealer broker trading
systems or platforms facilitate swaps
trading between multiple customers by
negotiating or arranging swaps through
voice-based or voice-assisted systems
that combine voice functionalities with
electronic systems such as order books.
Swap dealers currently use these trading
systems or platforms for several
purposes, including obtaining market
color or maintaining pre-trade
anonymity in the course of trading.
Specifically, an interdealer broker
typically ‘‘works’’ customer orders by
issuing RFQs-to-all among other
customers and negotiating or arranging
any resultant bids or offers. Once the
interdealer broker arranges a
reciprocating bid and reciprocating
offer, it sets a price for a specific swap
transaction for a particular product,
which in many cases enables a
subsequent ‘‘trade work-up’’ session.81
Finally, the interdealer broker will
either facilitate the execution of the
transaction(s) if the broker is part of a
SEF’s trading system or platform 82 or
will otherwise route the pre-arranged
transaction(s) to a SEF for execution if
the broker is not a part of the registered
SEF.
The Commission notes that
interdealer brokers have adopted
varying approaches to structuring
themselves in relation to the SEF
80 The Commission notes that potential courses of
action for such entities may include seeking SEF or
DCM registration; reorganizing into an existing
affiliated SEF; working with the appropriate
regulator within their home country to seek an
exemption from registration pursuant to CEA
section 5h(g); or adjusting their activity to avoid the
Commission’s jurisdiction.
81 For a description of a ‘‘trade work-up’’ session,
see infra note 269.
82 As discussed below, persons operating within
these SEFs that facilitate swaps trading are
commonly referred to as ‘‘trading specialists’’ or
‘‘execution specialists.’’ See infra Section VI.A.3.—
§ 37.201(c)—SEF Trading Specialists.
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regulatory framework. Some interdealer
brokers have registered components of
their trading systems or platforms as
SEFs. Other interdealer brokers have
operated very similar trading systems or
platforms outside of the structure of a
SEF, often through registered IB entities,
and have interacted with a SEF solely as
participants of the SEF.83 As SEF
participants, they submit transactions,
which have already been arranged on
those trading systems or platforms, to
the SEF for execution. Notably, many
interdealer brokers have maintained the
latter approach by operating both a SEF
platform and a non-SEF trading system
or platform simultaneously, using the
latter to facilitate the interaction of bids
and offers and bringing the resulting
arranged swaps to the SEF for
execution.
This bifurcated approach has existed
despite the close similarities among
interdealer broker trading systems or
platforms, whether they are registered or
not as SEFs—they offer trading systems
or platforms that facilitate the trading of
swaps between multiple participants.
This approach, however, has been
justified by the execution of the swap on
a SEF; as noted, the interdealer brokers
that conduct activity on non-SEF
platforms ultimately route the prearranged transactions to a SEF where
they are executed. This approach seems
premised on the view that because the
execution occurs on a registered SEF,
the facilitating interdealer broker does
not need to register as a SEF,
notwithstanding its role in negotiating
or arranging the transaction(s).
To facilitate trading in Required
Transactions outside the SEF, these
interdealer broker trading systems or
platforms typically operate outside of
SEFs pursuant to the time delay
requirement for Required Transactions
under § 37.9(b).84 Under § 37.9(b), the
Commission implemented a fifteensecond time-delay requirement for
Required Transactions that are prearranged or pre-negotiated by a broker
and submitted as cross trades for
execution through the SEF’s Order
Book. This requirement allows a broker
or dealer to execute a Required
83 In
becoming participants on a SEF, interdealer
brokers typically meet the SEF’s access criteria
prior to onboarding, which provides them with
trading privileges on the SEF. As SEF participants,
they are subject to the SEF’s jurisdiction, including
all applicable disciplinary rules, similar to any
other SEF participant. Where the SEF offers its
participants the ability to submit pre-arranged or
pre-negotiated transactions for execution, an
interdealer broker SEF participant will route
transactions it has arranged between its customers
or clients, who are also SEF participants, for
execution on the SEF.
84 17 CFR 37.9(b).
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Transaction by trading against a
customer’s order or executing two
customers’ orders against each other
through pre-negotiation or prearrangement, provided that one side of
the transaction is exposed to the Order
Book for fifteen seconds before the other
side of the transaction is submitted for
execution. The time delay is intended to
provide other market participants with
an opportunity to execute against the
first order.85 In practice, however, the
time delay requirement has enabled
interdealer brokers to facilitate
‘‘trading’’ of swaps i.e., the negotiating
or arranging of swaps transactions
outside the SEF, through the interdealer
brokers’ multiple-to-multiple trading
systems or platforms. Negotiating or
arranging consists of facilitating the
interaction of bids and offers.86 Once
the transaction is pre-negotiated or prearranged through the interdealer
broker’s multiple-to-multiple trading
system or platform, the interdealer
broker routes the pre-arranged
transaction to the SEF, where one side
of the transaction is exposed for fifteen
seconds on the Order Book prior to the
entry of the other side for execution.
For swaps that are not subject to the
trade execution requirement, i.e.,
Permitted Transactions, SEFs have
allowed their market participants to
conduct trading via pre-execution
communications away from their
respective facilities and then submit the
resulting transaction, with the price,
terms, and conditions already agreed
upon between the participants, to the
SEF’s trade capture functionality for
execution.87 The Commission notes that
several SEFs affiliated with interdealer
brokers offer this type of functionality
based in part on the execution flexibility
allowed under § 37.9(c)(2) for Permitted
Transactions, i.e., a SEF may offer any
method of execution for such swaps.
Accordingly, interdealer brokers submit
Permitted Transactions that have been
negotiated or arranged through their
trading systems or platforms to an
affiliated SEF without being subject to
any corresponding order exposure (e.g.,
a fifteen-second time-delay).88 Coupled
85 SEF Core Principles Final Rule at 33503. See
infra note 322 and accompanying discussion
(describing the policy reason for the § 37.9(b) time
delay requirement).
86 See infra Section VI.A.2.a.—§ 37.201(b)—PreExecution Communications (discussion of how preexecution communications between market
participants constitute ‘‘trading’’).
87 For further discussion of this execution
method, see infra Section VI.A.2.—§ 37.203(a)—PreArranged Trading Prohibition; § 37.9—Time Delay
Requirement.
88 The Commission has also observed that other
swaps broking entities that are not affiliated with
a SEF similarly negotiate or arrange transactions
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with the ability to submit Required
Transactions in accordance with the
time delay requirement, these
arrangements essentially enable the
operation of multiple-to-multiple
trading systems or platforms for a broad
range of swaps outside of the SEF
regulatory framework.
(2) SEF Registration Requirement for
Swaps Broking Entities, Including
Interdealer Brokers
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Based on the statutory SEF
registration requirement and SEF
definition, the associated SEF goals, the
Commission’s experience and
knowledge from implementing part 37,
and its evaluation of trading practices
that have developed under the current
SEF regulatory framework with respect
to swaps broking entities that include
interdealer brokers, the Commission
proposes that a trading system or
platform operated by such an entity
must register as a SEF pursuant to CEA
section 5h(a)(1) and § 37.3(a).89 The
Commission believes that such trading
systems or platforms conform to the
statutory SEF definition because they
allow multiple participants to trade
swaps by accepting bids and offers
made by multiple participants in that
facility or system (emphasis added). As
described above, these trading systems
or platforms facilitate the negotiation or
arrangement of swap transactions
through the interaction of bids and
offers. The Commission believes that
this ‘‘trading’’ activity should occur
within a SEF, regardless of whether the
product is subject to the trade execution
requirement.90 Accordingly, entities
away from a registered SEF and subsequently
submit those transactions to a registered SEF for
execution. These types of transactions, however, are
less common and constitute a smaller portion of the
overall volume of relevant transactions discussed
herein.
89 Although the Commission’s description of
swaps broking entities above focuses on the dealerto-dealer market, the Commission clarifies that any
person operating a system or platform for multipleto-multiple participant swaps trading as described
herein must register as a SEF consistent with CEA
section 5h(a)(1) and § 37.3(a) (emphasis added).
90 The Commission notes that this view is
consistent with the proposed amendment to
§ 37.3(a) to clarify that a person operating a facility
that meets the statutory SEF definition must register
as a SEF without regard to whether the swaps that
it lists for trading are subject to the trade execution
requirement. See supra Section IV.C.1.a.—Footnote
88. As part of the proposed elimination of the
prescriptive execution methods under § 37.9 for
Required Transactions, the Commission is
proposing to eliminate the time delay requirement
under § 37.9(b). See infra Section VI.A.2.—
§ 37.203(a)—Pre-Arranged Trading Prohibition;
§ 37.9(b)—Time Delay Requirement. Based on this
proposed elimination and the adoption of a flexible
approach to SEF execution methods, the
Commission notes that rules permitting the prearrangement or pre-negotiation of a swap
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operating these types of trading systems
or platforms should be subject to the
SEF registration requirement.91
In addition to the statutory basis for
this application, the Commission’s
proposed approach would advance the
Dodd-Frank goals of promoting swaps
trading on SEFs and pre-trade price
transparency.92 The Commission
believes that the operation of multipleto-multiple swaps trading systems or
platforms by swaps broking entities,
including interdealer brokers outside of
SEFs has frustrated these statutory goals
and moved liquidity formation away
from SEFs. To promote both trading on
SEFs and pre-trade price transparency,
the Commission believes that the
activities associated with swaps trading
should occur on SEFs consistent with
the SEF registration requirement.
Allowing such activities to occur away
from a SEF and submitting any resulting
transactions to a SEF for execution
effectively makes the SEF a tradebooking or post-trade processing engine,
which is inconsistent with the statutory
language and goals of the CEA related to
SEFs.
The Commission also believes that
requiring these types of swaps broking
entities to register as SEFs would help
to consistently apply the SEF regulatory
framework over a segment of swaps
trading activity that is very similar to
registered SEF activity. Interdealer
brokers currently operate trading
systems or platforms outside of the SEF
regulatory framework, yet act as
participants on SEFs, resulting in
multiple-to-multiple trading that is
opaque not only to the SEF where the
negotiated or arranged trade is
eventually routed to for execution, but
also to the Commission and the general
marketplace. Although many interdealer
brokers are registered as IBs pursuant to
CEA section 4f and are subject to the
Commission’s rules and regulations,93
the Commission believes that these
requirements are neither intended nor
sufficient for the regulation and
oversight of such interdealer brokers’
multiple-to-multiple trading activity.
The Commission believes that Congress
would not have created SEFs and added
the word ‘‘trading’’ in the statutory SEF
registration requirement and SEF
definition if it intended that an IB
framework would be sufficient for
swaps ‘‘trading.’’ Given that these
interdealer brokers operate trading
systems or platforms outside of the SEF
regulatory framework that are very
similar to the activity that occurs on
trading systems or platforms that are
located within interdealer brokers’
registered affiliated SEFs,94 the
Commission believes such activity
would be more appropriately subject to
a SEF-specific regulatory framework.
This approach would achieve the policy
goal of applying more consistent
regulatory treatment to very similar
swaps market activity.
Requiring interdealer brokers to either
register as SEFs or carry out their
multiple-to-multiple trading activities
within a SEF would also enhance
market integrity and monitoring because
such activities would become subject to
the SEF core principles and regulations,
as well as direct regulatory oversight of
a SEF in its capacity as a self-regulatory
organization (‘‘SRO’’).95 For example,
Core Principle 2 requires SEFs to
establish and enforce trading, trade
processing, and participation rules that
will deter abuses and have the capacity
to detect, investigate, and enforce those
rules, including means to capture
information that may be used in
establishing whether rule violations
have occurred.96 These requirements
enable SEFs to more comprehensively
monitor for, among other things,
potential abusive trading practices such
as fraud and manipulation.97 The
transaction subject to a time delay requirement
would no longer be needed or allowed.
91 In addition to negotiation or arrangement that
occurs through a swaps broking entity, the
Commission believes that negotiation or
arrangement that occurs directly between
participants should also occur within a SEF. The
Commission is proposing to require SEFs to have
rules that prohibit market participants from
engaging in pre-execution communications, i.e.,
negotiation or arrangement of swaps, away from a
SEF’s trading system or platform, subject to certain
exceptions. See infra Section VI.A.2.a.—
§ 37.201(b)—Pre-Execution Communications.
92 7 U.S.C. 7b–3(e).
93 7 U.S.C. 6f(a). Part 3 sets forth the registration
and regulatory requirements for IBs, among other
registered entities. 17 CFR part 3. Among those
requirements, IBs are required to register with the
National Futures Association (‘‘NFA’’) and therefore
are also subject to the NFA rules and regulations.
17 CFR 3.2. The Commission further notes that
§ 155.4 sets forth trading standards for IBs. 17 CFR
155.4. For a description of additional IB-related
Commission requirements, see infra note 341.
94 The Commission emphasizes that an
interdealer broker that solely solicits or accepts
individual or single bids or offers and introduces
them to an exchange, such as a SEF, would not be
required to register as a SEF because it would not
be facilitating the ‘‘trading,’’ i.e., negotiating or
arranging of swaps between multiple market
participants consistent with the SEF registration
requirement. Such brokers would be able to
continue to engage in such solicitation or
acceptance in conformance with the IB definition.
7 U.S.C. 1a(31).
95 17 CFR 1.3 (definition of ‘‘self-regulatory
organization’’).
96 7 U.S.C. 7b–3(f)(2)(B).
97 Given that the interdealer brokers are
participants of the SEFs to which they submit
negotiated or arranged transactions for execution,
the Commission notes that SEFs still have
jurisdiction over that activity and could investigate
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Commission notes that establishing SEF
monitoring and surveillance
requirements over activity in the
interdealer broker market is especially
beneficial based on the role of
interdealer brokers in the manipulation
of ISDAFIX, a benchmark for swap rates
and spreads for IRS; and the London
Interbank Offered Rate (‘‘LIBOR’’), an
average benchmark for short-term
interest rates used to determine floating
rates for IRS.98
Accordingly, the Commission
proposes that swaps broking entities,
including interdealer brokers, that offer
a trading system or platform in which
more than one market participant has
the ability to trade any swap with more
than one other market participant on the
system or platform, shall register as a
SEF or seek an exemption from
registration pursuant to CEA section
5h(g) (emphasis added). Where an entity
operates both a registered SEF and an
affiliated swaps broking entity—such as
an interdealer broker—that negotiates or
arranges trades via a non-SEF trading
system or platform and participates on
the affiliated SEF as a market
participant, the swaps broking entity
could also comply with the SEF
registration requirement by integrating
its non-SEF trading system or platform
into its affiliated SEF. The Commission
believes that this proposed application
of the SEF registration provision in CEA
section 5h(a)(1), which the Commission
continues to interpret in conjunction
with the SEF definition in CEA section
1a(50), is consistent with the statute and
helps further the statutory SEF goals
provided in CEA section 5h.
The Commission proposes to delay
the application of the SEF registration
requirement with respect to swaps
broking entities, including interdealer
brokers, for a period of six months,
subject to certain conditions and
starting from the compliance date of any
final rule adopted from this proposed
rulemaking. Swaps broking entities,
including interdealer brokers, that meet
the conditions set forth below would be
able to continue to maintain their
current practice of facilitating the
negotiating or arranging of swaps
transactions between multiple
participants and routing those swaps
suspected prohibited activity and issue sanctions
where appropriate, pursuant to the SEF’s selfregulatory obligations.
98 See, e.g., Enforcement Order re: Socie
´ te´
Ge´ne´rale S.A. Attempted Manipulation and False
Reporting of LIBOR and Euribor, CFTC Docket No.
18–14 (June 4, 2018); see also Enforcement Order
re: JP Morgan Chase Bank, N.A. Attempted
Manipulation of U.S. Dollar ISDAFIX Benchmark,
CFTC Docket No. 18–15 (June 18, 2018).
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transactions to SEFs for execution.99
Without the six-month delay period, the
Commission believes that applying the
SEF registration requirement to these
entities would disrupt their operations
and further fragment swaps liquidity.
As applied to swaps broking entities,
including interdealer brokers—most of
whom are registered with the
Commission as IBs—the Commission
proposes that the six-month delay from
the SEF registration requirement would
be subject to the following conditions:
(i) All swap transactions that are
traded on a swaps broking entity,
including an interdealer broker, must be
routed for execution to a SEF; and
(ii) The swaps broking entity,
including an interdealer broker, must
provide electronically the following
information with respect to itself to the
Secretary of the Commission at
submissions@cftc.gov and the
Commission’s Division of Market
Oversight (‘‘Division’’ or ‘‘DMO’’) at
DMOSubmissions@cftc.gov: (i) Entity
name as it appears in the entity’s
charter; (ii) name and address of the
entity’s ultimate parent company; (iii)
any names under which the entity does
business; (iv) address of principal
executive office; (v) a contact person’s
name, address, phone number, and
email address; (vi) asset classes and
swap products for which the entity
facilitates trading; and (vii) any
registrations, authorizations, or licenses
held.100
Upon a DMO determination that a
swaps broking entity’s notice is
complete, the Commission proposes to
post these notices on the Commission’s
website under the ‘‘Industry Filings’’
page. This proposed approach would
effectively maintain the status quo for
these swaps broking entities for the
proposed six-month delay period.
The Commission notes that the
proposed six-month delay for swaps
broking entities, including interdealer
99 As discussed below, the Commission is
proposing § 37.201(b) to prohibit the use of preexecution communications by market participants
away from a SEF’s trading system or platform. See
infra Section VI.A.2.a.—§ 37.201(b)—Pre-Execution
Communications. The Commission notes that to the
extent swaps broking entities, including interdealer
brokers, engage in such communications in the
course of negotiating or arranging transactions and
submitting them to a SEF for execution, the
prohibition—if adopted via a final rule—would not
apply during the six-month period.
100 The Commission anticipates that the effective
date of any final rule would be established ninety
days from the publication of the rule in the Federal
Register. The Commission believes that the
proposed ninety-day period would provide swaps
broking entities, including interdealer brokers
seeking to avail themselves of the six-month
compliance date delay with a sufficient opportunity
to compile and submit this information to the
Commission.
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Fmt 4701
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brokers, does not affect any other
requirements under the CEA or the
Commission’s regulations. In particular,
this delayed compliance date would not
affect the application of CEA section
2(e) and its requirement that only ECPs
be permitted to trade swaps on SEFs.101
As part of this proposed transition
period, swaps broking entities,
including interdealer brokers, would be
able to route their transactions to a SEF
for execution. Furthermore, during this
period, counterparties subject to the
trade execution requirement would be
able to satisfy that requirement by
trading via a swaps broking entity,
including an interdealer broker, that
routes the transactions to a SEF for
execution.
Request for Comment
The Commission requests comment
on all aspects of the proposed
application of the SEF registration
requirement to swaps broking entities.
The Commission may consider
alternatives to the proposed application
of the requirement and requests
comment on the following questions:
(11) Is the Commission’s view that
swap broking entities, including
interdealer brokers, meet the SEF
definition appropriate? Please explain
why or why not. Is it clear what activity
falls within the SEF registration
requirement and SEF definition,
including the meaning of ‘‘trading’’? If
not, please explain.
(12) Should the Commission apply
the SEF registration requirement to any
other type of entity or activity?
(13) What factors, if any, would
prevent a swaps broking entity,
including an interdealer broker, from
complying with the SEF registration
requirement or from seeking an
exemption from registration pursuant to
CEA section 5h(g)?
(14) Is the proposed six-month delay
period sufficient to allow swaps broking
entities, including interdealer brokers,
time to seek registration or alter their
operations in compliance with the SEF
registration requirements? Why or why
not?
(15) Should the Commission allow
swaps broking entities, including
interdealer brokers, to route swap
transactions to exempt SEFs during this
six-month delay period? Why or why
not?
d. Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps
Trading Facilities
As discussed above, the Commission
has observed that swaps broking
101 7
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U.S.C. 2(e). See supra note 61.
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entities, including interdealer brokers,
have utilized various business
structures to operate in a bifurcated
manner, i.e., a SEF and a non-SEF
trading system or platform. One
common structure consists of an entity
that serves as a parent to a registered
SEF entity and several affiliated broker
entities that negotiate or arrange trades
and participate exclusively on the
affiliated SEF as market participants.
While many of those broker entities are
domestically domiciled, a significant
number of them are also located in
numerous foreign jurisdictions.102
Similar to domestic swaps broking
entities, these foreign swaps broking
entities are not currently registered as
SEFs, but are typically registered with
the Commission as IBs.103 These entities
often serve as hubs for liquidity within
their particular jurisdiction during nonU.S. trading hours—operating trading
systems or platforms that facilitate the
negotiating or arranging of transactions
for multiple U.S. persons with local
customers and the routing of those
transactions to an affiliated SEF for
execution.104 These foreign swaps
broking entities’ trading systems or
platforms are very similar to those
operated by swaps broking entities
within in the U.S., such that they
provide more than one market
participant with the ability to trade
swaps with more than one other market
participant (emphasis added).
Therefore, the Commission proposes
that these foreign swaps broking entities
are ‘‘foreign multilateral swaps trading
facilities,’’ which are foreign facilities
that operate a trading system or platform
where multiple participants have the
102 Based on discussions with market
participants, the Commission is aware of foreign
swaps broking entities that are interdealer brokers
located in numerous foreign jurisdictions, including
Australia, Brazil, Canada, Chile, Colombia, Hong
Kong, Japan, Mexico, Singapore, and South Korea,
that participate on SEFs. The Commission is also
aware that interdealer brokers domiciled in the
European Union (‘‘EU’’) operate as investment firms
that operate Multilateral Trading Facilities
(‘‘MTFs’’) and Organized Trading Facilities
(‘‘OTFs’’). The Commission notes that it has
exempted certain MTFs and OTFs located in the EU
from registration as SEFs pursuant to CEA section
5h(g). See infra note 109 (describing December 2017
exemptive order issued by the Commission to
certain MTFs and OTFs based on comparability
determination).
103 See supra note 93 (general description of
Commission requirements with respect to IBs).
104 For purposes of this discussion, the term ‘‘U.S.
person’’ identifies those persons who, under the
Commission’s interpretation, could be expected to
satisfy the jurisdictional nexus set forth in CEA
section 2(i) based on their swap activities, either on
an individual or aggregate basis. See Interpretive
Guidance and Policy Statement Regarding
Compliance With Certain Swap Regulations; Rule,
78 FR 45292, 45301 (Jul. 26, 2013) (‘‘2013 CrossBorder Guidance’’).
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ability to execute or trade swaps with
multiple market participants.
Consistent with the proposal
regarding the SEF registration
requirement above, such foreign
multilateral swaps trading facilities,
including foreign swaps broking
entities, would be required to register as
a SEF or seek an exemption from SEF
registration if their activity falls within
the jurisdictional reach of the
Commission pursuant to CEA section
2(i). Pursuant to CEA section 2(i),
activities outside of the U.S. are not
subject to the swap provisions of the
CEA, including any rules prescribed or
regulations promulgated thereof, unless
those activities either have a ‘‘direct and
significant connection’’ with activities
in, or effect on, commerce of the United
States; or contravene any rule or
regulation established to prevent
evasion of a Dodd-Frank Act-enacted
provision of the CEA.105 The
Commission expects that it will clarify
the cross-border jurisdictional reach of
the SEF registration requirement in the
future for foreign multilateral swaps
trading facilities, including foreign
swaps broking entities, pursuant to CEA
section 2(i).106 To the extent that a
105 7
U.S.C. 2(i).
November 2013, DMO issued guidance
regarding the application of the SEF registration
requirement to foreign multilateral swaps trading
facilities. Division of Market Oversight Guidance on
Application of Certain Commission Regulations to
Swap Execution Facilities (Nov. 15, 2013). The
guidance specified that a foreign multilateral swaps
trading platform that provides U.S. persons or
persons located in the United States (including
personnel and agents of non-U.S. persons located in
the United States) (‘‘U.S.-located persons’’) with the
ability to trade or execute swaps on or pursuant to
the rules of the platform, either directly or
indirectly through an intermediary, would be
expected to register as a SEF or DCM. Id. at 2. The
guidance listed two non-exhaustive factors to
determine whether a foreign platform met this
registration requirement: (i) Whether a foreign
multilateral swaps trading facility directly solicits
or markets its services to U.S. persons or U.S.located persons; or (ii) whether a significant portion
of the market participants who a foreign
multilateral swaps trading facility permits to effect
transactions are U.S. persons or U.S.-located
persons. Id. at 2 n.8. The guidance further specified
DMO’s belief that U.S. persons and U.S.-located
persons generally comprise those persons whose
activities have the requisite ‘‘direct and significant’’
connection with activities in, or effect on,
commerce of the United States within the meaning
of CEA section 2(i). Id. at 2. The guidance also
stated DMO’s view that a multilateral swaps trading
facility’s provision of the ability to trade or execute
swaps on or through the platform to U.S. persons
or U.S.-located persons may create the requisite
connection under CEA section 2(i) for purposes of
the SEF/DCM registration requirement. Id.
Subsequently, the Commission learned that many
foreign multilateral swaps trading facilities
prohibited U.S. persons and U.S-located persons
from accessing their facilities due to the uncertainty
that the guidance created with respect to SEF
registration. The Commission understands that
these prohibitions reflect concerns that U.S. persons
106 In
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61961
foreign multilateral swaps trading
facility’s activities are determined to fall
within the Commission’s jurisdictional
reach, the facility would be required to
register as a SEF or seek an exemption
from SEF registration.107
Such facilities that do not wish to
register as a SEF and prefer to comply
with the regulatory requirements of
their home country may seek an
exemption from SEF registration
pursuant to CEA section 5h(g) either
directly or via the auspices of their
home country regulator. Pursuant to
CEA section 5h(g), the Commission may
exempt facilities from SEF registration if
the facility is subject to comparable,
comprehensive supervision and
regulation on a consolidated basis by
the appropriate governmental
authorities in the home country of the
facility.108 Based on this provision, the
Commission issued an order in
December 2017 that exempts certain
MTFs and OTFs authorized within the
EU from the SEF registration
requirement based on a finding that
their respective regulatory frameworks
satisfy the standard for granting an
exemption from the SEF registration
requirement pursuant to CEA section
5h(g).109 At this time, the Commission
has neither adopted a formal regulatory
framework for granting an exemption
pursuant to this provision nor has it
granted exemptive relief to facilities in
other jurisdictions beyond the 2017
order to EU-based MTFs and OTFs.
(1) Proposed Delay of SEF Registration
Requirement
Given that the Commission intends to
address the cross-border jurisdictional
reach of the Commission’s SEF
registration requirement in the future,
the Commission proposes to delay the
compliance date of the registration
and U.S.-located persons accessing their facilities
would trigger the SEF registration requirement. As
noted above, the Commission expects to address the
application of CEA section 2(i) to foreign
multilateral swaps trading facilities, including
foreign swaps broking entities, in the future.
107 The Commission discusses further below the
potential implications for foreign multilateral swaps
trading facilities offering swaps that are subject to
the trade execution requirement to applicable
counterparties.
108 7 U.S.C. 7b–3(g).
109 Order Exempting MTFs and OTFs Authorized
Within the EU from SEF Registration Requirement
(Dec. 8, 2017) (‘‘2017 MTF and OTF Exemptive
Order’’). The order established this finding with
respect to EU-wide legal requirements—including,
in particular, requirements under the EU’s new
Markets in Financial Instruments Regulation
(‘‘MiFIR’’), the EU’s amended Markets in Financial
Instruments Directive (‘‘MiFID II’’), and the EU’s
Market Abuse Regulation—that establish regulatory
frameworks for MTFs and OTFs. Pursuant to this
finding, the Commission provided specific
exemptions to several MTFs and OTFs. Id. at app.
A.
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requirement only with respect to foreign
swaps broking entities, including
foreign interdealer brokers, that
currently facilitate trading, i.e.,
negotiation or arrangement, of swaps
transactions for U.S. persons (‘‘Eligible
Foreign Swaps Broking Entities’’) for a
period of two years, subject to certain
conditions and starting from the
effective date of any final rule adopted
from this notice.
The proposed delay period would not
apply to foreign swaps broking entities
that do not currently facilitate trading,
i.e., negotiation or arrangement, of
swaps transactions for U.S. persons,
given that their operations would not be
materially affected by the proposed
application of the SEF registration
requirement to swaps broking entities.
Further, the proposed delay period
would not apply to foreign multilateral
swaps trading facilities, as described
above, that are not foreign swaps
broking entities. Such facilities are not
subject to the Commission’s proposed
application of the SEF registration
requirement, and therefore, are already
required to register as a SEF pursuant to
the SEF registration requirement or seek
an exemption pursuant to CEA section
5h(g). Similarly, the Commission notes
that MTFs and OTFs located in the EU
may not rely on this delay and instead
must seek an exemption from SEF
registration pursuant to the terms of the
Commission’s 2017 exemptive order.110
Eligible Foreign Swaps Broking
Entities that meet the conditions set
forth below would be able to continue
to maintain the current practice of
facilitating the negotiation or
arrangement of swaps transactions
between multiple participants and
routing those swaps transactions to
SEFs or Exempt SEFs for execution.111
Without the two-year period, the
Commission believes that applying the
SEF registration requirement to these
entities would disrupt their operations
and fragment swaps liquidity.
During this period, the Commission
anticipates that it will address what
constitutes a ‘‘direct and significant
connection with activities in, or effect
on, commerce of the United States’’ for
foreign multilateral swaps trading
110 2017
MTF and OTF Exemptive Order.
discussed below, the Commission is
proposing § 37.201(b) to prohibit the use of preexecution communications by market participants
away from a SEF’s trading system or platform. See
infra Section VI.A.2.a.—§ 37.201(b)—Pre-Execution
Communications. The Commission notes that to the
extent Eligible Foreign Swaps Broking Entities
engage in such communications in the course of
negotiating or arranging transactions and submitting
them to a SEF for execution, the prohibition—if
adopted via a final rule—would not apply during
the two-year period.
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111 As
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facilities, including foreign swaps
broking entities, under CEA section
2(i).112 The proposed delay would also
provide the Commission with time to
develop any threshold standards for the
application of CEA section 2(i) to the
SEF registration requirement in CEA
section 5h(a)(1). While the Commission
has yet to determine standards in this
area, the Commission notes that any
such standard could include a de
minimis component, whereby the
activity of U.S. persons below some
defined quantitative threshold on a
particular foreign multilateral swaps
trading facility would not trigger a need
for SEF registration.
The Commission notes that
counterparties that are required to
comply with the trade execution
requirement may only satisfy the
requirement by executing a swap on a
SEF, a DCM, or an Exempt SEF.113
Accordingly, any foreign multilateral
swaps trading facility that seeks to offer
such swaps to such counterparties for
trading must be registered as a SEF or
DCM or obtain an exemption from SEF
registration pursuant to CEA section
5h(g), regardless of whether that trading
system or platform meets the standards
(or any future standards the
Commission may develop) for CEA
section 2(i), i.e., a ‘‘direct and significant
connection,’’ to trigger SEF registration.
As noted above, the proposed delay
would not apply to these foreign
multilateral swaps trading facilities.
Similarly, upon the expiration of the
proposed two-year delay, any Eligible
Foreign Swaps Broking Entity that seeks
to offer such swaps to such
counterparties for trading on its trading
system or platform must be registered as
a SEF or DCM or obtain an exemption
from SEF registration pursuant to CEA
section 5h(g).
During this time, the Commission
could formalize a regulatory framework
for providing exemptions from the SEF
registration requirement for foreign
multilateral swaps trading facilities,
including foreign swaps broking
entities, that meet that CEA section 2(i)
standard. The proposed two-year delay
not only could provide the Commission
with sufficient time to formalize this
framework, which would require
standards and processes for evaluating
exemption requests, but also give
Eligible Foreign Swaps Broking Entities
more time to determine their best course
of action, i.e., seek SEF registration with
112 7
U.S.C. 2(i).
113 For a discussion of which counterparties must
comply with the Category A Transaction-Level
Requirements, including the trade execution
requirement, see 2013 Cross-Border Guidance at
45350–59 app. D.
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the Commission or obtain a CEA section
5h(g) exemption from registration.
Accordingly, the proposed delay would
further provide the Commission and
regulators in foreign jurisdictions with
additional time to evaluate such
registration applications or requests for
exemption received from Eligible
Foreign Swaps Broking Entities.
With respect to exemptions, the
Commission anticipates that most
foreign swaps broking entities and other
foreign multilateral swaps trading
facilities would seek to comply with the
rules and regulations of their home
countries, and thus, seek an exemption
from SEF registration. The Commission
further anticipates that the issuance of
such exemptions may take some time
based upon the large number of
jurisdictions in which these operations
are currently located.114 Thus, the
Commission believes that it would be
beneficial to provide more time for
evaluation of exemption requests
because exempting such comparablyregulated foreign entities from SEF
registration, similar to other deference
initiatives, should generally reduce
market fragmentation, regulatory
arbitrage, and duplicative or conflicting
regulatory requirements, while
increasing the potential for harmonized
regulatory standards on a global level.
Further, the Commission anticipates
that any future determination process
for granting exemptions from SEF
registration would ensure that foreign
and domestic multilateral swaps trading
facilities, which operate in a similar
fashion to one another, are all held to
comparable regulatory standards.
The Commission further believes that
this proposal should create strong
incentives for foreign jurisdictions to
establish or bolster their own robust
regulatory regimes for swaps trading.
Such measures would also be consistent
with the commitment made among the
G–20 countries in 2009 ‘‘to take action
at the national and international level to
raise standards together so that our
national authorities implement global
standards consistently in a way that
ensures a level playing field and avoids
fragmentation of markets, protectionism,
and regulatory arbitrage.’’ 115 To the
extent that foreign swaps broking
entities and other foreign multilateral
swaps trading facilities operate in
foreign jurisdictions that currently do
not have or are not expected to have
114 See supra note 102 (listing the foreign
jurisdictions where swaps broking entities operate).
115 Group of Twenty, ‘‘G–20 Leaders’ Statement:
The Pittsburgh Summit 7 (Sept. 24–25, 2009),
https://www.treasury.gov/resource-center/
international/g7-g20/Documents/pittsburgh_
summit_leaders_statement_250909.pdf.
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comparable and comprehensive
supervision and regulation, such
facilities would be subject to the
proposed SEF registration requirement
if their operations create a ‘‘direct and
significant’’ connection to activities in,
or effect on, commerce of the United
States under CEA section 2(i).
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(2) Proposed Conditions for Delay of
SEF Registration Requirement
As applied to Eligible Foreign Swaps
Broking Entities—most of whom are
registered with the Commission as IBs—
the Commission proposes that the twoyear delay from the SEF registration
requirement be subject to the following
conditions:
(i) All swap transactions involving
U.S. persons that are traded on an
Eligible Foreign Swaps Broking Entity
must be routed for execution to a SEF
or an Exempt SEF; 116 and
(ii) The Eligible Foreign Swaps
Broking Entities must provide the
following information electronically to
the Secretary of the Commission at
submissions@cftc.gov and DMO at
DMOSubmissions@cftc.gov: (i) Entity
name as it appears in the entity’s
charter; (ii) name and address of the
entity’s ultimate parent company; (iii)
any names under which the entity does
business; (iv) address of principal
executive office; (v) a contact person’s
name, address, phone number, and
email address; (vi) asset classes and
swap products for which the entity
facilitates trading; (vii) certification that
the entity currently arranges or
negotiates swap transactions for U.S.
persons; (viii) the entity’s home country
regulator or regulators; and (ix) any
registrations, authorizations, or licenses
held by the entity in its home
country.117
Upon a DMO determination that an
Eligible Foreign Swaps Broking Entity’s
notice is complete, the Commission
would post these notices on the
Commission’s website under the
‘‘Industry Filings’’ page. This proposed
approach would effectively maintain the
status quo for these Eligible Foreign
Swaps Broking Entities during the twoyear compliance date delay period. The
Commission notes that the proposed
two-year delay for Eligible Foreign
Swaps Broking Entities does not affect
116 For a current list of Exempt SEFs, see 2017
MTF and OTF Exemptive Order at app. A.
117 The Commission anticipates that the effective
date of any final rule would be established ninety
days from the publication of the rule in the Federal
Register. The Commission believes that a ninetyday effective date would provide Eligible Foreign
Swaps Broking Entities seeking a two-year
compliance date delay with sufficient opportunity
to compile and submit the requisite information to
the Commission.
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any other requirements under the CEA
or the Commission’s regulations. In
particular, this delayed compliance date
would not affect the application of CEA
section 2(e) and its limitation of SEF
and Exempt SEF trading to ECPs.118
As part of this proposed transition
period, Eligible Foreign Swaps Broking
Entities would be able to route their
transactions to either a SEF or an
Exempt SEF for execution. Furthermore,
during this two-year delay,
counterparties subject to the trade
execution requirement would be able to
satisfy that requirement by trading via
an Eligible Foreign Swaps Broking
Entity that routes the transactions to
either a SEF or an Exempt SEF for
execution.
In light of these considerations, the
Commission notes that the issue of
whether an Eligible Foreign Swaps
Broking Entity routes a transaction to a
SEF or an Exempt SEF during the
proposed two-year time delay period
would have practical implications for
the counterparties involved in the
transaction with respect to complying
with Commission reporting and clearing
requirements. For swap transactions
that are routed to a SEF for execution,
the SEF would be responsible for
compliance with (i) the real-time
reporting requirements under part 43 of
the Commission’s regulations and (ii)
the regulatory reporting requirements
under part 45 of the Commission’s
regulations.119 Counterparties to a swap
transaction that is routed to an Exempt
SEF for execution would be responsible
for the reporting requirements set forth
in both part 43 and part 45, unless there
is a substituted compliance
determination by the Commission with
respect to those requirements.120
Further, for swap transactions routed
to a SEF that are intended to be cleared
or subject to the clearing requirement,
the SEF would be responsible for
routing the swap transaction to a
Commission-registered derivatives
clearing organization (‘‘DCO’’) or a
clearing organization that has been
exempted from DCO registration by the
Commission pursuant to CEA section
5b(h), i.e., Exempt DCO, for clearing.121
For swap transactions routed to an
Exempt SEF for execution that are
118 7
U.S.C. 2(e). See supra note 61.
connection with swap transactions
executed on a SEF, the Commission notes that the
part 45 regulations continue to apply to
counterparties that are subject to such reporting
requirements. 17 CFR part 45.
120 Exempt SEFs may report transactions on
behalf of counterparties as a service provider; the
counterparties, however, retain ultimate
responsibility for reporting.
121 See 17 CFR 37.700–702.
119 In
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61963
intended to be cleared or are subject to
the clearing requirement, the
Commission notes that the following
clearing-related requirements would to
apply to such swap transactions:
(i) When a swap transaction executed
by a U.S. person on such an Exempt SEF
is a ‘‘customer’’ position subject to CEA
section 4d, the transaction, if intended
to be cleared, must be cleared through
a Commission-registered FCM at a
Commission-registered DCO;
(ii) When a swap transaction executed
by a U.S. person on such an Exempt SEF
is a ‘‘proprietary’’ position under
Commission regulation 1.3(y), the
transaction, if intended to be cleared,
must be cleared either through a
Commission-registered DCO or an
Exempt DCO; and
(iii) When a swap transaction is
subject to the Commission’s clearing
requirement, the transaction must be
cleared either through a Commissionregistered DCO or an Exempt DCO,
provided that consistent with (i) above,
the transaction must be cleared through
a Commission-registered FCM at a
Commission-registered DCO and cannot
be cleared through an Exempt DCO if
the transaction is a ‘‘customer’’ position
subject to CEA section 4d.
Request for Comment
The Commission requests comment
on all aspects of its proposed approach
to SEF registration for Eligible Foreign
Swaps Broking Entities, in particular the
proposed two-year delay in the
compliance date of any final rule. The
Commission may consider alternatives
to the proposed two-year delay and
requests comment on the following
questions:
(16) Is the delay of two years for
Eligible Foreign Swaps Broking Entities
an adequate delay? If not, then how long
of a delay should the Commission
consider and why?
(17) Are there additional
considerations that the Commission
should take into account in establishing
this delay?
(18) Are there additional conditions
that the Commission should consider
imposing on Eligible Foreign Swaps
Broking Entities during this delay
period?
2. §§ 37.3(a)(2)–(3)—Minimum Trading
Functionality and Order Book
Definition
In developing the regulatory
framework for SEFs, the Commission
adopted a ‘‘minimum trading
functionality’’ requirement under
§ 37.3(a)(2) that requires a SEF to
maintain and offer an Order Book for all
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of the swaps that it lists for trading.122
An Order Book is defined under
§ 37.3(a)(3) as (i) an electronic trading
facility; 123 (ii) a trading facility; 124 or
(iii) a trading system or platform in
which all market participants in the
trading system or platform have the
ability to enter multiple bids and offers,
observe or receive bids and offers
entered by other market participants,
and transact on such bids and offers.125
In the preamble to the SEF Core
Principles Final Rule, the Commission
acknowledged that the Order Book
functionality does not have the requisite
flexibility to serve as the ideal method
of execution for a variety of swaps, in
particular those that feature lower levels
of liquidity.126 The Commission
nevertheless believed that an Order
Book could establish a base level of pretrade price transparency to all market
participants and, therefore, required that
each SEF offer an Order Book for all
swaps that it lists for trading, including
both swaps subject to the trade
execution requirement and swaps not
subject to the trade execution
requirement.127
The Commission has observed that
market participants have rarely used
Order Books to trade swaps on SEFs
despite their availability for all swaps
listed by SEFs. Depending on the
product involved, for example, order
book trading typically ranges between
‘‘less than [one percent] to less than
[three percent] of total CDS
transactions’’ on SEFs, while order book
trading constitutes between ‘‘less than
[one percent] to approximately [twenty
percent] of total IRS
122 17
CFR 37.3(a)(2).
section 1a(16) defines ‘‘electronic trading
facility’’ as a trading facility that (i) operates by
means of an electronic or telecommunications
network; and (ii) maintains an automated audit trail
of bids, offers, and the matching of orders or the
execution of transactions on the facility. 7 U.S.C.
1a(16).
124 CEA section 1a(51) defines ‘‘trading facility’’
as a person or group of persons that constitutes,
maintains, or provides a physical or electronic
facility or system in which multiple participants
have the ability to execute or trade agreements,
contracts, or transactions by accepting bids or offers
made by other participants that are open to multiple
participants in the facility or system; or through the
interaction of multiple bids or multiple offers
within a system with a pre-determined nondiscretionary automated trade matching and
execution algorithm. 7 U.S.C. 1a(51)(A).
125 17 CFR 37.3(a)(3).
126 SEF Core Principles Final Rule at 33564–65.
In the preamble to the SEF Core Principles Final
Rule, the Commission stated its anticipation that an
Order Book would typically work well for liquid
Required Transactions, i.e., transactions involving
swaps that are subject to the trade execution
requirement. For less liquid Required Transactions,
however, it anticipated that RFQ systems would
help facilitate trading.’’ Id.
127 SEF Core Principles Final Rule at 33564.
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transactions. . . .’’ 128 The Commission
believes that this low level of swaps
trading on Order Books is
attributable 129 to an Order Book’s
inability to support the broad and
diverse range of products traded in the
swaps market that trade episodically,
rather than on a continuous basis.130
Given the broad array of liquid and
illiquid swaps listed on SEFs,
mandating that a SEF offer an Order
Book for all of these products has
imposed significant operational and
financial costs and burdens, particularly
from a technological standpoint, with
little benefit to most market participants
who choose not to utilize them.131
Therefore, based in part on its
experience, the Commission proposes to
eliminate the minimum trading
functionality requirement and the
regulatory Order Book definition. The
Commission believes that eliminating
the minimum trading functionality
would help reduce operating costs for
SEFs, as they would no longer be
required to operate and maintain order
book systems that are poorly suited for
trading in less liquid swaps, and
therefore, do not attract significant
trading activity. Instead of employing
resources to build and support a
seldom-utilized trading system or
platform, the proposed elimination
128 J. Christopher Giancarlo and Bruce Tuckman,
Swaps Regulation Version 2.0: An Assessment of
the Current Implementation of Reform and
Proposals for Next Steps 49–50 (Apr. 26, 2018),
available at https://www.cftc.gov/sites/default/files/
2018-05/oce_chairman_swapregversion2white
paper_042618.pdf.
129 In addition to reasons stated above, the
Commission acknowledges that the lack of swaps
trading on SEF Order Books may also be attributed
to other factors, such as concerns over ‘‘name giveup’’ practices and the current lack of certain trading
features, such as the ability to calculate volumeweighted average pricing.
130 In their study of the index CDS market, Pierre
Collin-Dufresne, Benjamin Junge, and Anders B.
Trolle state that ‘‘[p]roponents of bringing all
market participants onto one limit order book
typically argue that it would (i) increase quote
competition among dealers and (ii) allow clients to
occasionally supply liquidity via limit orders
thereby lowering overall transaction costs (although
at the cost of execution risk). However, a limit order
book arguably works best when trading is
continuous and it is not necessarily optimal when
trading is more episodic as is the case for index
CDSs. For instance, Barclay, Hendershott, and Kotz
(2006) document a precipitous drop in electronic
trading (via limit order books) when Treasuries go
off-the-run and trading volumes decline.’’ Pierre
Collin-Dufresne, Benjamin Junge, & Anders B.
Trolle, Market Structure and Transaction Costs of
Index CDSs 6 n.10 (Swiss Fin. Inst. Res. Paper No.
18–40, 2017) (‘‘2017 Collin-Dufresne Research
Paper’’), citing Michael J. Barclay, Terrence
Hendershott, & Kenneth Kotz, Automation Versus
Intermediation: Evidence from Treasuries Going Off
the Run, 61 J. Fin. 2395, 2395–2414 (2006).
131 The Commission understands that these costs
include regularly occurring software updates to
electronic order book systems and other ongoing
technology-related maintenance.
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provides a SEF with the flexibility to
determine how to allocate its resources,
particularly as it relates to developing
methods of execution that are better
suited to trading the products that it
lists. As discussed below, other
execution methods may be better suited
to maximizing participation and
concentrating liquidity formation on
SEFs in episodically liquid swaps
markets.132 Therefore, removing this
requirement may spur development and
innovation in execution methods. The
Commission also believes that
eliminating this requirement may
encourage SEFs to list new and different
types of swaps, given that they would
no longer have to incur the costs of
operating and supporting Order Books.
The Commission notes, however, that a
SEF would be free to continue to offer
an order book if it so chooses.
The Commission adopted the
minimum trading functionality
requirement based in part on the goal of
promoting pre-trade price
transparency,133 but acknowledges that
the CEA does not explicitly prescribe
the Order Book as a SEF minimum
trading functionality. Accordingly, with
the elimination of this requirement
under § 37.3(a)(2), the only trading
functionality obligation that a SEF must
comply with on an ongoing basis is
based upon the CEA section 1a(50)
definition of SEF.134 Therefore, the SEF
must operate a trading system or
platform in which multiple participants
have the ability to execute or trade
swaps by accepting bids and offers
made by multiple participants in the
facility or system, through any means of
interstate commerce.135 To meet the SEF
definition, a trading system or platform
must provide multiple participants with
the ability to accept bids and offers from
other multiple participants within the
facility or system. As long as multiple
participants have the ability to accept
bids and offers from other multiple
participants within the facility or
system, the facility or system will meet
the SEF definition, regardless of how
the multiple participants choose to
interact with one another. Based on this
more straightforward approach, the
Commission expects that determining
whether a particular system or platform
132 See infra Section IV.I.4.b.—Elimination of
Required Execution Methods.
133 7 U.S.C. 7b–3(e).
134 The Commission emphasizes that while the
SEF definition in CEA section 1a(50) would serve
as the baseline requirement for the type of trading
systems or platforms that a SEF must maintain, it
also provides the basic criterion to determine which
types of trading systems or platforms are subject to
the SEF registration requirement.
135 7 U.S.C. 1a(50).
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meets the SEF definition would
generally be self-evident. Nevertheless,
the Commission will continue to work
with entities that seek interpretive
guidance on the parameters of that
definition.136
other provisions in proposed § 37.3(b)
and proposed § 37.3(h), as discussed
below.
3. § 37.3(b)—Procedures for
Registration 137
To request registration as a SEF,
§ 37.3(b)(1)(i) requires an applicant to
electronically file a complete Form SEF,
as set forth in Appendix A to part 37,
with the Commission.141 The
Commission uses Form SEF, which is
comprised of a series of different
exhibits that require an applicant to
provide details of its operations, to
determine whether the applicant
demonstrates compliance with the Act
and applicable Commission’s
regulations.142 Applicants must also use
Form SEF to amend a pending
application or to seek an amended
registration order.143 As part of the SEF
registration process, an applicant must
also request from the Commission a
unique, extensible, alphanumeric
identifier code for the purpose of
identifying the SEF in connection with
swap reporting requirements pursuant
to part 45 of the Commission’s
regulations.144
Based on its experience with the SEF
registration process, the Commission
believes that some of the information
requested under Form SEF has proven
to be unnecessary to determine an
applicant’s compliance with the Act and
applicable Commission regulations. The
Commission also recognizes that some
of the exhibit requirements are unclear
in the amount of information required to
be provided, thereby causing
inconsistency across applications in the
information received to evaluate
compliance. The proposed changes to
the part 37 framework, as discussed
further herein, would also necessitate
certain Form SEF revisions. Therefore,
the Commission is proposing several
amendments to Form SEF that would
consolidate or eliminate several of the
existing exhibits and also request some
additional information. Further, the
Commission is proposing several
amendments to the Form SEF
instructions. The Commission intends
for these proposed changes to establish
a clearer and more streamlined
application process that would still
provide the Commission with sufficient
and appropriate information to
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a. Elimination of Temporary
Registration
To implement the SEF regulatory
framework, the Commission established
a temporary SEF registration regime to
help minimize disruptions to incumbent
platforms that had been operating prior
to the adoption of part 37 and to allow
new entities to compete with those
incumbent platforms.138 Section 37.3(c)
sets forth the process for SEF applicants
to apply for temporary SEF registration
prior to the Commission’s review of an
application for full SEF registration. The
temporary registration process,
however, has expired pursuant to a twoyear sunset provision established under
§ 37.3(c)(5).139 Since the expiration of
this process, the Commission has
reviewed SEF applications pursuant to
a 180-day Commission review period.140
Based on the expiration of the
temporary registration regime, the
Commission proposes to eliminate the
provisions under existing § 37.3(c) and
adopt various conforming changes to
136 Based on the Commission’s proposed
elimination of the Order Book as a minimum
trading functionality requirement, the Commission
clarifies one particular issue regarding the scope of
the CEA section 1a(50) SEF definition. In the
preamble to the SEF Core Principles Final Rule, the
Commission expressed doubt as to whether an RFQto-one system met the multiple participant aspect
of the SEF definition. SEF Core Principles Final
Rule at 33498, 33561, and 33563. This view,
articulated in the context of the Commission’s
discussion of RFQ Systems as a required method of
execution, would suggest that an ‘‘RFQ-to-one’’
trading system or platform may, on its face, not
meet the SEF definition. The Commission notes,
however, that this view does not appropriately give
meaning to the ‘ability’ factor of the SEF definition.
Therefore, the Commission seeks to clarify the
application of the ‘ability’ factor as it applies to
RFQ-to-one transactions. The Commission believes
that an entity that permits its market participants
to use its RFQ-to-one functionality to issue
concurrent or serial RFQs to multiple, different
recipients would fit within the SEF definition, as
it provides participants the ‘‘ability’’ to accept bids
and offers from multiple participants within the
trading system or platform.
137 Based on the elimination of the temporary
registration requirements, the Commission proposes
to retitle § 37.3(b) to ‘‘Procedures for registration’’
from ‘‘Procedures for full registration.’’ The
Commission also proposes to add a title to
§ 37.3(b)(1)—‘‘Application for registration.’’
138 SEF Core Principles Final Rule at 33487.
139 The Commission notes that the part 37
regulations became effective on August 5, 2013.
Accordingly, the temporary registration provisions
expired on August 5, 2015, subject to certain
exceptions.
140 17 CFR 37.3(b)(5).
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b. § 37.3(b)(1)—Application for
Registration
141 17
CFR 37.3(b)(1)(i).
exhibits that comprise Form SEF concern
the applicant’s business organization (Exhibits A–
H); financial information (Exhibits I–K); compliance
(Exhibits L–U); and operational capability (Exhibit
V). 17 CFR part 37 app. A.
143 17 CFR 37.3(b)(3); 17 CFR part 37 app. A.
144 17 CFR 37.3(b)(1)(iii).
142 The
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determine compliance with the Act and
Commission regulations.
(1) Form SEF Exhibits—Business
Organization
The Commission proposes several
amendments to the ‘‘Business
Organization’’ exhibits—existing
Exhibits A through H—of Form SEF.145
First, the Commission proposes to
consolidate certain existing exhibits, in
particular (i) existing Exhibit G, which
requires an applicant to submit various
governance documents, into existing
Exhibit C, which requires information
regarding the applicant’s board of
directors; 146 and (ii) existing Exhibit F,
which requires an analysis of the
applicant’s staffing, into existing Exhibit
E, which requires a description of the
personnel qualifications for each
category of the applicant’s professional
employees.147 Under the consolidated
new Exhibit E, the Commission
proposes to require more specific detail
about the applicant’s personnel
structure, including personnel seconded
to the applicant. As proposed, Exhibit E
would require information about the
reporting lines among the applicant’s
personnel; estimates of the number of
non-management and non-supervisory
employees; and a description of the
duties, background, skills, and other
qualifications for each officer, manager/
supervisor, and any other category of
non-management and non-supervisory
employees. The Commission believes
that amending Exhibit E to provide
145 The Commission is not proposing any
substantive changes to Exhibit A, which requires an
applicant to specify persons who own ten percent
or more of the applicant’s stock or otherwise may
control or direct the applicant’s management or
policies; and Exhibit B, which requires an applicant
to provide a list of present officers, directors and
governors, or their equivalents. The Commission is
proposing non-substantive amendments to Exhibit
A to reorganize the existing requirements to
paragraphs (a)–(b) and to revise the existing
language accordingly.
146 Existing Exhibit C requires a narrative that
describes the composition and fitness standards for
the applicant’s board of directors. Existing Exhibit
G requires a copy of the applicant’s constitution,
articles of incorporation, articles of formation, or
articles of association with all amendments thereto;
partnership or limited liability agreements; existing
by-laws, operating agreement, rules or instruments
corresponding thereto; any governance fitness
information not included in existing Exhibit C; and
a certificate of good standing. As proposed, the
existing Exhibit G requirements would be redesignated as paragraphs (a) and (c) of a
consolidated new Exhibit C; existing Exhibit C
would be re-designated as paragraph (b) within new
Exhibit C.
147 Existing Exhibit E requires a description of
such employees employed by the applicant or a
division, subdivision, or other separate entity
within the applicant. Existing Exhibit F requires the
analysis of staffing requirements that are necessary
to operate the applicant as a SEF, including the staff
names and qualifications.
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greater specificity would promote
consistency among applications and
further assist in evaluating the
applicant’s compliance with the Act and
the Commission’s regulations,
particularly with respect to selfregulatory requirements.148
The Commission also proposes to
narrow the scope of information
required by existing Exhibit D, which
requires a description of the applicant’s
organizational structure that includes a
list and description of affiliates and
relevant divisions, subdivisions, or
other separate entities related to the
applicant. As proposed, Exhibit D
would require an applicant to describe
the nature of the business of any
affiliated entities which engage in
financial services or market activities,
including but not limited to, the trading,
clearing, or reporting of swaps. The
Commission believes that this
amendment would more appropriately
focus the required information on
entities related to the applicant’s swapstrading business and minimize the
submission of information that is not
related. Further, the Commission
proposes non-substantive amendments
to the existing exhibit.
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(2) Form SEF Exhibits—Financial
Information
The Commission proposes several
amendments to the ‘‘Financial
Information’’ exhibits—existing Exhibits
I through K—of Form SEF.
The Commission proposes to adopt
several changes to existing Exhibit I.149
This exhibit requires applicants to
submit financial information to
demonstrate compliance with the
financial resources requirements under
Core Principle 13. Among other
required information, paragraph (a)
requires applicants to submit their most
recent fiscal-year financial
statements 150 and paragraph (b)
requires a narrative of how the value of
the applicant’s financial resources is
sufficient to cover operating costs of at
least one year, on a rolling basis, of
148 Based on the proposed consolidation of
existing Exhibit F and existing Exhibit G, existing
Exhibit H would be re-designated as a new Exhibit
F with no additional substantive changes. This
exhibit requires a brief description of any material
pending legal proceeding(s), other than ordinary
and routine litigation incidental to the business, to
which the applicant or any of its affiliates is a party
or to which any of its or their property is the
subject.
149 The Commission also proposes to re-designate
existing Exhibit I as a new Exhibit G based on the
proposed changes described above.
150 The financial information currently required
under paragraph (a) includes an applicant’s balance
sheet; income and expense statement; cash flow
statement; and statement of sources and application
revenues and all notes or schedules thereto.
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which six months’ value of those
resources are unencumbered and liquid.
Paragraph (c) requires an applicant to
submit copies of any agreements (i)
establishing or amending a credit
facility, (ii) insurance coverage, or (iii)
other arrangement that demonstrate
compliance with the liquidity
requirement. Paragraph (d) requires an
applicant to submit representations
regarding sources and estimates for
future ongoing operational resources.
The Commission proposes to amend
the requirements of paragraphs (a)
through (c) to conform to the proposed
amendments to the SEF financial
resources requirements under Core
Principle 13. In particular, the proposed
required documentation would
demonstrate an applicant’s ability to
maintain resources that exceed one year
of operating costs and the existence of
resources to meet the liquidity
requirement.151 The Commission also
proposes to eliminate paragraph (d)
because the representation of an
applicant’s future ongoing operational
resources is not necessary to determine
compliance with Core Principle 13.
Additionally, the Commission proposes
to amend paragraph (a) to incorporate
the existing Form SEF instruction for
newly-formed applicants who cannot
submit the requisite financial
statements, but who alternatively seek
to provide pro forma financial
statements for a six-month period.
The Commission also proposes to
adopt several changes to Exhibit K.152
This exhibit requires an applicant to
provide disclosures related to fees that
it would impose upon participants.
Paragraph (a) requires a complete list of
all of the facility’s dues, fees, and other
charges for its services; paragraph (b)
requires a description of the basis or
methods used to determine those
amounts; and paragraph (c) requires a
description of any differences in charges
between different customers or groups
of customers for similar services. The
Commission proposes to amend
paragraph (a) to require applicants to
identify any market maker programs,
other incentive programs, or other
discounts on dues, fees, or other charges
to be imposed. Based on the
Commission’s experience, this
information is beneficial in evaluating
compliance with access requirements
151 See infra Section XVIII.—Part 37—Subpart N:
Core Principle 13 (Financial Resources) for a
description of the Commission’s proposed changes
to the Core Principle 13 regulations upon which
new Exhibit G is based.
152 The Commission also proposes to re-designate
existing Exhibit K as a new Exhibit H based on the
proposed changes described above.
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pursuant to Core Principle 2.153 Given
the Commission’s proposed revisions to
the existing impartial access
requirements—in particular, the
elimination of the ‘‘comparable fees’’
requirement under existing
§ 37.202(a)(3)—the Commission further
proposes to eliminate the requirement
for a description of fee differentials
under paragraph (c). The Commission
also proposes several streamlining
changes to the existing language.
In addition to the amendments to new
Exhibit G (existing Exhibit I) and new
Exhibit H (existing Exhibit K), the
Commission proposes to eliminate
existing Exhibit J, which requires an
applicant to disclose the financial
resources information for any SEF,
DCM, or other swap trading platform
affiliates. Based on its experience with
Exhibit J, the Commission recognizes
that this information related to an
applicant’s affiliates is not particularly
useful in demonstrating an applicant’s
compliance with Core Principle 13 or
the conflicts of interest requirements
under Core Principle 12.
(3) Form SEF Exhibits—Compliance
The Commission proposes several
amendments to the ‘‘Compliance’’
exhibits—existing Exhibits L through
U—of Form SEF.
First, the Commission proposes to
eliminate several exhibits including (i)
existing Exhibit P, which requires the
applicant to provide information on
disciplinary and enforcement protocols,
tools, and procedures that is generally
duplicative to the details contained in
an applicant’s rulebook and compliance
manual; 154 (ii) existing Exhibit R, which
requires a list of the applicant’s
prohibited trade practice violations that
is duplicative to the rules that an
applicant must include in its rulebook
pursuant to Core Principle 2
requirements; 155 and (iii) existing
Exhibit U, which requires a list of items
subject to a request for confidential
153 The Commission notes that proposed
§ 37.202(a)(2) would require a SEF to establish and
apply fee structures and fee practices to its market
participants in a fair and non-discriminatory
manner. See infra Section VII.A.1.b.—
§ 37.202(a)(2)—Fees.
154 An applicant is currently required to submit
a copy of its rules under existing Exhibit M and a
copy of its compliance manual under existing
Exhibit O, as currently designated. The Commission
is maintaining those requirements under the
proposed revisions to Form SEF as a new Exhibit
J and a new Exhibit K, respectively. The
Commission notes that it proposes to move
‘‘arrangements for alternative dispute resolution’’
under existing Exhibit P to a new Exhibit L
described below. See infra note 159.
155 Section 37.203 requires a SEF to establish and
enforce trading rules that will deter abuses,
including prohibitions on abusive trading practices
in its markets. 17 CFR 37.203.
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treatment under § 145.9 of the
Commission’s regulations—as described
further below, the Commission proposes
to instead require SEFs to identify these
documents within the Table of Contents
to Form SEF.
Second, the Commission proposes to
streamline the requirements of existing
Exhibit L.156 This exhibit currently
requires a narrative and documentation
that describe the manner in which the
applicant complies with each SEF core
principle. This documentation includes
a regulatory compliance chart that sets
forth each core principle and cites the
relevant rules, policies, and procedures
that describe the manner in which the
applicant is able to comply with each
core principle. For issues that are novel
or for which compliance with a core
principle is not evident, this exhibit also
requires an applicant to explain how
that item and the application satisfy the
SEF core principles. The Commission
proposes to streamline this exhibit to
require that the applicant only submit
the regulatory compliance chart and an
explanation of novel issues, as is
currently required. Based on its
experience, the Commission believes
that the regulatory compliance chart
with citations to relevant rules, policies,
and procedures is sufficient to
determine an applicant’s compliance
with the Act and the Commission’s
regulations. The Commission has found
that the additional narrative and
documentation that describe the manner
in which the applicant complies with
each SEF core principle creates
unnecessary paperwork and does not
further the Commission’s review of an
application in this regard. The
Commission further proposes certain
non-substantive amendments to the
existing language of Exhibit L.
Third, the Commission proposes to
simplify the requirements of existing
Exhibit M.157 This exhibit currently
requires a copy of the applicant’s rules,
and any technical manuals, other
guides, or instruction for SEF users,
including minimum financial standards
for members or market participants. The
Commission proposes to eliminate the
existing requirement to cite position
limits and aggregation standards in part
151 of the Commission’s regulations and
any position limit rules set by the
facility. As discussed below with
respect to Core Principle 6, the
Commission intends to address the
position limit issue in a separate
156 The Commission also proposes to re-designate
existing Exhibit L as a new Exhibit I based on the
proposed changes described above.
157 The Commission also proposes to re-designate
existing Exhibit M as a new Exhibit J based on the
proposed changes described above.
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rulemaking; 158 the Commission also
notes that this requirement is redundant
to the applicant’s requirement to submit
a copy of its rules. Further, the
Commission proposes several nonsubstantive amendments to streamline
Exhibit M’s existing language.
Fourth, the Commission proposes to
eliminate the requirements under
existing Exhibit N. The exhibit currently
requires an applicant to provide
executed or executable copies of any
agreements or contracts that facilitate
the applicant’s compliance with the SEF
core principles, including third-party
regulatory service provider or member
or user agreements. To streamline Form
SEF, the Commission would require
instead that applicants submit these
documents pursuant to other relevant
exhibits, as described below.
Fifth, the Commission proposes a new
Exhibit L, which would continue to
require an applicant to submit user
agreements. As proposed, the new
exhibit would specify that the required
agreements would include, but not be
limited to, on-boarding documentation,
regulatory data use consent agreements,
intermediary documentation, and
arrangements for alternative dispute
resolution.159 The new Exhibit L would
also require a narrative of the legal,
operational, and technical requirements
for users to directly or indirectly access
the SEF. This requirement reflects some
documents that applicants have
previously submitted under existing
Exhibit N. The additional specificity,
however, reflects the Commission’s
experience with different participantrelated agreements that implicate (i) a
SEF participant’s ability to access the
facility’s trading system or platform
pursuant to Core Principle 2; and (ii) the
facility’s use of a SEF participant’s
proprietary data or personal information
under existing § 37.7.160
Sixth, the Commission proposes a
new Exhibit M to establish requirements
related to an applicant’s swaps reporting
capabilities. The new Exhibit M would
require the applicant to submit (i) a list
of the SDRs to which the applicant will
report swaps data, including the
158 See infra Section XI.—Part 37—Subpart G:
Core Principle 6 (Position Limits or Accountability).
159 The Commission notes that ‘‘arrangements for
alternative dispute resolution’’ are included based
on the requirements of existing Exhibit P, which the
Commission proposes to eliminate from Form SEF.
See supra note 154.
160 The Commission notes that it proposes to
move the language of existing § 37.7, which
generally prohibits a SEF from using a participant’s
proprietary data or personal information that it
collects or receives for regulatory purposes for
business or marketing purposes, to a new § 37.504.
See infra Section X.D.—§ 37.504—Prohibited Use of
Data Collected for Regulatory Purposes.
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respective asset classes; 161 (ii) an
executed copy of all agreements
between the applicant and those SDRs;
and (iii) a representation from each of
those SDRs stating that the applicant
has satisfactorily completed all
requirements, including all necessary
testing, that enables the SDR to reliably
accept data from the applicant. These
requirements reflect some of the
documents that the Commission has
required applicants to submit under
existing Exhibit N and would enable the
Commission to determine the
applicant’s ability to comply with
§ 37.901, which requires a SEF to report
swap data pursuant to parts 43 and 45
of the Commission’s regulations.162
Seventh, the Commission proposes a
new Exhibit N to incorporate the
requirements in existing Exhibit T
related to an applicant’s ability to
submit swaps to a DCO for clearing.
New Exhibit N would require the
applicant to submit (i) a list of DCOs
and exempt DCOs to which the
applicant will submit swaps for
clearing, including the respective asset
classes; (ii) a representation that the
clearing members of those DCOs and
exempt DCOs will guarantee all trades
submitted by the swap execution facility
for clearing; (iii) an executed copy of the
clearing agreement and any related
documentation for each of those DCOs
or exempt DCOs; and (iv) a
representation from each of those DCOs
or exempt DCOs stating that the
applicant has satisfactorily completed
all requirements, including all necessary
testing, that enable its acceptance of
swap transactions submitted by the
applicant for clearing. These
requirements reflect some of the
documents that the Commission has
required applicants to submit under
existing Exhibit N and would enable the
Commission to determine an applicant’s
ability to comply with proposed
§ 37.702(b)(1) under Core Principle 7,
which requires a SEF to coordinate with
each DCO to facilitate ‘‘prompt,
efficient, and accurate’’ processing and
routing of transactions to the DCO for
clearing.163
Eighth, the Commission proposes a
new Exhibit O to require an applicant to
submit all other agreements or contracts
that enable the applicant to comply with
the applicable SEF core principles and
are not already required to be submitted
161 The Commission notes that the reference to a
Commission-registered SDR in Exhibit M also
includes a provisionally-registered SDR.
162 17 CFR 37.901.
163 For a discussion of the relevant proposed
amendments to the Core Principle 7 regulations, see
infra Section XII.B.—§ 37.702—General Financial
Integrity.
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under new Exhibits L, M, N, or Q.164 In
conjunction with these other exhibits,
new Exhibit O matches the scope of
documents that an applicant is currently
required to submit under existing
Exhibit N.165
Ninth, the Commission proposes to
adopt several changes to existing
Exhibit Q.166 This exhibit currently
requires an applicant to provide an
explanation of how its trading system(s)
or platform(s) satisfy the Commission’s
rules, interpretations, and guidelines
concerning SEF execution methods.
Where applicable, paragraphs (a) and (b)
of Exhibit Q specify that the explanation
should include various details related to
the minimum trade functionality
requirement under § 37.3(a)(2), i.e., an
Order Book, and the prescribed
execution methods for Required
Transactions under § 37.9, i.e., an Order
Book or an RFQ System. As discussed
below, the Commission is proposing to
eliminate these requirements and to
allow SEFs to offer flexible means of
execution,167 subject to certain tradingrelated rules under proposed
§ 37.201(a).168 Accordingly, the
Commission proposes conforming
changes to Exhibit Q. In addition to the
explanation of the applicant’s trading
system(s) or platform(s), the
Commission also proposes to require an
applicant to provide screenshots of any
of its trading system(s) or platform(s).
Based on the Commission’s experience,
these screenshots provide a useful
164 Exhibit Q requires an applicant to complete
and submit the Program of Risk Analysis and
Oversight Technology Questionnaire. Among other
things, the questionnaire requires an applicant to
provide any agreements with third-party IT
providers. See infra Section XIX.B.—§ 37.1401(g)—
Program of Risk Analysis and Oversight Technology
Questionnaire.
165 Given this new proposed exhibit, the
Commission proposes to re-designate existing
Exhibit O as a new Exhibit K. The content of the
exhibit would remain the same and require an
applicant to submit a copy of a compliance manual
and documents that describe how the applicant will
conduct trade practice, market, and financial
surveillance.
166 The Commission also proposes to re-designate
existing Exhibit Q as a new Exhibit P based on the
proposed changes described above.
167 See infra Section IV.I.—§ 37.9—Methods of
Execution for Required and Permitted Transactions;
§ 37.10—Process for a Swap Execution Facility to
Make a Swap Available to Trade; § 37.12—Trade
Execution Compliance Schedule; § 38.11—Trade
Execution Compliance Schedule; § 38.12—Process
for a Designated Contract Market to Make a Swap
Available to Trade.
168 Proposed § 37.201(a) would require a SEF to
establish rules that govern the operation of the SEF,
including rules that specify (i) the protocols and
procedures for trading and execution; (ii) the use of
discretion in facilitating trading and execution; and
(iii) the sources and methodology for generating any
market pricing information. See infra Section
VI.A.1.—§ 37.201(a)—Required Swap Execution
Facility Rules.
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supplement to evaluate any explanation
provided under this exhibit.
Finally, the Commission proposes to
consolidate existing Exhibit S, which
currently requires a discussion of how
the applicant will maintain trading data,
into new Exhibit K (re-designated from
existing Exhibit O). Exhibit K would
require an applicant to submit a copy of
its compliance manual and documents
that describe how the applicant will
conduct trade practice, market, and
financial surveillance.
(4) Form SEF Exhibits—Operational
Capability
The Commission proposes to redesignate existing Exhibit V, which
requires the applicant to provide
information pertaining to its program of
risk analysis and oversight via the
Technology Questionnaire, as a new
Exhibit Q and to adopt non-substantive
amendments to the exhibit’s existing
language.169 Additionally, the
Commission is making certain
amendments to update the
questionnaire, as described below.170
(5) Other Form SEF Amendments
In addition to the proposed
amendments to the existing exhibits, the
Commission is proposing several
changes to the Form SEF instructions.
Form SEF currently requires applicants
to include a Table of Contents that lists
each exhibit submitted as part of the
application. In lieu of a separate list
provided via existing Exhibit U, the
Commission proposes to require that
applicants designate, in the Table of
Contents, the exhibits that are subject to
a request for confidential treatment. The
Commission also proposes to require
that any such confidential treatment be
reflected by some type of identifying
number and code on the appropriate
exhibit(s), similar to the approach
followed for DCO applications and
Form DCO.171 Further, the Commission
proposes to eliminate the existing
instruction for newly-formed applicants
regarding pro forma financial
statements, which the Commission
proposes to incorporate in paragraph (a)
of new Exhibit G.
169 As discussed below, the Commission is
proposing § 37.1401(g) to require a SEF to annually
prepare and submit an up-to-date Technology
Questionnaire to Commission staff. See infra
Section XIX.B.—§ 37.1401(g)—Program of Risk
Analysis and Oversight Technology Questionnaire.
170 See infra Section XIX.B.—§ 37.1401(g)—
Program of Risk Analysis and Oversight Technology
Questionnaire.
171 The Commission also proposes to specify in
the Form SEF instructions that an applicant must
file a confidentiality request in accordance with
§ 145.9 of the Commission’s regulations.
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The Commission also proposes two
minor amendments related to the Form
SEF cover sheet. First, to enable the
Commission to evaluate a SEF’s
compliance with ongoing filing
requirements more readily, the
Commission proposes to require an
applicant to specify its fiscal year-end
date.172 Second, the Commission
proposes to eliminate the reference to
the use of Form SEF to amend an
existing order or registration, in
conformance with the proposed
amendment to § 37.3(b)(3) discussed
further below.173
(6) Request for Legal Entity Identifier
The Commission proposes to
eliminate the requirement that an
applicant request a ‘‘unique, extensible,
alphanumeric code’’ from the
Commission under § 37.3(b)(1)(iii) and
to require instead that the applicant
obtain a legal entity identifier (‘‘LEI’’).
The Commission adopted part 37 prior
to the establishment of the technical
specification and governance
mechanism for a global entity identifier.
Since that adoption, a 20-digit
alphanumeric LEI has been developed
and adopted by many regulatory
authorities in other jurisdictions, as well
as the Commission, for use in
identifying counterparties and other
entities pursuant to various regulatory
reporting requirements, including part
45 of the Commission’s regulations.174
Request for Comment
The Commission requests comments
on all aspects of the proposed
amendments to § 37.3(b)(1) and
Appendix A to part 37.
172 The Commission notes that these ongoing
filing requirements include (i) a fiscal year-end
financial report that a SEF would be required to file
within ninety days after the end of its fourth fiscal
quarter under proposed § 37.1306(d), see infra
Section XVIII.F.4.—§ 37.1306(d); (ii) proposed
Exhibit Q of Form SEF, i.e., the Program of Risk
Analysis and Oversight Technology Questionnaire
that a SEF would be required to file within ninety
days after the end of its fiscal year under proposed
§ 37.1401(g), see infra Section XIX.B.—
§ 37.1401(g)—Program of Risk Analysis and
Oversight Technology Questionnaire; and (iii) an
annual compliance report that a SEF would be
required to file within ninety days after the end of
its fiscal year under proposed § 37.1501(e)(2), see
infra Section XX.A.5.—§ 37.1501(e)—Submission of
Annual Compliance Report and Related Matters.
173 See infra Section IV.C.3.d.—§ 37.3(b)(3)—
Amendment of Application for Registration.
174 The Commission notes that applicants may
obtain an LEI from an LEI-issuing organization that
has been accredited by the Global Legal Entity
Identifier Foundation (‘‘GLEIF’’). GLEIF, About
LEI—Get an LEI: Find LEI Issuing Organizations,
https://www.gleif.org/en/about-lei/get-an-lei-findlei-issuing-organizations.
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c. § 37.3(b)(2)—Request for Confidential
Treatment
The Commission is not proposing any
amendments to § 37.3(b)(2).
d. § 37.3(b)(3)—Amendment of
Application for Registration 175
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Section 37.3(b)(3) specifies that an
applicant amending a pending
application or requesting an amendment
to a registration order must file an
amended application with the Secretary
of the Commission in the manner
specified by the Commission. The Form
SEF instructions correspond to this
requirement and currently specify that
requests for amending a registration
order and any associated exhibits must
be submitted via Form SEF. Section
37.3(b)(3) otherwise specifies that a SEF
must file any amendment to its
application subsequent to registration as
a submission under part 40 of the
Commission’s regulations, or as
specified by the Commission.176 In the
preamble to SEF Core Principles Final
Rule, the Commission also stated that if
any information provided in a Form SEF
is or becomes inaccurate for any reason,
even after registration, the SEF ‘‘must
promptly make the appropriate
corrections with the Commission.’’ 177
The Commission proposes to clarify
and amend the requirements regarding
post-registration amendments to both
Form SEF exhibits and registration
orders. First, the Commission proposes
to amend § 37.3(b)(3) and Form SEF to
eliminate the required use of Form SEF
to request an amended order of
registration from the Commission.178
Under current practice, SEFs file a
request for an amended order with the
Commission rather than submitting
Form SEF. Commission staff typically
will review the request, obtain
additional information from the SEF
where necessary, and subsequently
recommend to the Commission whether
to grant or deny the amended order.
Given current practice, the Commission
believes that an updated Form SEF is
not needed to request an amended order
of registration.
175 The Commission proposes to retitle
§ 37.3(b)(3) to ‘‘Amendment of application for
registration’’ from ‘‘Amendment of application prior
or subsequent to full registration’’ based on the
proposed changes described below.
176 17 CFR 37.3(b)(3). Part 40 governs the
submission of new products, rules and rule
amendments for registered entities, including a
process for the voluntary submission of rules for
Commission review and approval under § 40.5 and
a process for the self-certification of rules under
§ 40.6. 17 CFR 40.5–6.
177 SEF Core Principles Final Rule at 33485.
178 See infra Section IV.C.4.—§ 37.3(c)—
Amendment to an Order of Registration.
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Second, the Commission proposes to
eliminate the existing language that
specifies the use of part 40 to file
application amendments subsequent to
registration. The Commission
emphasizes that not all of the
information from the Form SEF exhibits
need to be updated pursuant to part 40
subsequent to registration; certain part
37 provisions already require SEFs to
update their information on an ongoing
basis. For example, under § 37.1306, a
SEF is required to file updated financial
reports, including fiscal year-end
reports, which precludes the need to
amend and file new Exhibit G (existing
Exhibit I) through part 40. The
Commission clarifies that part 40 only
applies to information from application
exhibits that constitute a ‘‘rule,’’ as
defined under § 40.1(i).179 Therefore,
registered SEFs have already been
submitting changes to these types of
documentation pursuant to the part 40
rule filing procedures. Given that part
40 defines ‘‘rule,’’ the existing language
is not required to be included under
proposed § 37.3(b)(3). If certain
information from the Form SEF exhibits
are not required to be updated through
other part 37 provisions or part 40, then
a SEF does not have to file those
amendments subsequent to registration.
The Commission notes, however, that it
may otherwise request information
related to a SEF’s business pursuant to
§ 37.5(a).180
Request for Comment
The Commission requests comments
on all aspects of the proposed
amendments to § 37.3(b)(3).
e. § 37.3(b)(4)—Effect of Incomplete
Application
The Commission is not proposing any
amendments to § 37.3(b)(4).
179 ‘‘Rule’’ is defined under § 40.1(i) as any
constitutional provision, article of incorporation,
bylaw, rule, regulation, resolution, interpretation,
stated policy, advisory, terms and conditions,
trading protocol, agreement or instrument
corresponding thereto, including those that
authorize a response or establish standards for
responding to a specific emergency, and any
amendment or addition thereto or repeal thereof,
made or issued by a registered entity or by the
governing board thereof or any committee thereof,
in whatever form adopted. 17 CFR 40.1(i). The
Commission generally interprets the § 40.1(i) rule
definition broadly to encompass governance
documentation (proposed Exhibit C); fees (proposed
Exhibit H); rulebooks (proposed Exhibit J);
compliance manuals (proposed Exhibit K);
participant agreements (proposed Exhibit L); SDRrelated agreements (proposed Exhibit M); clearingrelated agreements (proposed Exhibit N); other
third-party agreements (proposed Exhibit O); and
information related to execution methods (proposed
Exhibit P).
180 17 CFR 37.5(a).
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f. § 37.3(b)(5)—Commission Review
Period
Based on the elimination of the
temporary registration regime under
existing § 37.3(c), the Commission
proposes to amend the existing
provision to eliminate related language
and specify that the Commission
reviews a SEF registration application
pursuant to a 180-day timeframe and the
procedures specified in CEA section
6(a).
g. § 37.3(b)(6)—Commission
Determination
The Commission is not proposing any
amendments to § 37.3(b)(6).
4. § 37.3(c)—Amendment to an Order of
Registration
Consistent with existing Commission
practice and the proposal to eliminate
the use of Form SEF to request an
amended registration order, the
Commission proposes a new § 37.3(c)—
‘‘Amendment to an order of
registration’’—to establish a separate
process for such requests.181 A SEF
would be required to submit its request
electronically in the form and manner
specified by the Commission.182 Similar
to the procedures set forth for the
registration application process, a SEF
would be required to provide the
Commission with any additional
information and documentation
necessary to review a request. The
Commission would issue an amended
order if the SEF would continue to
maintain compliance with the Act and
the Commission’s regulations after such
amendment. Further, the Commission
may also issue an amended order
subject to conditions. The Commission
also proposes to specify that it may
decline to issue an amended order based
upon a determination that the SEF
would not continue to maintain
compliance with the Act and the
Commission’s regulations upon such
amendment.
Request for Comment
The Commission requests comments
on all aspects of proposed § 37.3(c).
5. § 37.3(d)—Reinstatement of Dormant
Registration
The Commission is not proposing any
amendments to § 37.3(d).
181 See supra Section IV.C.3.d.—§ 37.3(b)(3)—
Amendment of Application for Registration.
182 The Commission proposes to eliminate
existing § 37.3(c), which establishes the temporary
SEF registration process that is no longer available
to applicants, as described above. See supra Section
IV.C.3.a.—Elimination of Temporary Registration.
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6. § 37.3(e)—Request for Transfer of
Registration
Section 37.3(e) establishes
requirements that a SEF must follow
when seeking to transfer its registration
from its current legal entity to a new
legal entity as a result of a corporate
change.183 Among these requirements,
§ 37.3(e)(2) requires a SEF to file a
transfer request no later than three
months prior to the anticipated
corporate change, or if not possible, as
soon as it knows of the change.184
Section 37.3(e)(3) requires a transfer
request to include certain information,
such as the transferee’s governing
documents under § 37.3(e)(3)(iv).185
Under § 37.3(e)(3)(vi), the request must
also include certain representations
from a transferee, including
representations that it will (i) retain and
assume, without limitation, all of the
assets and liabilities of the transferor;
(ii) assume responsibility for complying
with the Act and the Commission’s
regulations; (iii) assume, maintain, and
enforce all of the transferor’s rules that
are applicable to SEFs, including the
transferor’s rulebook and any
amendments; (iv) comply with all selfregulatory responsibilities, including
maintaining and enforcing all selfregulatory programs; and (v) notify
market participants of all changes to the
rulebook prior to the transfer, as well as
the transfer and issuance of a
corresponding order by the
Commission.186 Under § 37.3(e)(3)(vii),
the transfer request must also include a
representation from the transferee that
upon the transfer, it will assume
responsibility for and maintain
compliance with the SEF core
principles for all swaps previously
made available for trading through the
transferor; and that none of the
proposed rule changes will affect the
rights and obligations of any market
participant.187
The Commission proposes several
non-substantive amendments to
streamline the existing requirements
under § 37.3(e) for filing a transfer
request. First, the Commission proposes
to simplify the timeline for filing a
request by requiring that a SEF file the
request ‘‘as soon as practicable,’’ rather
than no later than three months prior to
the anticipated corporate change or as
soon as it knows of such a change, if
183 17
CFR 37.3(e).
CFR 37.3(e)(2).
185 17 CFR 37.3(e)(3).
186 17 CFR 37.3(e)(3)(vi).
187 17 CFR 37.3(e)(3)(vii).
184 17
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less than three months prior to the
change.188
Second, with respect to the required
information in a transfer request, the
Commission also proposes to
specifically reference other types of
governing documents that would be
adopted by transferees, such as a limited
liability agreement or an operating
agreement.189 This proposed change
acknowledges that a transferee of a
SEF’s registration may be a noncorporate entity, such as a limited
liability company or partnership.
Third, the Commission proposes to
simplify a transferee’s compliancerelated representations under
§ 37.3(e)(3)(vi). The Commission
proposes to consolidate and eliminate
unnecessary language; 190 and eliminate
the existing requirement that the
transferee attest that it will assume,
maintain, and enforce compliance with
the SEF core principles, as well as
maintain and enforce self-regulatory
programs.191 The Commission notes that
the language that it proposes to delete
is otherwise duplicative to
§ 37.3(e)(3)(vi)(B), which generally
requires the transferee to represent that
it will assume responsibility for
compliance with all applicable
provisions of the Act and the
Commission’s regulations. Further, the
Commission proposes to eliminate the
existing requirement under
§ 37.3(e)(3)(vii)(A) that a transferee
represent that it will continue to comply
with the SEF core principles for all
swaps made available for trading
through the transferor. The Commission
notes that all SEFs, whether or not a
transferee, must comply with the Act
and Commission regulations, including
all requirements applicable to a SEF’s
listed swaps.
Fourth, the Commission proposes to
amend § 37.3(e) to better reflect the
practical realities of the transfer process.
188 The Commission proposes to adopt this
amendment under § 37.3(e)(2).
189 The Commission proposes to adopt this
amendment under § 37.3(e)(3)(iv). The Commission
recognizes that different types of entities are
established and governed by different types of
documentation. For example, a corporation is
formed based on articles of incorporation and
operates pursuant to bylaws; a limited liability
company is generally established pursuant to
articles of organization and operates pursuant to an
operating agreement; and a limited partnership is
generally formed based on a limited partnership
agreement. Based on the proposed amendments to
§ 37.3(e)(iv), the Commission also proposes to
amend § 37.3(e)(3)(i) by changing the word
‘‘agreement’’ to ‘‘documentation.’’
190 The Commission proposes to consolidate
existing clauses (B) and (D) into a new proposed
clause (B).
191 The Commission proposes to eliminate this
requirement under existing clause (C) and renumber
existing clause (E) as clause (C).
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Rather than require a transferee to
represent that it will retain and assume
all the assets and liabilities of the
transferor without limitation, the
Commission proposes to instead require
that the transferee state in the request
when it would not do so.192 In addition,
rather than require a transferee to
represent that none of a transferee’s
proposed rule changes will affect the
rights and obligations of any market
participant, the Commission proposes
instead to require that the transferee
represent that it will notify market
participants of changes that may affect
their rights and obligations.193 These
amendments would eliminate certain
pre-emptive restrictions upon businessrelated changes associated with the
transfer, but also allow the Commission
to continue reviewing whether such
changes may be inconsistent with the
Act or the Commission’s regulations.
7. § 37.3(f)—Request for Withdrawal of
Application for Registration
The Commission is not proposing any
amendments to § 37.3(f).
8. § 37.3(g)—Request for Vacation of
Registration
The Commission is not proposing any
amendments to § 37.3(g).
9. § 37.3(h)—Delegation of Authority
Given the deletion of the phrase
relating to temporary registration in the
existing paragraph, the Commission
proposes a conforming non-substantive
amendment.
D. § 37.4—Procedures for Implementing
Rules 194
Section 37.4 currently sets forth rules
related to the listing of swap products
and the submission of rules on a preand post-registration basis. Section
37.4(a) specifies that a SEF applicant
may submit the terms and conditions of
swaps that it intends to list for trading
as part of its registration application.195
Section 37.4(b) specifies that any swap
192 The Commission proposes to adopt this
amendment under subparagraph (3)(vi)(A).
193 The Commission proposes to amend the
language of existing subparagraph (3)(vii)(B) and
renumber the provision to subparagraph (3)(vii)(C)
based on the proposed changes described above.
The Commission notes that the transferee’s
notification obligations would not be limited to
those that may affect a market participant’s rights
and obligations; the proposed rule would maintain
the existing requirement that a transferee represent
that it will notify market participants of all changes
to the transferor’s rulebook prior to the transfer.
194 The Commission proposes to retitle § 37.4 to
‘‘Procedures for implementing rules’’ from
‘‘Procedures for listing products and implementing
rules’’ based on the proposed changes described
below.
195 17 CFR 37.4(a).
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terms and conditions or rules submitted
as part of the SEF’s application shall be
considered for approval by the
Commission at the time it issues the
SEF’s registration order.196 Section
37.4(c) specifies that after the
Commission issues a registration order,
the SEF shall submit any proposed swap
terms and conditions, including
amendments to such terms and
conditions, proposed new rules, or
proposed rule amendments, pursuant to
part 40 of the Commission’s
regulations.197 Section 37.4(d) specifies
that any swap terms and conditions or
rules submitted as part of an application
to reinstate a dormant SEF shall be
considered for approval at the time that
the Commission approves the dormant
SEF’s reinstatement of registration.198
The Commission proposes to
eliminate § 37.4(a) and to adopt
conforming amendments to § 37.4(b) to
establish that the Commission’s process
of reviewing the terms and conditions of
a swap product that the applicant
intends to list for trading upon
registration is separate from the review
process of a SEF’s application for
registration.199 As amended, § 37.4(b)
would specify that rules, except swap
product terms and conditions,
submitted by the SEF applicant as part
of a registration application would be
considered for approval at the time the
Commission issues an order of
registration. Upon obtaining an order of
registration, a registered SEF may
formally submit product terms and
conditions under § 40.2 or § 40.3, which
controls the submission of new product
terms and conditions by registered
entities.200 Given that the submission
procedures for rules, including product
terms and conditions, are established
under part 40, the Commission also
proposes to eliminate unnecessary
language by deleting § 37.4(c). The
Commission believes that separating
these two processes would promote
efficiency for both Commission staff and
SEF applicants. For example, a SEF
applicant’s registration order could
otherwise be unnecessarily delayed or
stayed if the SEF applicant submits for
Commission approval, along with its
application for registration, a novel or
196 17
CFR 37.4(b).
CFR 37.4(c).
198 17 CFR 37.4(d).
199 The Commission proposes to renumber
subsection (b) to subsection (a) based on the
proposed amendment as described above.
200 17 CFR part 40. Although an applicant may
not submit swap product terms and conditions for
approval as part of the registration process, the
Commission notes that SEF applicants may
informally discuss any proposed products with
Commission staff for informal feedback as part of
the registration process.
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197 17
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complex product that would require
additional consideration or analysis by
Commission staff.
To conform to the proposed approach
for reviewing swap product terms and
conditions from SEF applicants
described above, the Commission also
proposes to amend § 37.4(d) to delete
the reference to any ‘‘swap terms and
conditions’’ submitted by a dormant
SEF that is applying for reinstatement of
registration.201 Accordingly, dormant
SEFs would not be able to provide
proposed swap product terms and
conditions for approval as part of the
dormant SEF registration reinstatement
process. Upon obtaining a reinstatement
of registration, a SEF may formally
submit product terms and conditions
under § 40.2 or § 40.3, which controls
the submission of new product terms
and conditions by registered entities.
Request for Comment
The Commission requests comments
on all aspects of the proposed
amendments to § 37.4.
E. § 37.5—Provision of Information
Relating to a Swap Execution Facility 202
1. § 37.5(a)—Request for Information
The Commission is not proposing any
amendments to § 37.5(a).
2. § 37.5(b)—Demonstration of
Compliance
The Commission is proposing certain
non-substantive amendments to
§ 37.5(b).
3. § 37.5(c)—Equity Interest Transfer
Section 37.5(c) sets forth notification
requirements related to transfers of
equity interest in a SEF. Section
37.5(c)(1) requires a SEF to notify the
Commission if the SEF enters into a
transaction involving the transfer of fifty
percent or more of the equity interest in
the SEF.203 Section 37.5(c)(2) requires
the SEF to file the notice at the earliest
possible time, but no later than the open
of business ten business days following
the date upon which the SEF enters into
a firm obligation to transfer the equity
interest.204 Upon such a notification, the
Commission may request supporting
documentation of the transaction.205
201 The Commission proposes to renumber
subsection (d) to subsection (b) based on the
proposed amendments as described above.
202 The Commission proposes to retitle § 37.5 to
‘‘Provision of information relating to a swap
execution facility’’ from ‘‘Information relating to
swap execution facility compliance’’ based on the
proposed changes described below.
203 17 CFR 37.5(c)(1).
204 17 CFR 37.5(c)(2).
205 17 CFR 37.5(c)(1). In the SEF Core Principles
Final Rule, the Commission specified the types of
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Where any aspect of the transfer
constitutes a rule as defined under part
40, § 37.5(c)(3) requires a SEF to comply
with the requirements of CEA section
5c(c) and part 40.206
The Commission has previously
stated that in situations where such an
equity transfer occurs, the Commission
has an interest in reviewing and
considering the implications of the
changes in ownership.207 In particular,
the Commission seeks to determine
whether the change in ownership will
adversely impact the operations of the
SEF or the SEF’s ability to comply with
the core principles and the
Commission’s regulations
thereunder.208 Further, the Commission
intended for § 37.5(c) to enable
Commission staff to consider whether
any term or condition contained in an
equity transfer agreement(s) is
inconsistent with the self-regulatory
responsibilities of a SEF or with any of
the core principles.209
The Commission proposes to amend
§ 37.5(c)(1) to require a SEF to file a
notice with the Commission in the event
of any transaction that results in the
transfer of direct or indirect ownership
of fifty percent or more of the equity
interest in the SEF. The Commission
notes that indirect ownership may
transpire, for example, through a
transaction involving a direct or indirect
parent company of the SEF. Section
37.5(c), however, only requires a SEF to
file a notice where the SEF is a party to
a transaction involving a transfer of
direct ownership of fifty percent or
more of the equity interest in the SEF,
but not where the SEF is not a party to
the transaction, or where the transaction
results in a transfer of indirect
ownership of the SEF. The Commission
believes that such transfers implicate
the same regulatory policies underlying
the existing rule and therefore proposes
documentation to include, but not be limited to, (i)
relevant agreement(s); (ii) associated changes to
relevant corporate documents; (iii) a chart outlining
any new ownership or corporate or organization
structure, if available; and (iv) a brief description
of the purpose and any impact of the equity interest
transfer. SEF Core Principles Final Rule at 33490.
The final rule also stated that a SEF must file a
certification regarding its compliance with CEA
section 5h and the Commission’s regulations
thereunder, as set forth in existing § 37.5(c)(4). Id.
206 17 CFR 37.5(c)(3).
207 Core Principles and Other Requirements for
Swap Execution Facilities, 76 FR 1214, 1217 (Jan.
7, 2011) (‘‘SEF Core Principles Proposed Rule’’).
208 Id.
209 Id. In the SEF Core Principles Final Rule, the
Commission raised the provision to 50 percent from
10 percent and maintained a similar policy
rationale, SEF Core Principles Final Rule at 33490,
i.e., to ‘‘ensure that SEFs remain mindful of their
self-regulatory responsibilities when negotiating the
terms of significant equity interest transfers.’’ SEF
Core Principles Proposed Rule at 1217.
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amendments to broaden the
requirement. Based on the proposed
changes described above, the
Commission further proposes
conforming non-substantive
amendments to § 37.5(c)(2)—‘‘Timing of
notification’’—and § 37.5(c)(4)—
‘‘Certification.’’ 210
The Commission further proposes to
streamline § 37.5(c) by deleting
§ 37.5(c)(3)—the Commission notes that
part 40 already applies to SEFs with
respect to rule filings, and therefore, a
separate provision is not necessary to
apply part 40 to SEFs.
Request for Comment
The Commission requests comments
on all aspects of the proposed
amendments to § 37.5(c).
4. § 37.5(d)—Delegation of Authority
The Commission is not proposing any
amendments to § 37.5(d).
F. § 37.6—Enforceability
1. § 37.6(a)—Enforceability of
Transactions
Section 37.6(a) is intended to provide
market participants with legal certainty
with respect to swap transactions on a
SEF and generally clarifies that a swap
transaction entered into on or pursuant
to the rules of a SEF cannot be void,
voidable, subject to recession, otherwise
invalidated, or rendered unenforceable
due to a violation by the SEF of the Act
or applicable Commission regulations or
any proceeding that alters or
supplements a rule, term or condition
that governs such swap or swap
transaction.211
The Commission proposes nonsubstantive amendments to § 37.6(a).212
These amendments include (i)
amending the phrase ‘‘entered into’’ to
‘‘executed’’ to provide greater clarity;
and (ii) eliminating the reference to
swaps executed ‘‘pursuant to the rules
of’’ a SEF, which conforms to the
proposed amendment to the ‘‘block
trade’’ definition under § 43.2,
discussed further below.213
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2. § 37.6(b)—Swap Documentation
Section 37.6(b) requires a SEF to
provide each counterparty to a
transaction with a written
‘‘confirmation’’ that contains all of the
terms of a swap transaction at the time
210 The Commission also proposes to renumber
paragraph (c)(4) to paragraph (c)(3) based on the
proposed elimination of the existing language in
paragraph (c)(3) described below.
211 17 CFR 37.6(a).
212 The Commission also proposes to add a new
title to § 37.6(a)—‘‘Enforceability of transactions.’’
213 See infra Section XXII.—Part 43—§ 43.2—
Definition of ‘‘Block Trade.’’
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of the swap’s execution for both cleared
and uncleared swap transactions,
including (i) ‘‘economic terms’’ that are
specific to a transaction, e.g., swap
product, price, and notional amount;
and (ii) non-specific ‘‘relationship
terms’’ that generally govern all
transactions between two
counterparties, e.g., default provisions,
margin requirements, and governing
law.214 ‘‘Confirmation’’ is defined under
parts 43 and 45 of the Commission’s
regulations as the consummation
(electronically or otherwise) of legally
binding documentation that
memorializes the agreement of the
counterparties to all terms of the swap
(emphasis added).215 The definition also
states that a confirmation shall be in
writing (electronic or otherwise) and
legally supersede any previous
agreement (electronic or otherwise)
relating to the swap.216 The Commission
adopted § 37.6(b), in part, to facilitate
this process for swaps transactions—
both cleared and uncleared—executed
on or pursuant to the rules of a SEF.217
For uncleared swap transactions, the
Commission is aware that many
relationship terms that may govern
certain aspects of an uncleared swap
transaction are often negotiated and
executed between potential
counterparties prior to execution.218
The Commission previously provided
that SEFs may satisfy § 37.6(b) for
uncleared swap transactions by
incorporating by reference the relevant
terms set forth in such agreements, as
long as those agreements have been
submitted to the SEF prior to
execution.219 As applied, § 37.6(b)
requires that the SEF obtain and
incorporate this documentation into the
214 17
CFR 37.6(b).
CFR 43.2; 17 CFR 45.1. See also 17 CFR
23.500 (similar definition of ‘‘confirmation’’ that
applies to swap dealers (‘‘SDs’’) and major swap
participants (‘‘MSPs’’)).
216 17 CFR 43.2; 17 CFR 45.1.
217 SEF Core Principles Final Rule at 33491.
218 SEF Core Principles Final Rule at 33491 n.195.
Swap counterparties have typically relied on the
use of industry-standard legal documentation,
including master netting agreements, definitions,
schedules, and confirmations, to document their
swap trading relationships. This documentation,
such as the ISDA Master Agreement and related
Schedule and Credit Support Annex (‘‘ISDA
Agreements’’), as well as related documentation
specific to particular asset classes, offers a
framework for documenting uncleared swap
transactions between counterparties. See
Confirmation, Portfolio Reconciliation, Portfolio
Compression, and Swap Trading Relationship
Documentation Requirements for Swap Dealers and
Major Swap Participants, 77 FR 55904, 55906 (Sept.
11, 2012). For uncleared swap transactions,
§ 23.504(b) requires written documentation of all
the terms governing the trading relationship
between an SD or MSP and its counterparty. 17 CFR
23.504(b).
219 SEF Core Principles Final Rule at 33491 n.195.
215 17
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issued confirmation, which is intended
in part to provide SEF participants with
legal certainty with respect to uncleared
swap transactions.220
This requirement, however, has
created impractical burdens for SEFs.
Based upon feedback from SEFs, the
Commission understands that SEFs
have encountered many issues in trying
to comply with the requirement for
uncleared swaps, including high
financial, administrative, and logistical
burdens to collect and maintain bilateral
transaction agreements from many
individual counterparties. SEFs have
stated that they are unable to develop a
cost-effective method to request, accept,
and maintain a library of every previous
agreement between counterparties.221
SEFs have also noted that the potential
number of previous agreements is
considerable, given that SEF
counterparties enter into agreements
with many other parties and have
multiple agreements for different asset
classes.222
Commission staff has acknowledged
these technological and operational
challenges and has accordingly granted
time-limited no-action relief.223 Based
on this relief, SEFs have incorporated
220 To ensure that the SEF confirmation provides
legal certainty, the Commission stated that
counterparties choosing to execute a swap
transaction on or pursuant to the rules of a SEF
must have all terms, including possible long-term
credit support arrangements, agreed to no later than
execution, such that the SEF can provide a written
confirmation inclusive of those terms at the time of
execution. SEF Core Principles Final Rule at 33491.
221 Many of these agreements are maintained in
paper form or scanned PDF files that are difficult
to quickly digitize in a cost-effective manner. See
WMBAA, Request for Extended Relief from Certain
Requirements under Parts 37 and 45 Related to
Confirmations and Recordkeeping for Swaps Not
Required or Intended to be Cleared at 3 (Mar. 1,
2016). Further, some SEFs have cited the
considerable resource cost of obtaining the number
of different agreements that exist to accommodate
the different parties and different asset classes. Id.
222 Id.
223 Commission staff provided initial no-action
relief in 2014. CFTC Letter No. 14–108, Re: Staff
No-Action Position Regarding SEF Confirmations
and Recordkeeping Requirements under Certain
Provisions Included in Regulations 37.6(b) and 45.2
(Aug. 18, 2014). Commission staff has since
extended this no-action relief on several occasions.
See CFTC Letter No. 17–17, Re: Extension of NoAction Relief for Swap Execution Facility
Confirmation and Recordkeeping Requirements
under Commodity Futures Trading Commission
Regulations 37.6(b), 37.1000, 37.1001, 45.2, and
45.3(a) (Mar. 24, 2017); CFTC Letter No. 16–25, Re:
Extension of No-Action Relief for Swap Execution
Facility Confirmation and Recordkeeping
Requirements under Commodity Futures Trading
Commission Regulations 37.6(b), 37.1000, 37.1001,
45.2, and 45.3(a) (Mar. 14, 2016); CFTC Letter 15–
25, Re: Extension of No-Action Relief for SEF
Confirmation and Recordkeeping Requirements
under Commission Regulations 37.6(b), 37.1000,
37.1001, and 45.2, and Additional Relief for
Confirmation Data Reporting Requirements under
Commission Regulation 45.3(a) (Apr. 22, 2015).
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applicable relationship terms from
previous agreements by reference in the
confirmation without obtaining copies
of these agreements prior to the
execution of a swap.224 SEFs, however,
still must memorialize the relationship
terms contained in separate, previouslynegotiated agreements that the SEF has
not reviewed at the time of
incorporation, and would likely not
review post-execution. One industry
participant, however, noted that a SEF
would not be familiar with the terms of
the agreements that it is required to
incorporate by reference into a
confirmation.225
Based on its experience with the part
37 implementation, the Commission
acknowledges that cleared and
uncleared swaps raise different issues
with respect to confirmation
requirements and the current SEF
requirements create difficulties for the
latter type of swap transaction.
Therefore, the Commission is proposing
a revised approach to § 37.6(b) as
described below.
a. § 37.6(b)(1)—Legally Binding
Documentation
The Commission proposes
§§ 37.6(b)(1)(i)–(ii) to establish separate
swap transaction documentation
requirements for cleared and uncleared
swaps. Proposed § 37.6(b)(1)(i)(A)
would apply the existing confirmation
requirement—that a SEF must issue a
written confirmation that includes all of
the terms of the transaction—to cleared
swap transactions. The Commission
further proposes to define ‘‘confirmation
document’’ under § 37.6(b)(1)(i)(B) as a
legally binding written documentation
that memorializes the agreement to all
terms of a swap transaction and legally
supersedes any previous agreement that
relates to the swap transaction between
the counterparties.
With respect to uncleared swap
transactions the Commission proposes a
revised approach under § 37.6(b)(1)(ii)
that would require a SEF to provide the
counterparties to an uncleared swap
transaction with a ‘‘trade evidence
record’’ that memorializes the terms of
the swap transaction agreed upon
between the counterparties on the SEF.
In contrast to a cleared swap
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224 Id.
225 See SIFMA Asset Management Group, Re:
Straight-Through Processing, Swap Execution
Facility Implementation and Relief Relating to the
Aggregation Provision in Final Block Trade Rule at
6 n.14 (Oct. 25, 2013) (stating that ‘‘it is highly
impractical for a SEF to familiarize itself with the
often complex, bespoke master agreement and trade
terms (and the various documents that may be
incorporated by reference) in order to produce a
customized, potentially complex confirmation on a
trade by trade basis.’’).
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confirmation, the trade evidence record
would not be required to include all of
the terms of the swap transaction,
including relationship terms contained
in underlying documentation between
the counterparties. As defined under
proposed § 37.6(b)(1)(ii)(B), a trade
evidence record means a legally binding
written documentation that
memorializes the terms of a swap
transaction agreed upon by the
counterparties and legally supersedes
any conflicting term in any previous
agreement that relates to the swap
transaction between the counterparties.
The Commission anticipates that these
terms would include, at a minimum, the
‘‘economic terms’’ that are agreed upon
between the counterparties to a specific
SEF transaction, e.g., trade date,
notional amount, settlement date, and
price.
The Commission believes that the
proposed rule would provide SEFs with
a simplified approach to comply with
the legal documentation requirement,
but also continue to promote the policy
objective of § 37.6(b) by providing SEF
participants with legal certainty with
respect to both cleared and uncleared
swap transactions. Further, the
proposed approach accommodates
existing counterparty trading practices
for uncleared swaps, particularly the
use of separate, previously-negotiated
underlying agreements to establish
relationship terms that generally govern
the trading relationship, as opposed to
a specific transaction, between two
counterparties. To the extent that such
terms either are agreed upon between
the counterparties in underlying
documentation established away from
the SEF and continue to govern the
transaction post-execution or are not
required to establish legal certainty for
a specific transaction, a SEF would not
be required to incorporate those terms
into a trade evidence record. The
proposed approach should address the
challenges that have prevented SEFs
from fully complying with § 37.6(b) by
reducing the administrative burdens for
SEFs, who would not be required to
obtain, incorporate, or reference those
previous agreements, and for
counterparties, who would not be
required to submit all of their relevant
documentation with other potential
counterparties to the SEF.226
226 The Commission acknowledges that the
issuance of a trade evidence record would not alter
the other obligations of a SEF or the counterparties
under the CEA and the Commission’s regulations.
For example, a SEF would still be required to report
all required swap creation data under § 45.3(a), as
applicable. 17 CFR 45.3(a). Further, a counterparty
that is a swap dealer or major swap participant
would also still be required to transmit a
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Request for Comment
The Commission requests comments
on all aspects of proposed § 37.6(b)(1).
In particular, the Commission is
particularly interested in the prescribed
contents and legal import of a trade
evidence record and requests comment
on the following questions:
(19) Should the Commission allow a
SEF to issue a trade evidence record that
does not include all the terms of a swap
transaction agreed to on the SEF?
(20) Should the Commission require a
SEF to include a minimum set of terms
in a trade evidence record, e.g., material
economic terms? Should the
Commission specify those terms in the
proposed regulation?
(21) Should the Commission require a
SEF to include any of the ‘‘primary
economic terms,’’ as defined under
§ 45.1, in a trade evidence record? If so,
which terms should be included?
(22) Should the Commission specify
that a trade evidence record (i) serves as
evidence of a legally binding agreement
upon the counterparties; and (ii) legally
supersedes any previous agreement,
rather than any conflicting term in any
previous agreement, as proposed? With
respect to (i), are there terms that are
generally contained within previouslynegotiated, underlying agreements
between the counterparties that are
necessary to make a transaction legally
binding, and therefore must be
submitted to the SEF?
(23) Should the Commission specify
in its regulations that notwithstanding
the trade evidence record requirement,
a SEF is allowed to incorporate by
reference underlying, previous
agreements containing terms governing
a swap transaction into any trade
evidence record associated with the
transaction?
(24) Do proposed §§ 37.6(b)(1)(i)–(ii)
provide sufficient legal certainty with
respect to any contradictory terms that
may be contained within the previous
agreements?
b. § 37.6(b)(2)—Requirements for Swap
Documentation
Section 37.6(b) requires that the
confirmation take place at the same time
as execution, except for a limited
exception for certain information for
bunched orders.227 The Commission
proposes § 37.6(b)(2)(i) to amend this
requirement and instead require a SEF
to provide a confirmation document or
trade evidence record to the
counterparties to a transaction ‘‘as soon
as technologically practicable’’ after the
confirmation pursuant to § 23.501, as applicable. 17
CFR 23.501.
227 17 CFR 37.6(b).
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execution of the swap transaction on the
SEF.228
The Commission recognizes that a
strict implementation of the existing
requirement is not practical from a
temporal standpoint, given that a SEF’s
issuance of a written confirmation
document or trade evidence record
would only occur upon execution by
counterparties.229 Further, the required
issuance of a written confirmation
document or trade evidence record
simultaneous with execution may
become further impracticable for some
SEFs from an operational and
technological standpoint based on the
different trading systems or platforms
that SEFs may offer under a more
flexible approach to execution methods
proposed by the Commission.230
Therefore, proposed § 37.6(b)(2)(i) is
intended to establish a more practical
approach that accommodates different
types of SEF operations. The
Commission believes that the proposed
standard—‘‘as soon as technologically
practicable’’—would also continue to
promote the Commission’s goals of
providing the swap counterparties with
legal certainty in a prompt manner.
Based on this proposed amendment to
the existing language of § 37.6(b), the
Commission also proposes to renumber
the existing requirement regarding
bunched orders to proposed
§ 37.6(b)(2)(ii) and adopt nonsubstantive amendments.
As noted, § 37.6(b) requires a SEF to
provide the written confirmation of a
transaction executed on or pursuant to
the SEF’s rules to ‘‘each counterparty to
[the] transaction.’’ The Commission
proposes to add § 37.6(b)(2)(iii) to
provide that a SEF may issue a
confirmation document or trade
evidence record to the intermediary
trading on behalf of a counterparty,
provided that the SEF establish and
enforce rules to require any
228 The Commission notes that in the context of
real-time public reporting, it has defined ‘‘as soon
as technologically practicable’’ to mean as soon as
possible, taking into consideration the prevalence,
implementation and use of technology by
comparable market participants. 17 CFR 43.2. The
meaning of this term, as proposed in § 37.6(b)(2)(i)
herein, would be consistent with this definition.
229 The Commission notes that a public
commenter previously cited execution and
confirmation as two separate processes in the swap
transaction process. SEF Core Principles Final Rule
at 33491 (comment from the Energy Working Group
that execution and confirmation are ‘‘distinct steps’’
in the swap transaction process).
230 See infra Section IV.I.—§ 37.9—Methods of
Execution for Required and Permitted Transactions;
§ 37.10—Process for a Swap Execution Facility to
Make a Swap Available to Trade; § 37.12—Trade
Execution Compliance Schedule; § 38.11—Trade
Execution Compliance Schedule; § 38.12—Process
for a Designated Contract Market to Make a Swap
Available to Trade.
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intermediary to transmit any such
document or record to the counterparty
as soon as technologically practicable.
Based on industry practice, the
Commission notes that to the extent that
intermediaries, acting on behalf of swap
participants, facilitate swap execution
on a SEF, the SEF transmits the written
confirmation to the intermediary and
then requires the intermediary to
forward the confirmation to its
customer. The Commission understands
that participants using intermediaries to
trade on a SEF may not establish the
appropriate connectivity necessary to
receive written confirmations directly
from the SEF. Requiring the
intermediary to transmit the document
or record as soon as technologically
practicable would further accommodate
current market practices, as discussed
above.
Request for Comment
The Commission requests comments
on all aspects of proposed § 37.6(b)(2).
In particular, the Commission requests
comment on the following questions:
(25) Is the Commission’s proposal, to
require a SEF to transmit confirmation
documents or trade evidence records to
counterparties ‘‘as soon as
technologically practicable’’ after the
execution of the swap transaction on the
SEF an appropriate time frame? Should
the Commission require that the SEF
issue the confirmation document or
trade evidence record within a specified
time limit?
(26) Is the Commission’s proposal to
require a SEF to establish and enforce
rules that require an intermediary acting
on behalf of a counterparty to transmit
a confirmation document or trade
evidence record to such counterparty
‘‘as soon as technologically practicable’’
an appropriate time frame? Should the
Commission require that the SEF issue
the confirmation document or trade
evidence record within a specified time
limit?
(27) Should the Commission define
‘‘as soon as technologically practicable’’
in a similar manner to the definition in
part 43?
G. § 37.7—Prohibited Use of Data
Collected for Regulatory Purposes
The Commission proposes to move
and amend § 37.7, which prohibits a
SEF from using proprietary or personal
information that it collects or receives to
fulfill regulatory obligations for business
or marketing purposes, as a new
§ 37.504 under the Core Principle 5
(Ability to Obtain Information)
regulations. The Commission discusses
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the proposed amendments to the
existing requirements further below.231
H. § 37.8—Boards of Trade Operating
Both a Designated Contract Market and
a Swap Execution Facility 232
Section 37.8(a) requires an entity that
operates as both a DCM and a SEF to
separately register with the Commission
in accordance with the procedures set
forth under part 38 and part 37 of the
Commission’s regulations, respectively.
Section 37.8(a) further requires that a
dually-registered entity comply with the
respective DCM and SEF core principles
and regulations on an ongoing basis.
The Commission notes that the
language is superfluous to the similar
requirements that already exist under
§ 38.2 and § 37.2 for DCMs and SEFs,
respectively, and therefore proposes to
delete this latter requirement. The
Commission notes, however, that this is
not a substantive change and DCMs and
SEFs must otherwise comply with the
Act and applicable regulations.
I. § 37.9—Methods of Execution for
Required and Permitted Transactions;
§ 37.10—Process for a Swap Execution
Facility To Make a Swap Available to
Trade; § 37.12—Trade Execution
Compliance Schedule; § 38.11—Trade
Execution Compliance Schedule;
§ 38.12—Process for a Designated
Contract Market To Make a Swap
Available To Trade
The CEA, as amended by the DoddFrank Act, requires the Commission to
develop and implement a regulatory
framework for trading swaps on
registered SEFs and establishes a
corresponding trade execution
requirement that requires certain swaps
to be executed on DCMs, SEFs, or
Exempt SEFs.233 The regulatory
framework that the Commission
developed to implement these
provisions prescribes, among other
things, (i) a process that allows SEFs
and DCMs to initiate determinations of
which swaps should be subject to the
CEA section 2(h)(8) trade execution
requirement, i.e., the MAT process; and
(ii) the methods of execution that must
be used for swaps that are subject to the
trade execution requirement. In
addition, the framework permits SEFs to
offer any method of execution for swaps
231 See infra Section X.D.—§ 37.504—Prohibited
Use of Data Collected for Regulatory Purposes.
232 The Commission proposes to renumber § 37.8
to § 37.7 based on the proposed changes described
above.
233 7 U.S.C. 2(h)(8). Although the trade execution
requirement may be satisfied through DCMs, the
Commission’s discussion of the trade execution
requirement in this proposed rulemaking will
generally pertain to SEFs, unless otherwise noted.
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that are not subject to the trade
execution requirement.
The Commission adopted this
framework in part to achieve the SEF
statutory goals in CEA section 5h(e) of
promoting trading on SEFs and
promoting pre-trade transparency in the
swaps market. The Commission
acknowledges that the existing
framework has transitioned some swaps
trading and market participants to SEFs.
Since 2013, however, the Commission
has gained considerable knowledge and
experience with swaps trading
dynamics through implementing part
37, particularly with respect to the
required use of certain execution
methods. Based on that knowledge and
experience, the Commission believes
that certain aspects of the current SEF
regulatory framework should be
enhanced to further promote the
statutory SEF goals and better maximize
the role of SEFs as vibrant and liquid
marketplaces for swaps trading.
Accordingly, the Commission is
proposing two revisions to the current
framework. First, the Commission
proposes to adopt a revised
interpretation of CEA section 2(h)(8) to
set the applicability of the trade
execution requirement, i.e., swaps
subject to the clearing requirement and
listed for trading by a SEF or DCM
would be subject to the requirement.
Instead of maintaining the current MAT
determination process, the Commission
believes that this proposed approach
would be better aligned with the intent
of CEA section 2(h)(8) and further the
statutory goal of promoting swaps
trading on SEFs. As applied to the
current scope of swaps that are subject
to the clearing requirement and listed
for trading by SEFs and DCMs, the
Commission anticipates that this
approach would significantly expand
the scope of swaps that are subject to
the trade execution requirement.
Second, based on its understanding of
swaps trading dynamics and the
increased scope of swaps that would
become subject to the trade execution
requirement, the Commission also
proposes to allow greater flexibility in
the trading of such swaps by eliminating
the prescribed execution methods for
swaps subject to the requirement.
1. Trade Execution Requirement and
MAT Process
The trade execution requirement
mandates counterparties to execute
swap transactions subject to the clearing
requirement on a SEF or DCM, unless
no SEF or DCM ‘‘makes the swap
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available to trade.’’ 234 The Commission
adopted § 37.10 and § 38.12 to establish
a ‘‘MAT determination’’ process that
allows SEFs and DCMs, respectively, to
make swaps ‘‘available to trade,’’ and
therefore, subject to the trade execution
requirement.235 These processes enable
a SEF or DCM to make a swap
‘‘available to trade’’ by submitting a
determination to the Commission
pursuant to the part 40 rule filing
procedures.236 A SEF or DCM that
submits a MAT determination must
include an assessment of whether the
subject swap has ‘‘sufficient trading
liquidity’’ and must address at least one
of six factors that serve as indicia of the
swap’s trading liquidity.237 Swaps that
become subject to the trade execution
requirement pursuant to the approval or
certification of a MAT determination
must, with the limited exception of
block transactions, be executed by
counterparties on a SEF or DCM.238
2. Execution Method Requirements
Section 37.9 defines swaps that are
subject to the trade execution
requirement, i.e., those swaps that must
be executed on a SEF or DCM, as
‘‘Required Transactions’’ 239 and
specifies that a SEF may only offer two
methods for executing such swaps.
Specifically, Required Transactions
must be executed on (i) an Order Book,
as defined under § 37.3(a)(3) and
234 7 U.S.C. 2(h)(8). CEA section 2(h)(8) also
specifies that swaps that are subject to a clearing
exception under section 2(h)(7) are not subject to
the trade execution requirement. See infra Section
XXI.A.3.—§ 36.1(c)—Exemption for Swap
Transactions Excepted or Exempted from the
Clearing Requirement under Part 50. The
Commission interprets ‘‘swap execution facility’’ in
CEA section 2(h)(8)(B) to include a swap execution
facility that is exempt from registration pursuant to
CEA section 5h(g). See supra note 10.
235 17 CFR 37.10; 17 CFR 38.12.
236 The Commission notes that a SEF or DCM may
submit a MAT determination pursuant to the rule
approval process under § 40.5 or through the rule
certification process under § 40.6. 17 CFR
37.10(a)(1) and 38.12(a)(1).
237 17 CFR 37.10(b), 38.12(b). Parts 37 and 38
respectively specify the same six factors: (i)
Whether there are ready and willing buyers and
sellers for the swap; (ii) the frequency or size of
transactions in the swap; (iii) the swap’s trading
volume; (iv) the number and types of market
participants trading the swap; (v) the swap’s bid/
ask spread; and (vi) the usual number of resting
firm or indicative bids and offers in the swap. 17
CFR 37.10(b), 38.12(b). The Commission explained
in the preamble to the MAT Final Rule that with
respect to factors (ii)–(iii), the submitting DCM or
SEF could look to DCM, SEF, or bilateral
transactions. MAT Final Rule at 3360.
238 Based on part 40, a MAT determination filing
applies the trade execution requirement to a
particular swap either upon Commission approval
(in the case of a filing submitted for approval under
§ 40.5) or upon the lack of Commission objection (in
the case of a filing submitted on a self-certified
basis under § 40.6).
239 17 CFR 37.9(a)(1).
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discussed above; 240 or (ii) an RFQ
System, as defined under § 37.9(a)(3).241
An RFQ System is defined, among other
requirements, as a trading system or
platform where a market participant
transmits a request for a bid or offer to
no less than three market participants
who are not affiliates of, or controlled
by, the requester or each other (‘‘RFQto-3 requirement’’).242 To the extent that
a SEF offers an RFQ System for
Required Transactions, that system must
operate in conjunction with an Order
Book, which a SEF is currently required
to establish and maintain as a minimum
trading functionality.243 Pursuant to the
statutory SEF definition, SEFs have
been able to offer these methods through
‘‘any means of interstate commerce,’’ 244
which the Commission has interpreted
to mean ‘‘a variety of means of
execution or communication, including,
but not limited to, telephones, internet
communications, and electronic
transmissions.’’ 245 Accordingly, SEFs
have been able to develop and offer an
Order Book or RFQ System through
various forms, including voice-based
systems.
In establishing the Order Book and
RFQ System requirements, the
Commission sought in part to transition
swaps trading onto SEFs and achieve
the statutory SEF goal of promoting pretrade price transparency in the swaps
market. In addition to establishing the
Order Book as a minimum trading
functionality for all swaps listed for
trading by a SEF, the Commission
intended for the Order Book
requirement to promote such
transparency for swaps subject to the
trade execution requirement. The
Commission did acknowledge, however,
that an Order Book lacks the appropriate
240 See supra notes 123–125 and accompanying
discussion (definition of ‘‘Order Book’’ under
§ 37.3(a)(3)).
241 17 CFR 37.9(a)(2).
242 17 CFR 37.9(a)(3). The RFQ System definition
additionally specifies that the three requesters may
not be affiliates or controlled by one another; and
the system must provide each of its market
participants with equal priority in receiving RFQs
and transmitting and displaying for execution
responsive orders. 17 CFR 37.9(a)(3); 17 CFR
37.9(a)(3)(iii).
243 17 CFR 37.9(a)(2)(i)(B). In operating an RFQ
System in conjunction with an Order Book, a SEF
must communicate to a requester any firm bid or
offer pertaining to the same instrument resting on
any of the SEF’s Order Books; and provide the
requester with the ability to execute against such
firm resting bids or offers along with any responsive
RFQ orders. 17 CFR 37.9(a)(3)(i)–(ii). As discussed
above, the Commission is proposing to eliminate
the minimum trading functionality under
§ 37.3(a)(2) and the Order Book definition under
§ 37.3(a)(3). See supra Section IV.C.2.—
§§ 37.3(a)(2)–(3)—Minimum Trading Functionality
and Order Book Definition.
244 7 U.S.C. 1a(50).
245 SEF Core Principles Final Rule at 33501 n.328.
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flexibility to be suitable for trading
many types of swaps, in particular those
lacking liquidity.246 The lack of
liquidity is a characteristic of broad
segments of the swaps market, which
trade episodically among a limited
number of market participants in large
average notional amounts.
To address this lack of suitability
even within the scope of Required
Transactions, the Commission
prescribed the RFQ System as an
alternative execution method for these
transactions.247 At the time, the
Commission observed that RFQ systems
provide market participants with a
certain level of trading flexibility, in
particular by allowing them to balance
the risks of information leakage and
front-running associated with disclosing
trading interests against the price
competition benefits derived by
disseminating a request to a larger
number of participants.248 The
Commission recognizes that most SEFs
currently offer an RFQ System for most
of the respective products that they list
for trading; when trading swaps subject
to the trade execution requirement,
market participants have mostly utilized
an RFQ System, transmitting RFQs to
more than three unaffiliated market
participants in many instances.249
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3. Implementation of Existing
Requirements
While the Commission acknowledges
that the existing approach has
transitioned some swaps trading to
246 SEF Core Principles Final Rule at 33564–65.
In the preamble to the SEF Core Principles Final
Rule, the Commission expressed its anticipation
that ‘‘the order book method will typically work
well for liquid Required Transactions (i.e.,
transactions involving swaps that are subject to the
trade execution requirement in CEA section
2(h)(8)), but for less liquid Required Transactions,
RFQ systems are expected to help facilitate
trading.’’ Id.
247 17 CFR 37.9(a)(2). The Commission adopted
the RFQ System requirement based upon its
prevalence in the OTC swaps market. Id. at 33564.
The Commission stated that ‘‘RFQ systems are
currently used by market participants in the OTC
swap market, many in conjunction with order book
functionality.’’ In adopting the requirement, the
Commission also stated it was ‘‘leveraging best
practices from current swaps trading platforms.’’ Id.
at 33565.
248 SEF Core Principles Final Rule at 33476.
249 In discussing trading of CDX and iTraxx
indices, Lynn Riggs, Esen Onur, David Reiffen, and
Haoxiang Zhu found that ‘‘[c]ustomers most
frequently request quotes from three dealers, which
happens in about 45% of the RFQ sessions,
followed by five dealers, which happens in just
below 30% of the RFQ sessions. In about 18% of
the sessions the customer selects four dealers.’’
Lynn Riggs, Esen Onur, David Reiffen, & Haoxiang
Zhu, Mechanism Selection and Trade Formation on
Swap Execution Facilities: Evidence from Index
CDS 10 (2017), https://www.cftc.gov/idc/groups/
public/@economicanalysis/documents/file/oce_
mechanism_selection.pdf (‘‘2017 Riggs Study’’).
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SEFs, this transition has stagnated and
will not likely increase further without
changes to the existing regulatory
framework. This stagnation, as
discussed further below, is reflected by
the limited set of swaps that have
become subject to the trade execution
requirement, and therefore subject to
mandatory trading on SEFs, through the
Commission’s MAT process. The lack of
additional swaps becoming subject to
the requirement over the last several
years has been attributable to market
participants’ concerns over the
Commission’s Order Book and RFQ
System requirements for Required
Transactions under § 37.9; this concern,
in turn, has dissuaded SEFs from
submitting additional MAT
determinations.
Since the Commission’s adoption of
the MAT determination process, a small
number of swaps that are subject to the
clearing requirement have become
subject to the trade execution
requirement. In the fall of 2013, four
SEFs and one DCM submitted a limited
number of swaps to the Commission as
‘‘available to trade’’ via the
Commission’s § 40.6 self-certification
process.250 The swaps submitted consist
of the current ‘‘on-the-run’’ and most
recent ‘‘off-the-run’’ index CDS with a
five-year tenor and fixed-to-floating IRS
with benchmark tenors denominated in
U.S. dollars, euros, and pound
sterling.251 The IRS and CDS that are
currently subject to the trade execution
requirement represent the most
standardized and highly liquid swaps
contracts offered by SEFs,252 but also
250 TW SEF LLC—Amendment to SelfCertification for Swaps to be Made Available to
Trade (Jan. 26, 2014) (third amended filing from
initial submission on October 28, 2013); Javelin
SEF, LLC, No. 13–06R(3), Javelin Determination of
Made Available to Trade of Certain Interest Rate
Swaps made Pursuant to Parts 37 of the Rules of
the Commodity Futures Trading Commission (Jan.
8, 2014) (third amended filing from initial
submission on October 18, 2013) (‘‘Javelin SEF
MAT Determination’’); Bloomberg SEF LLC, No.
2013–R–9, Bloomberg SEF LLC—Made Available to
Trade (‘‘MAT’’) Submission of Certain Credit
Default Swaps (‘‘CDS’’) and Interest Rate Swaps
(‘‘IRS’’) pursuant to Commodity Futures Trading
Commission (the ‘‘Commission’’) Regulation 40.6
(submission #2013–R–9) (Dec. 5, 2013) (‘‘Bloomberg
SEF MAT Determination’’); MarketAxess SEF
Corporation, Made Available to Trade (‘‘MAT’’)
Submission of Certain Credit Default Swaps (Oct.
30, 2013) (‘‘MarketAxess SEF MAT
Determination’’); trueEX, LLC, Submission 2013–
14, Made Available to Trade (‘‘MAT’’) Submission
of Certain Interest Rate Swaps (‘‘IRS’’) pursuant to
CFTC Regulation 40.6 (Oct. 21, 2013) (‘‘trueEX
MAT Determination’’).
251 CFTC, Industry Filings—Swaps Made
Available to Trade, https://www.cftc.gov/idc/
groups/public/@otherif/documents/file/swapsmade
availablechart.pdf.
252 See, e.g., TW SEF LLC—Self-Certification for
Swaps to be Made Available to Trade at 8 (Oct. 28,
2013) (describing the IRS submitted as benchmark
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represent a very limited segment of the
potential universe of swaps eligible to
become subject to the trade execution
requirement, i.e., those swaps that are
both subject to the clearing requirement
and currently listed for trading on a
SEF.253 Based on data evaluated by the
International Swaps and Derivatives
Association (‘‘ISDA’’), approximately 85
percent of total reported IRS traded
notional volume (‘‘traded notional’’) in
2017 consisted of swaps subject to the
clearing requirement.254 This represents
an increase from the approximately 73
to 77 percent of total reported IRS
traded notional during 2015 to 2016 that
was subject to the clearing
requirement.255 Data analysis conducted
by Commission staff found that the
percentage of trading volume in IRS
subject to the trade execution
requirement is far lower than the
percentage subject to the clearing
requirement and has actually declined,
from approximately 10 to 12 percent of
total reported IRS traded notional in
2015 to approximately 7 to 9 percent of
the total reported IRS traded notional in
2017 and the first half of 2018.256
Beyond this limited initial set of selfcertified MAT determinations, however,
swaps with the most liquidity and the CDS
submitted as the most actively traded); Javelin SEF
MAT Determination at 11 (noting that the bid-offer
spreads for the IRS submitted is tight and
characteristic of considerable liquidity); Bloomberg
SEF MAT Determination at 3 (stating that the scope
of the MAT determination represents IRS and CDS
that are the most standardized and liquid);
MarketAxess SEF MAT Determination at 1 (stating
that the MAT determination consists of the most
liquid CDS listed); trueEX MAT Determination at 4
(specifying that the trade frequency of IRS with
whole-year tenors is sufficient to support a MAT
determination).
253 The clearing requirement currently applies to
various categories of IRS, including fixed-to-floating
swaps denominated in U.S. dollars, pound sterling,
and euros with whole- and partial-year tenors that
range from 28 days to 50 years; fixed-to-floating
swaps in additional currency denominations with
whole and partial tenors that range from 28 days up
to 30 years; basis swaps, overnight index swaps,
and forward rate agreements in varying
denominations and tenors; and various CDX and
iTraxx index CDS in the current on-the-run series
and a broad range of older series (prior to the most
recent off-the-run series) with whole-year
benchmark tenors. 17 CFR 50.4.
254 ISDA, ISDA Research Note: Actual Cleared
Volumes vs. Mandated Cleared Volumes: Analyzing
the US Derivatives Market 3 (July 2018), https://
www.isda.org/a/6yYEE/Actual-Cleared-Volumes-vsMandated-Cleared-Volumes.pdf (‘‘2018 ISDA
Research Note’’).
255 Id.
256 Commission staff conducted data analysis
based on publicly available data accessed via Clarus
Financial Technology (‘‘Clarus’’). In a separate
analysis, ISDA found that only 5 percent of trading
volume in IRS during 2015 and the first three
quarters of 2016 consisted of IRS subject to the
trade execution requirement. ISDA, ISDA Research
Note: Trends in IRD Clearing and SEF Trading 1,
3, 11 (December 2016), https://www.isda.org/a/
xVDDE/trends-in-ird-clearing-and-sef-trading1.pdf
(‘‘2016 ISDA Research Note’’).
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the Commission has not received any
additional MAT determinations for the
significantly large number of IRS and
CDS that are subject to the clearing
requirement. This discrepancy has
grown even larger as a result of a
subsequent expansion of the clearing
requirement.257 The Commission
believes that the lack of further MAT
determinations from SEFs or DCMs is
largely attributed to the influence of
market participants who believe that
applying the trade execution
requirement, and therefore the required
use of an Order Book or RFQ System,
would adversely impact their ability to
utilize execution methods that are best
suited for the swap they are trading and
their individual trading needs.258
To establish which swaps would be
sufficiently liquid to be traded via an
Order Book or RFQ System, the
Commission relied upon the expertise
and experience of SEFs and DCMs in
the MAT determination process.259 The
limited number of MAT determinations
that has resulted reflects these execution
methods’ lack of suitability in
facilitating a broad range of swaps
trading. Market participants have stated
that the prescriptive requirements under
§ 37.9 limit their ability to otherwise
utilize other execution methods that
they believe may be better suited to
address their business needs, adapt to
quickly-changing market conditions, or
257 The Commission expanded the list of swaps
subject to the clearing requirement in 2016 by
adding several new classes of IRS denominated in
nine different currencies. See supra note 35. The
Commission believes that the expansion likely
contributed to the increase noted above in the
percentage of total reported IRS traded notional
subject to the clearing requirement in 2017 relative
to prior years.
258 SIFMA AMG noted that these limited methods
of execution meant that a MAT determination
‘‘could force the entire swap market to change its
practice, disrupting trading and upending the
natural evolution of market dynamics.’’ See Letter
from the Asset Management Group of the Securities
Industry and Financial Markets Association
(‘‘SIFMA AMG’’), In re Concerns Regarding the SEF
Framework 3 (May 11, 2015) (‘‘2015 SIFMA AMG
Letter’’). Further, SIFMA AMG argued that the
‘‘artificial limitation’’ on execution methods for
required transactions ‘‘has resulted in reduced
liquidity and fewer options for asset managers
working to reduce portfolio risk in a cost-effective
manner. . . .’’ Id. At a Commission roundtable
discussion on the MAT process, one participant
noted that market participant aversion to a broad
MAT determination by Javelin SEF discouraged
other SEFs from submitting determinations, based
on the fear that market participants would cease
trading or avoid their respective platforms
altogether. 2015 MAT Roundtable at 65–67. See
also Joe Rennison, Experts split on MAT
determinations, Risk.net (Nov. 8, 2013), https://
www.risk.net/infrastructure/trading-platforms/
2305790/experts-split-mat-determinations (noting
market participant resistance to Javelin SEF’s initial
MAT submission).
259 MAT Final Rule at 33609.
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achieve some combination thereof.260
Given that many of the swaps that are
subject to the clearing requirement are
highly customizable and less liquid,
continuing to mandate the use of an
Order Book and RFQ System is
inconsistent with transitioning a
broader segment of the swaps market to
the SEF regulatory framework.
Therefore, the Commission recognizes
the need for greater flexibility in
execution methods to broaden the scope
of the trade execution requirement over
additional swaps trading.261
The Commission acknowledges that
the Order Book and RFQ System
requirements are too prescriptive and
limiting to be applied over a broader
segment of the swaps market.
Specifically, these methods do not
account for the swaps products that are
highly customized and episodically
liquid by nature. The Commission
previously acknowledged that market
participants take into account factors
such as swap product complexity, trade
size, and liquidity in deciding how to
trade swaps, including the number of
market participants to whom a request
for quote will be sent.262 Thus, even the
RFQ-to-3 requirement, which the
Commission adopted to provide more
execution flexibility, may hinder market
participants from determining the
appropriate number of market
participants to disseminate an RFQ for
the additional swaps that would be
subject to the trade execution
requirement. Mandating the use of
limited methods of execution for swaps
subject to the requirement imposes the
Commission’s judgment regarding how
best to execute different swaps and
260 See 2015 SIFMA AMG Letter at 8 (In re the
current approach to required methods of execution:
‘‘this prescriptive approach has negatively impacted
market conditions and has caused fragmentation of
the U.S. swap market. The unnecessary restriction
on modes of execution . . . limits a SEF’s ability
to foster liquidity and diminishes the venues that
asset managers may access for liquid, competitive
pricing.’’).
261 The Commission notes that the current SEF
regulatory framework allows a SEF to offer flexible
methods of execution for swaps that are not subject
to the trade execution requirement, i.e., Permitted
Transactions; this approach would facilitate trading
in bespoke or less liquid swaps on a SEF. 17 CFR
37.9(c). As noted above, only 7 to 9 percent of total
reported IRS traded notional has consisted of swaps
subject to the trade execution requirement in recent
months; however, approximately 57 percent of total
reported IRS traded notional has occurred on SEFs
in 2018. ISDA, ISDA SwapsInfo Weekly Analysis:
Week Ending October 19, 2018, https://
analysis.swapsinfo.org/2018/10/interest-rate-andcredit-derivatives-weekly-trading-volume-weekending-october-19-2018/ (‘‘2018 ISDA SwapsInfo
Weekly Analysis’’). Accordingly, the Commission
believes that adopting a more flexible approach to
execution methods in the SEF regulatory framework
would better reflect the current swaps market
environment.
262 SEF Core Principles Final Rule at 33562.
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ultimately inhibits market participants
from tailoring their own trading
strategies and decisions based on the
swaps involved, their individual
business needs, the desired transaction
size, and existing market conditions,
among other factors.
The required methods of execution
has also limited SEFs from developing
more efficient, transparent, and costeffective methods of trading, as well as
impeded their ability to compete with
one another using innovative and
different methods of execution.263 For
example, a SEF may develop a new
trading functionality that does not
qualify as an Order Book or RFQ
System, but is effective and efficient in
trading both IRS that are and are not
subject to the trade execution
requirement. Under the current
regulatory framework, participants
could not use that new method for IRS
that are subject to the trade execution
requirement or IRS that would become
subject to the requirement in the future.
This scenario deprives market
participants of a useful execution
method and deprives the SEF that
developed the method of benefitting
from its innovative efforts.
The Commission notes that this
scenario could occur with respect to
forward rate agreements (‘‘FRAs’’),
many of which are economically similar
to IRS that are currently subject to the
trade execution requirement. In spite of
this economic similarity, FRAs in
several different types of currency
denominations and tenor ranges that are
currently subject to the clearing
requirement, but have not been
submitted to the Commission as
‘‘available to trade.’’ 264 Based on an
ISDA analysis, over 97 percent of total
reported FRA traded notional during the
third quarter of 2016 was cleared and
approximately 81 percent of which was
traded on SEF and accounted for
slightly less than 54 percent of total
reported IRS traded notional occurring
on SEFs.265 The Commission has
263 At the Commission’s 2015 MAT Roundtable,
one participant expressed concern that a MAT
determination would ‘‘cut[ ]off potential modes of
execution,’’ rather than promoting new innovative
execution methods. See 2015 MAT Roundtable at
165.
264 17 CFR 50.4 (specifying the FRAs that are
subject to mandatory clearing).
265 2016 ISDA Research Note at 5. The
Commission notes that these statistics include both
swaps subject to the clearing requirement and
swaps that are voluntarily cleared. In a subsequent
analysis, however, ISDA determined that 92 to 98
percent of total reported FRA traded notional from
2014 to 2017 consisted of FRAs subject to the
clearing requirement. 2018 ISDA Research Note at
9. Commission staff replicated ISDA’s results and
also found that in 2018, the share of total reported
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observed that FRA trading on SEFs
occurs through ‘‘permitted’’ execution
methods, such as risk mitigation
services,266 that assist market
participants with managing their
exposures to market, credit, and other
sources of risk.267 Despite their utility,
risk mitigation services do not
constitute an Order Book or RFQ
System, and therefore, are not available
as an execution method for swaps
subject to the trade execution
requirement under the current
regulatory framework. Given that many
FRAs would become subject to the trade
execution requirement under the
Commission’s proposed regulatory
framework, as discussed further below,
allowing SEF participants to continue
executing these types of swaps would
require more flexible execution methods
that are appropriate for conducting risk
mitigation exercises.
Further, the Commission believes that
the current approach to required
methods of execution may have
imposed barriers to entry for entities
that seek to offer swaps trading. As
noted above, limiting the execution
methods that a SEF can provide limits
their ability to offer new and innovative
trading solutions. As a result, new
entrant SEFs have been unable to
differentiate themselves from incumbent
SEFs on the basis of innovation and
development, given that both incumbent
platforms and newly-registered entities
are otherwise limited to offering an
Order Book and an RFQ System.
Accordingly, SEFs have been forced to
compete with one another on a more
ancillary basis, rather than on
fundamental operating aspects that
provide value to market participants, in
particular the available trading system
and platform.
FRA traded notional that is cleared has increased
to 99 percent, with approximately 81 percent of
cleared FRAs continuing to trade on SEF.
Commission staff also found that during the first
half of 2018, cleared FRAs accounted for
approximately 48 percent of IRS volume on SEFs,
a somewhat smaller share than the amount that
ISDA found during its own review period.
266 The Commission notes that market
participants have contended that the required
methods of execution are unsuitable for allowing
SEFs to conduct risk mitigation services for swaps
that are subject to the trade execution requirement.
See CFTC Letter No. 13–81, Time-Limited NoAction Relief from Required Transaction Execution
Methods for Transactions that Result from Basis
Risk Mitigation Services (Dec. 23, 2013). See also
2016 WMBAA Letter at app. A (stating that
‘‘[a]dditional methods of execution for Required
Transactions should include risk mitigation
[platforms]’’).
267 The Commission previously determined that
risk mitigation services that facilitate swap
execution are subject to the SEF registration
requirement. SEF Core Principles Final Rule at
33482–83.
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The Commission’s current approach
to required methods of execution has
also compelled SEFs to make
unintended adjustments and alterations
to their execution methods, including
auction platforms 268 and work-up
trading protocols.269 Given the
prescriptive requirements that a SEF
execution method must comply with to
qualify as an Order Book under
§ 37.3(a)(3) or as an RFQ System under
§ 37.9(a)(3), some SEFs have expended
time and effort to amend certain aspects
of their trading systems or platforms,
including trading protocols, prior to
allowing participants to use those
methods to execute swaps subject to the
trade execution requirement. The
Commission acknowledges that SEFs
have not been able to employ and
operate execution methods that are fully
developed to facilitate price discovery
and more robust participation on the
SEF in periods of episodic liquidity.
Rather, requiring SEFs to adjust various
aspects of their respective systems or
platforms to comply with the required
methods of execution has likely
introduced operating inefficiencies that
have not provided corresponding
benefits to SEF participants. Therefore,
the Commission believes that the
prescriptive execution methods have
inhibited the effectiveness of execution
methods designed and developed by
SEFs to promote trading.
4. Proposed Approach
To further promote the SEF statutory
goals, the Commission proposes a SEF
regulatory framework that would
facilitate a more robust application of
the trade execution requirement and
allow more flexibility in the execution
methods that may be offered and used
for trading swaps that are subject to the
requirement. The Commission believes
that this approach would better
establish SEFs as vibrant and liquid
marketplaces for swaps trading that
foster price discovery and liquidity
formation. The Commission believes
268 For a description of auction-based platforms,
see infra note 313 and accompanying discussion.
269 In a trade work-up session associated with a
SEF’s trading system or platform, two participants
that execute a particular swap transaction at a
particular price have the opportunity to execute
additional volume of that swap at that price within
a given time period established by the SEF. When
that period has lapsed, multiple other buyers and
sellers may then seek to execute that particular
swap at the established price set by the initial
transaction. Interested participants may continue to
seek to execute that swap at the established price
until the buying and selling interest is exhausted or
the work-up session has expired, as set forth by the
SEF. The Commission has observed that SEFs offer
these sessions within a particular execution
method, e.g., an electronic order book, to encourage
participants to provide liquidity to the market.
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that its proposed approach is consistent
with the statutory SEF provisions and
would also further the statutory SEF
goals, while helping to alleviate the
challenges of the existing approach
described above.
The Commission proposes to adopt a
new interpretation of the trade
execution requirement that would
greatly expand the scope of swaps that
are subject to the requirement.
Considering the market characteristics
and episodic liquidity profiles of these
additional swaps, the Commission’s
proposed approach would provide
needed flexibility to SEFs and market
participants to support more trading
through SEF trading systems or
platforms. In conjunction with an
expansion of the trade execution
requirement, the Commission also
proposes to eliminate the prescriptive
execution methods for swaps subject to
the requirement. Rather than impose
execution method requirements that are
limited to an Order Book or RFQ
System, the Commission’s proposed
approach would allow SEFs to develop
and offer—and therefore enable—market
participants to choose execution
methods that are appropriate to their
trading. Providing market participants
with greater choice in execution
methods allows them to utilize trading
systems or platforms that are not
constrained by prescriptive regulatory
requirements and suit their trading
circumstances and the market
conditions for those swaps at a given
time. This flexibility is necessary to
facilitate trading in the broad scope of
swaps that would become subject to the
trade execution requirement. This
flexibility should also allow the swaps
market and SEFs to continue to
naturally evolve and innovate to more
efficient, transparent, and cost effective
means of trading, even for swaps
currently subject to the trade execution
requirement. The Commission believes
that this flexibility, in concert with the
concentration of trading activity in
episodically liquid swaps on SEFs,
should help foster price discovery and
allow market participants to pursue
more appropriate, counterparty and
swap-specific levels of pre-trade price
transparency through additional
methods of execution.270 Accordingly,
270 As discussed above, the Commission
acknowledges that market participants take into
account factors such as swap product complexity,
trade size, liquidity, and the associated desire to
minimize potential information leakage and frontrunning risks in deciding how to trade swaps,
including the number of market participants to
whom a request for quote will be sent. In selecting
that number of market participants to whom a
request for quote will be sent, the market
participant is determining the appropriate level of
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the Commission believes that more
execution flexibility also reduces certain
complexity, costs, and burdens that
have impeded SEF development and
innovation, particularly with more
swaps that would be subject to
mandatory trading on SEFs. Ultimately,
this approach is intended to attract
greater liquidity that would promote
more trading on SEFs.
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a. § 36.1(a)—Trade Execution
Requirement
The Commission has interpreted the
trade execution requirement in CEA
Section 2(h)(8)—in particular, the
phrase ‘‘makes the swap available to
trade’’—in a manner that has limited the
scope of swaps that must be traded on
a SEF.271 Initially designed to ensure
that the Order Book and RFQ System
requirements could support swaps that
are sufficiently liquid for trading, the
MAT determination process has
resulted in a small number of swaps that
are currently subject to the trade
execution requirement. As noted above,
Commission staff has determined that
only a small and declining percentage of
total reported IRS traded notional over
a recent time period is subject to the
trade execution requirement, with only
part of overall IRS trading volume
occurring on SEFs.272
Given the current regulatory
framework’s limited ability in
promoting swaps trading on SEFs,
which limits the statutory SEF goals, the
Commission is proposing to adopt a
revised interpretation of CEA section
2(h)(8). The Commission believes that
the phrase ‘‘makes the swap available to
trade’’ should be interpreted to mean
that once the clearing requirement
applies to a swap, then the trade
execution requirement applies to that
swap upon any single SEF or DCM
listing the swap for trading.273 As
previously noted by some commenters
to the proposed MAT rule, CEA section
2(h)(8) does not mandate the MAT
pre-trade transparency necessary to efficiently and
effectively execute that swap transaction based on
the above factors and its individual trading needs.
See supra Section I.B.1.b.—Swaps Market
Characteristics.
271 MAT Final Rule at 33606.
272 See supra notes 256 and 261 and
accompanying discussion.
273 In addition to DCMs and SEFs, CEA section
2(h)(8) contemplates the ability of Exempt SEFs to
list swaps subject to the clearing requirement. As
discussed below, the Commission proposes to use
its exemptive authority pursuant to CEA section
4(c) to exclude swaps that are exclusively listed by
Exempt SEFs from being subject to the trade
execution requirement. Accordingly, only a CFTCregistered DCM or SEF would be able to trigger the
CEA section 2(h)(8) trade execution requirement by
listing a clearing requirement swap. See infra
Section XXI.A.2.—§ 36.1(b)—Exemption For Certain
Swaps Listed Only By Exempt SEFs.
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process adopted by the Commission to
implement the trade execution
requirement.274 The Commission
believes that the most straightforward
reading of CEA section 2(h)(8) would
specify that once the clearing
requirement applies to a swap, then the
trade execution requirement also
applies to that swap unless no SEF or
DCM ‘‘makes the swap available to
trade.’’ Accordingly, once any single
DCM or SEF ‘‘makes available,’’ i.e.,
lists, a swap that is subject to the
clearing requirement for trading on its
facility, then the trade execution
requirement would apply to that swap,
such that market participants may only
execute the swap on a SEF, a DCM, or
an Exempt SEF.
The Commission notes that Congress
had the ability to delineate a
comprehensive statutory process for
determining when a swap should be
subject to the trade execution
requirement, but did not do so when
amending the CEA via the Dodd-Frank
Act.275 In contrast, the clearing
requirement, established by Congress
concurrently with the trade execution
requirement under the Dodd-Frank Act,
sets forth a formal statutory process for
the Commission to follow in
determining which swaps must be
submitted to a DCO for clearing.276 The
Commission notes that the statutory
process in CEA section 2(h)(2)
establishes that submissions from a DCO
for each swap, or any group, category,
type, or class of swap that it plans to
274 MAT Final Rule at 33607. These commenters
believed that use of the clearing determination
process in CEA section 2(h)(2) ‘‘as the exclusive
basis for finding that a swap is available to trade
would subject more swaps to the trade execution
requirement and further the objectives of the DoddFrank Act.’’ SEF Core Principles Final Rule at
33607–08. Some commenters pointed out that the
procedure for determining whether a swap was
made available to trade was ‘‘duplicative of the
mandatory clearing determination process [in CEA
section 2(h)(2)] and accordingly stated that the
Commission should rely on the clearing
determination process to also determine whether a
swap is available to trade.’’ MAT Final Rule at
33607.
275 The Commission also observes that Congress
specifically placed the trade execution requirement
within the CEA section 2(h) heading of ‘‘clearing
requirement.’’ The Commission believes that this
placement of the trade execution requirement
within the clearing requirement further supports
the view that no additional framework was
intended by Congress beyond the processes already
enumerated within this section. 7 U.S.C. 2(h).
276 Specifically, CEA section 2(h)(2) delineates a
structured process that outlines a specific set of
factors that the Commission must consider in its
clearing requirement determination and includes a
provision for public comment. Among other things,
the Commission must consider outstanding
notional exposures; trading liquidity; adequate
pricing data; adequate clearing infrastructure;
mitigation of systematic risk; effects on
competition; and legal certainty surrounding
solvency concerns. 7 U.S.C. 2(h)(2).
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61979
accept for clearing is automatically
subject to a clearing determination by
the Commission.277 As part of a clearing
requirement determination, the CEA
requires the Commission to evaluate
submitted swaps based on a prescribed
set of factors that includes trading
liquidity.278 Given the absence of
analogous CEA provisions governing the
trade execution requirement and based
on its experience since implementing
the swaps trading framework, the
Commission believes that the proposed
interpretation of CEA section 2(h)(8) is
consistent both with that statutory
provision and with the statutory goal of
promoting the trading of swaps on SEFs.
As support for its view that the
proposed interpretation of CEA section
2(h)(8) would promote the trading of
swaps on SEFs, the Commission notes
that more than 85 percent of IRS and
index CDS trading volume is currently
subject to the clearing requirement; 279
many, but not all, of those swaps are
currently listed for trading by SEFs.
Therefore, the proposed reading would
both promote the statutory SEF goal of
swaps trading on SEFs and help to
further swaps liquidity on SEFs by
requiring all counterparties to trade
these swaps on a SEF, which may
promote increased pre-trade price
transparency.280 A more robust trade
277 CEA
section 2(h)(2)(B)(iii)(II).
adopted under part 50 of the Commission’s
regulations, the Commission has noted that this
required analysis of a swap’s trading liquidity is
intended for risk management purposes, i.e., pricing
and margining of cleared swaps. In this connection,
the Commission has noted that higher trading
liquidity in swaps would assist DCOs in end-of-day
settlement procedures, as well as in managing the
risk of CDS portfolios, particularly in mitigating the
liquidity risk associated with unwinding a portfolio
of a defaulting clearing member. 77 FR 47176.
279 2018 ISDA Research Note at 3, 15–16.
280 The Commission believes that further
achieving both SEF statutory goals—promoting
trading on SEFs and promoting pre-trade price
transparency—requires both (i) increasing the
number of swaps that are subject to the trade
execution requirement, thereby increasing the
amount of trading that must occur on SEF; and (ii)
concurrently providing flexible execution methods.
The Commission believes that requiring market
participants to conduct a larger portion of their
swaps trading on SEFs would centralize liquidity,
foster additional competition among a more
concentrated number of market participants, and
reduce information asymmetries that would
increase market efficiency and decrease transaction
costs. While offering flexible methods of execution
alone could transition additional swaps trading to
SEFs, the Commission believes that maximizing the
potential benefits of the proposed approach
necessitates an approach that would also lessen
fragmentation in trading of swaps on SEFs versus
the OTC environment.
Accordingly, the Commission’s proposed
approach would have a profound impact on the
amount of swaps trading that occurs on SEFs. As
noted above, Commission staff found that a small
and declining percentage of the reported IRS
278 As
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execution requirement would help
migrate and concentrate additional
trading interests to available trading
systems or platforms on SEFs.281 The
Commission believes that all of these
factors can increase activity on SEFs, as
well as help improve their efficiency
and effectiveness.
Given the Commission’s proposed
approach to the trade execution
requirement, as described above, the
Commission proposes to eliminate (i)
the MAT process for SEFs under
§ 37.10; (ii) the associated trade
execution compliance schedule under
§ 37.12; (iii) the MAT process for DCMs
under § 38.12; and (iv) the associated
trade execution compliance schedule
under § 38.11.
The Commission further proposes to
codify under § 36.1(a) the statutory
language of the trade execution
requirement in CEA section 2(h)(8),
which requires counterparties to
execute a swap that is subject to the
clearing requirement on a DCM, a SEF,
or an exempt SEF unless no such entity
‘‘makes the swap available to trade’’ or
the swap is subject to a clearing
exception in CEA section 2(h)(7).282 As
proposed, § 36.1(a) would specify that
volume in recent months has consisted of swaps
subject to the trade execution requirement
(currently less than 10 percent). ISDA determined,
however, that more than 55 percent of total reported
IRS traded notional has been occurring on SEFs
since 2015. See supra note 261 (noting that SEFs
have facilitated trading of Permitted Transactions).
Based on these determinations, the Commission’s
proposed interpretation of the trade execution
requirement may result in a significantly larger
amount of additional IRS trading volume on SEFs,
given that the Commission believes that many, but
not all, of that 85 percent of IRS that is subject to
clearing requirement is currently listed on SEFs.
Moreover, it is plausible that adopting this
proposed interpretation would induce SEFs to list
additional swaps subject to the clearing
requirement, which would expand the amount of
swaps trading that is subject to the trade execution
requirement.
281 As noted above, the Commission expects that
the proposal would greatly expand the scope of the
trade execution requirement. In particular, the
Commission expects that the following swaps
would become subject to the trade execution
requirement based on the fact they are currently
subject to the clearing requirement and also listed
by at least one SEF or DCM: (i) Various swaps in
the interest rate asset class including fixed-to
floating swaps denominated in U.S. dollars, pound
sterling, and euros with non-benchmark tenors
(whole and partial) that range from 28 days to 50
years; fixed-to-floating swaps in additional
denominations with whole and partial tenors
ranging from 28 days up to 30 years; basis swaps,
overnight index swaps (‘‘OIS’’), and FRAs with
different denominations and tenors; and (ii) various
CDX and iTraxx index CDSs in older series (prior
to the most recent off-the-run series) and additional
tenors, as well as new CDS indices.
282 7 U.S.C. 2(h)(8)(B). The Commission interprets
‘‘swap execution facility’’ in CEA section 2(h)(8)(B)
to include a swap execution facility that is exempt
from registration pursuant to CEA section 5h(g). See
supra note 10.
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counterparties must execute a
transaction subject to the clearing
requirement on a DCM, a SEF, or an
Exempt SEF that lists the swap for
trading. As discussed above, the
Commission believes that the statutory
phrase ‘‘makes the swap available to
trade’’ specifies the listing of a swap by
a DCM, a SEF, or an exempt SEF on its
facility for trading. Accordingly, the
trade execution requirement would
apply to a swap that is subject to the
clearing requirement upon the listing of
that swap by any DCM or SEF.283
As discussed further below, the
Commission is also proposing (i)
exemptions of various transactions from
the trade execution requirement under
§ 36.1 pursuant to its exemptive
authority in CEA section 4(c); (ii) a
compliance schedule for market
participants with respect to the
expanded application of the trade
execution requirement to additional
swaps; (iii) a public registry with
information as to which swaps are
subject to the trade execution
requirement and the SEFs or DCMs that
list them for trading; and (iv) a
standardized form to assist the
Commission in populating the public
registry with relevant information
regarding the trade execution
requirement.284
Request for Comment
The Commission requests comment
on all aspects of its proposed approach
to the trade execution requirement,
including § 36.1(a) as well as any
alternative approaches to
implementation of the trade execution
requirement.
b. Elimination of Required Execution
Methods
To better foster trading on SEFs—
particularly with respect to the many
episodically liquid swaps that will
become subject to the trade execution
requirement—the Commission proposes
to eliminate the existing execution
method requirements under § 37.9.
These requirements include the (i)
definition of and associated
requirements for Required Transactions
under § 37.9(a), including the RFQ
System definition under § 37.9(a)(3); 285
283 As discussed below, the Commission is
proposing an exemption from the requirement for
swap transactions involving swaps that are listed
for trading only by an Exempt SEF. See infra
Section XXI.A.2.—§ 36.1(b)—Exemption For Certain
Swaps Listed Only By Exempt SEFs.
284 See infra Section XXI.A.—§ 36.1—Trade
Execution Requirement.
285 As discussed above, the Commission is also
proposing to eliminate the Order Book definition
set forth under § 37.3(a)(3). See supra Section
IV.C.2.—§§ 37.3(a)(2)–(3)—Minimum Trading
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and (ii) the definition and associated
provision for Permitted Transactions
under § 37.9(c). Therefore, a SEF would
be permitted to offer any method of
execution that meets the SEF definition
for any swap that it lists for trading,
irrespective of whether the particular
swap is or is not subject to the trade
execution requirement. The
Commission believes that this approach
is consistent with the statutory SEF
definition in CEA section 1a(50), which
establishes that a SEF operates a trading
system or platform whereby multiple
participants have the ability to execute
or trade swaps by accepting bids and
offers made by multiple participants
also using the trading system or
platform.286
The Commission’s proposed
elimination of § 37.9(a) also includes the
elimination of subparagraph (a)(2)(ii),
which currently specifies that with
respect to offering an Order Book or
RFQ System for Required Transactions,
a SEF may utilize ‘‘any means of
interstate commerce’’ for purposes of
execution and communication,
including, but not limited to, the mail,
internet, email and telephone.287 Given
the elimination of the Order Book and
RFQ System requirements, the
Commission notes that this provision is
no longer necessary.
As noted above, implementing the
proposed interpretation of the trade
execution requirement would increase
the number of swaps that are required
to trade on a SEF. Many of these swaps,
which are all currently subject to the
clearing requirement would have terms
and conditions, e.g., partial-year tenors
and varying payment terms, that
counterparties customize to address
idiosyncratic risks, such as larger and
longer duration risk exposures.288 Given
Functionality and Order Book Definition. As
discussed below, the Commission is also proposing
to eliminate the time delay requirement under
§ 37.9(b), which applies to Required Transactions
executed on an Order Book. See infra Section
VI.A.2.—§ 37.203(a)—Pre-Arranged Trading
Prohibition; § 37.9(b)—Time Delay Requirement.
286 7 U.S.C. 1a(50).
287 17 CFR 37.9(a)(2)(ii).
288 Additionally, market participants may execute
such swaps as part of different transaction
structures, including package transactions
composed of multiple risk-assuming or risk-hedging
swap and non-swap components that are priced
together. In their review of three months of OTC IRS
trading, Federal Reserve Bank of New York
(‘‘FRBNY’’) staff found that the swaps traded were
‘‘broad in scope with a wide range of products,
currencies, and maturities traded . . . [including]
transactions in eight different product types, 28
currencies and maturities ranging from less than
one month to 55 years.’’ Michael Fleming, John
Jackson, Ada Li, Asani Sarkar, & Patricia Zobel,
Federal Reserve Bank of New York Staff Report No.
557, An Analysis of OTC Interest Rate Derivatives
Transactions: Implications for Public Reporting 2
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their variable and complex nature,
trading in these types of swaps can be
punctuated by alternating periods of
liquidity and illiquidity.289 The markets
for many of these swaps may consist of
only a few trades per day or, in some
cases, a few trades per month.290
Historically, market participants have
had discretion to utilize execution
methods tailored to their particular
trading motives and needs, the liquidity
profile and characteristics of the swap
being traded, and current market
conditions, among other
considerations.291
The existing execution methods for
Required Transactions under the current
(2012) (‘‘2012 FRBNY Analysis’’). The analysis
further identified ‘‘a meaningful degree of
customization in contract terms, particularly in
payment frequencies and floating rate tenors.’’ Id.
at 3. The Commission acknowledges that while
some of the swaps that were included in the
FRBNY’s analysis would not be subject to the
clearing requirement, e.g., any IRS with a 55-year
tenor, the Commission nevertheless believes that
this analysis captures many of the swaps that are
subject to the clearing requirement.
289 In a 2011 Senate hearing related to SEFs, one
participant testified that ‘‘[t]rading in [swaps]
markets is characterized by variable or non[]continuous liquidity. Such liquidity can be
episodic, with liquidity peaks and troughs that can
be seasonal . . . or more volatile and tied to
external market and economic conditions (e.g.,
many credit, energy and interest rate products).’’
Emergence of Swap Execution Facilities: A Progress
Report: Hearing Before the S. Subcomm. on Sec.,
Ins., and Investment of the S. Comm. on Banking,
Hous., and Urban Affairs, 112th Cong. 15 (2011)
(statement of Stephen Merkel, Executive Vice
President and General Counsel, BGC Partners, Inc.).
290 In their review of three months of OTC IRS
swaps, FRBNY staff also ‘‘found over 10,500
combinations of product, currency, tenor and
forward tenor traded during [their] three-month
sample, with roughly 4,300 combinations traded
only once.’’ 2012 FRBNY Analysis at 3. Further,
their analysis found that within the data set, even
the most commonly traded instruments were not
frequently traded. No single instrument in the data
set traded more than 150 times per day, on average,
and the most frequently traded instruments in OIS
and FRA only traded an average of 25 and 4 times
per day, respectively. Id. Collin-Dufresne, Junge,
and Trolle also made similar observations with
respect to index CDS trading on SEFs, noting that
the market is generally characterized by relatively
few trades in very large sizes. Based on their
analysis, the CDX.IG swaps market consists of 114
dealer-to-client trades and 24 dealer-to-dealer trades
per day, on average, with a median trade size of
USD $50 million in both segments. The average
number of trades in the CDX.HY market are
greater—164 dealer-to-client trades and 27 dealerto-dealer trades per day, on average—but the
median trade size is smaller—USD $10 million in
both segments—which they attributed to the
significantly higher volatility of high-yield
contracts. 2017 Collin-Dufresne Research Paper at
16.
291 Those means include, for example, voicebased trading systems or platforms that utilize
human trading specialists who exercise discretion
and judgment in managing the degree to which
trading interests are exposed and how orders are
filled. Where pre-trade market information from
bids and offers may be limited due to market
participants’ caution in displaying trading interests,
SEFs often offer session-based execution methods,
such as auctions, to generate trading interest.
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framework, however, has precluded the
full use of such discretion and forces
participants to trade certain swaps in
accordance with an Order Book or an
RFQ System. As noted above, the
Commission believes that these limited
execution methods would not be
suitable for the broad swath of the
swaps market that would become newly
subject to the trade execution
requirement. Instead, prescribing those
execution methods for this expanded
group of swaps would likely impose
greater trading risks on market
participants, including execution and
liquidity risks that negate any benefits
associated with the centralized
exchange trading of such swaps.292 The
Commission also notes that the current
execution methods could exacerbate the
current information leakage and front
running risks as described above.293
The existing framework was designed
to promote the SEF statutory goals, in
particular to promote pre-trade price
transparency, but based on its
implementation experience, the
Commission believes that a SEF
regulatory framework that requires a
greater number of swaps to be traded
through flexible execution methods on a
SEF will better promote both SEF
statutory goals. The Commission
believes that requiring more swaps to be
traded on SEFs would help foster
vibrant and liquid SEF markets as
liquidity formation and price discovery
is centralized on these markets. With
more swaps trading activity occurring in
a concentrated SEF environment, the
Commission anticipates that a greater
number of observable transactions—for
example, IRS of varying tenors along a
single price curve—would allow for a
richer price curve that provides
participants with more accurate pricing
for economically similar swaps along
other points of the curve.
For example, auction platforms and
work-up sessions—both of which SEFs
currently offer under the existing
framework—help to maximize
participation and trading on the SEF at
specific points of time and serve as
effective tools for price discovery for
market participants in periods of
episodic liquidity. By allowing SEFs the
flexibility to develop and tailor these
types of functionalities to facilitate
292 See supra note 130 (explaining that requiring
all market participants to use a central limit order
book will not necessarily promote price
competition among dealers in markets that lack
continuous trading or have episodic liquidity).
293 SEF Core Principles Final Rule at 33562. See
generally 2017 Riggs Study (discussing the
‘‘winner’s curse,’’ which is similar to information
leakage in context, in the dealer-to-client CDS
market).
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trading across a wide range of market
liquidity conditions, a SEF can
effectively promote appropriate
counterparty and swap-specific levels of
pre-trade price transparency 294 across a
broader range of swaps. Further, as
discussed above, affording SEFs with
greater flexibility with execution
methods would avoid forcing them to
alter these types of functionalities in a
sub-optimal manner simply to conform
to certain limited execution methods
that are not suitable for trading a broad
range of swaps with varying liquidity
profiles.
By eliminating the existing approach
to required methods of execution, the
Commission’s proposed regulatory
framework is also expected to foster
customer choice in a manner that would
benefit the swaps markets. The
Commission believes that its proposed
approach appropriately allows market
participants, each of whom is a
sophisticated entity trading in a
professional market, to determine the
execution method that best suits the
swap being traded and their trading
needs and strategies.295 As noted above,
the Commission believes that market
participants in a professional market, in
part because of sophistication and selfinterest, will seek the most efficient and
cost-effective method of execution to
achieve their business and trading
objectives. The Commission believes
that providing for customer choice,
while also concentrating liquidity and
price discovery onto SEFs, may help
create an environment for swaps trading
that is better able to promote
appropriate counterparty and swapspecific levels of pre-trade price
transparency than the existing
framework and will also do so for a
significantly broader segment of the
swaps markets than the existing
framework. As noted above, execution
methods such as auction platforms and
work-up sessions may do a better job of
maximizing participation and
concentrating liquidity than Order
Books or RFQ Systems in episodically
liquid markets.
The proposed approach would allow
SEFs to offer varied and innovative
execution methods that are best suited
to the products they list, as well as the
294 See supra note 270 (discussing appropriate
counterparty and swap-specific levels of pre-trade
price transparency).
295 The Commission notes that other markets—
such as bonds, U.S. treasuries, and FX—do not
prescribe methods of execution, but rather permit
their market participants to determine the best
method of execution for the transaction. Swaps
markets have historically followed this model. In
this respect, the Commission believes that its
proposal realigns the swaps market trading
characteristics with other fixed income markets.
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trading needs of their market
participants. Rather than being confined
to limited execution methods, SEFs
would be able to develop more efficient,
transparent, and cost-effective means for
participants to trade swaps. In turn, the
Commission believes that this
innovation may serve to promote more
competition between SEFs to attract
participation through novel trading
systems or platforms. The Commission
further believes greater execution
flexibility may also potentially
incentivize new entrant trading venues
to enter the SEF marketplace, as they
would be able to utilize new and
different execution methods than are
currently employed by incumbent
platforms.
Request for Comment
The Commission requests comment
on all aspects of its proposed approach
to execution methods as well as any
alternative approaches.
V. Part 37—Subpart B: Core Principle 1
(Compliance With Core Principles)
The Commission is not proposing any
amendments to § 37.100, which codifies
the language of Core Principle 1.296
VI. Part 37—Regulations Related to SEF
Execution Methods—Subpart C: Core
Principle 2 (Compliance With Rules)
Core Principle 2 requires a SEF to
establish and enforce rules that govern
its facility, including trading procedures
to be followed when entering and
executing orders, among other
requirements.297
To support the proposed approach of
allowing more flexible execution
methods on SEFs, which is intended to
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296 Core
Principle 1 requires a SEF to comply
with the core principles set forth in CEA section
5h(f) and any requirement that the Commission may
impose by rule or regulation pursuant to CEA
section 8a(5) as a condition of obtaining and
maintain registration as a SEF. 7 U.S.C. 7b–3(f)(1).
Core Principle 1 also provides a SEF with
reasonable discretion in establishing the manner in
which it complies with the core principles, unless
the Commission determines otherwise by rule or
regulation. 7 U.S.C. 7b–3(f)(1)(B).
297 Core Principle 2 also requires a SEF to (i)
establish and enforce compliance with rules,
including terms and conditions of swaps traded or
processed on or through the SEF and any limitation
on access to the SEF; (ii) establish and enforce
trading, trade processing, and participation rules
that will deter abuses and have the capacity to
detect, investigate, and enforce those rules,
including means to provide market participants
with impartial access to the market and to capture
information that may be used in establishing
whether rule violations have occurred; and (iii)
provide by its rules that when a SD or MSP enters
into or facilitates a swap that is subject to the
clearing requirement, the SD or MSP will be
responsible for compliance with the trade execution
requirement. 7 U.S.C. 7b-3(f)(2). The Commission
codified Core Principle 2 under § 37.200. 17 CFR
37.200.
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foster more liquidity formation through
trading activity on SEF trading systems
and platforms, the Commission is
proposing to amend certain rules and
adopt new rules under Core Principle 2,
as described below. These proposed
rules would, among other things, help
foster open and transparent markets as
well as promote market efficiency and
integrity. In particular, the Commission
proposes to establish general rules that
would apply to any execution method
that a SEF offers on its facility. The
Commission also proposes to limit the
ability of market participants to conduct
pre-execution communications and
submit resulting pre-negotiated or prearranged trades to a SEF for execution;
and eliminate exceptions to the prearranged trading prohibition under
§ 37.203(a), including the time delay
requirement under § 37.9(b).
Additionally, the Commission
proposes to amend certain existing rules
and adopt new rules under Core
Principle 2, as described below, that
correspond to the Commission’s
application of the SEF registration
requirement to swap broking entities,
including interdealer brokers. Among
other goals, these proposed rules would
enhance professionalism requirements
for certain SEF personnel—‘‘SEF trading
specialists’’—that operate as part of a
SEF’s trading system or platform, e.g.,
voice-based trading functionalities, by
facilitating trading and execution on the
facility. Specifically, the Commission
proposes rules under § 37.201(c) that
would require SEFs to ensure minimum
proficiency and conduct standards for
SEF trading specialists.
A. § 37.201—Requirements for Swap
Execution Facility Execution
Methods 298
Section 37.201 implements the Core
Principle 2 requirement that a SEF
establish and enforce rules that govern
its facility. Section 37.201(a) specifies
that these requirements include trading
procedures to be followed when
entering and executing orders traded or
posted on the SEF.299 Section 37.201(b)
additionally requires a SEF to establish
and impartially enforce rules related to
(i) the terms and conditions of swaps
traded or processed on the SEF; (ii)
access to the SEF; (iii) trade practice
requirements; (iv) audit trail
requirements; (v) disciplinary
requirements; and (vi) mandatory
298 The
Commission proposes to retitle § 37.201 to
‘‘Requirements for swap execution facility
execution methods’’ from ‘‘Operation of swap
execution facility and compliance with rules’’ based
on the proposed changes described below.
299 17 CFR 37.201(a).
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trading requirements.300 The
Commission proposes to eliminate these
rules, which are largely duplicative of
the Core Principle 2 requirements, and
adopt the new rules described below.
1. § 37.201(a)—Required Swap
Execution Facility Rules
Proposed § 37.201(a) would require a
SEF to establish rules that govern the
operation of the SEF, including rules
that specify (i) the protocols and
procedures for trading and execution;
(ii) the permissible uses of ‘‘discretion’’
in facilitating trading and execution;
and (iii) the sources and methodology
for generating any market pricing
information.
Pursuant to a SEF regulatory
framework that would allow SEFs to
offer flexible execution methods, the
Commission believes that such rules
would benefit market participants by
providing a baseline level of
transparency in SEF trading. As the
Commission previously noted, one of
the central goals of the Dodd-Frank Act
is to bring transparency to the opaque
OTC swaps market.301 The Commission
has further observed that when markets
are open and transparent, prices are
more competitive and markets are more
efficient.302 In this regard, the
Commission notes that rather than
imposing detailed, prescriptive SEF
execution method requirements that do
not comport with swaps market
characteristics, this proposed rule
represents a more balanced approach—
a SEF would have the flexibility to
develop and offer execution methods
designed to foster trading based on the
dynamics of the applicable swaps
market (e.g., liquidity and product
characteristics) and on its market
participants’ needs, but also would be
required to disclose how these
execution methods operate. This
disclosure would help to foster open
and transparent markets, and promote
market efficiency and integrity by
establishing a consistent level of
disclosure and information across all
SEFs, which would allow market
participants to make informed decisions
regarding whether to onboard to a
particular SEF and whether to use a
particular execution method offered by
a SEF.303 In making such decisions,
300 17
CFR 37.201(b).
Core Principles Final Rule at 33553.
301 SEF
302 Id.
303 The Commission notes that this view is
analogous to the principles set forth in the FX
Global Code. The FX Global Code was developed
by a partnership between central banks and
participants from 16 jurisdictions. The code does
not impose legal or regulatory obligations on
participants nor does it act as a substitute for
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market participants would be able to
understand more fully any differences
among those flexible methods across
SEFs.
Based on the definition of ‘‘rule’’
under § 40.1(a), which encompasses any
SEF ‘‘trading protocol,’’ the proposed
rule clarifies those features of a SEF’s
execution methods that constitute SEF
‘‘rules’’ and must be submitted to the
Commission pursuant to part 40 and
disclosed to SEF market participants.304
Accordingly, SEFs would be required to
disclose such information in their
rulebooks. After reviewing SEF
rulebooks, the Commission believes that
this proposed disclosure requirement is
consistent with current market practice
and the general level of information
already disclosed by many SEFs.
Accordingly, the Commission does not
anticipate that this proposed rule would
require material changes to most SEF
rulebooks; rather, the proposed rule
would ensure that currently-registered
and new SEFs provide a consistent,
minimum level of transparency and
disclosure to the marketplace. The
Commission further notes that SEFs are
free to provide additional levels of
disclosure beyond that required under
proposed § 37.201(a).
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a. § 37.201(a)(1)—Trading and
Execution Protocols and Procedures
Proposed § 37.201(a)(1) would require
a SEF to establish rules governing the
protocols and procedures for trading
and execution, including entering,
amending, cancelling, or executing
orders for each execution method
offered by the SEF. The Commission
believes that requiring SEFs to provide
this level of detail and transparency for
each of their execution methods is
particularly important given the
Commission’s proposal to permit SEFs
to offer flexible execution methods for
all of their listed swaps.
The Commission believes that
proposed § 37.201(a)(1) clarifies a SEF’s
existing obligations and is consistent
with current market practice, in
particular the general level of disclosure
and information that many SEFs already
provide in their rulebooks. This
proposed rule is also better aligned with
regulation, but rather serves as a supplement to
local laws by setting forth guidelines for good
practices in the FX markets. The code specifies,
among other recommendations, that ‘‘Market
Participants,’’ which include operators of trading
systems or platforms, should provide all relevant
disclosures and information to participants to help
them make informed decisions about whether to
transact or not. See FX Global Code at 13–14
(updated Aug. 2018) (‘‘FX Global Code’’), available
at https://www.globalfxc.org/docs/fx_global.pdf.
304 See supra note 179 (definition of ‘‘rule’’ in the
Commission’s regulations).
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other proposed Core Principle 2
regulations that relate to SEF trading
protocols and procedures, such as
proposed § 37.203(e), which would
require SEFs to promulgate rules and
procedures to resolve error trades,
including trade amendments or
cancellations, as discussed below.305
To comply with this rule, for
example, a SEF that offers an RFQ
protocol could specify various
operational aspects of that protocol in
its rulebook. Those aspects could
include, among other things, how a
requestor could initiate an RFQ;
whether the RFQ requestor’s identity is
disclosed or anonymous; whether an
RFQ request could be made visible to
the entire market; whether a responder
could offer either indicative or firm bids
or offers; the length of time that an RFQ
response with a firm bid or firm offer
would have to remain executable by the
RFQ requestor; or whether RFQ
responses are disclosed to the whole
market or just the requestor. By
specifically requiring a SEF to disclose
information regarding how each offered
execution method operates, a market
participant would have the ability to (i)
make an informed decision about
whether to trade and execute on that
SEF; (ii) determine the type of trading
system or platform that best suits its
needs; and (iii) conform its trading and
execution practices to the SEF’s
protocols and procedures.306
b. § 37.201(a)(2)—Discretion
Proposed § 37.201(a)(2) would require
a SEF, where applicable, to establish
rules specifying the manner or
circumstances in which the SEF may
exercise ‘‘discretion’’ in facilitating
trading and execution for each of its
execution methods. Many SEFs, in
particular those that resemble or are
based upon operations of swaps broking
entities, including interdealer brokers,
feature execution methods that involve
the use of discretion.307 SEF trading
specialists,308 who have traditionally
305 See infra Section VII.B.5.—§ 37.203(e)—Error
Trade Policy.
306 See FX Global Code at 13–14 (recommending
that trading systems or platforms have rules that are
transparent, including how orders are handled and
transacted).
307 As noted above, upon the adoption of part 37,
some interdealer brokers have registered their
operations or components of their operations, i.e.,
trading systems or platforms, as SEFs. See supra
Section IV.C.1.c.(1)—Structure and Operations of
Swaps Broking Entities, Including Interdealer
Brokers.
308 ‘‘SEF trading specialist’’ refers to a natural
person employed by a SEF (or acting in a similar
capacity as a SEF employee) to perform various core
functions that facilitate trading and execution,
including discussing market color with market
participants, negotiating trade terms, issuing RFQs,
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61983
served as interdealer brokers in the
wholesale swaps market, exercise
discretion on behalf of market
participants in a variety of ways. This
discretion includes determining how,
when, and with whom to disseminate,
arrange, and execute bids and offers;
and determining whether and when to
amend or cancel those bids and offers in
response to market developments.
Exercising this type of trading and
execution judgment involves taking
different factors into account, such as
the characteristics and needs of the
client, size and nature of the order,
likelihood and speed of execution, price
and costs of execution, and current
market conditions. The use of discretion
in trading reflects the market
characteristics of the wholesale swaps
market, where the wide range of
different swaps and transaction sizes
results, in some instances, in low
liquidity markets with episodic, noncontinuous trading activity.
Given the established role of swaps
broking entities, including interdealer
brokers, in fostering market liquidity
through identifying and arranging
multiple trading interests—both liquid
and illiquid—amidst changing market
conditions, the Commission recognizes
that the use of discretion is an important
element in fostering an efficient market.
Therefore, the Commission’s proposed
regulatory framework would further
accommodate the use of discretion by
SEFs. As described above, SEFs would
be allowed to offer flexible execution
methods, thereby allowing methods that
involve the exercise of discretion by
SEF trading specialists.309 Further, the
proposed expansion of the trade
execution requirement would lead to a
greater number of swaps being traded on
SEFs.
The Commission believes that the
proposed broadening of both the SEF
registration requirement and the trade
execution requirement would increase
the level of discretion that SEFs (and
their trading specialists) exercise in
connection with swaps trading. To
address this situation, proposed
§ 37.201(a)(2) would require SEFs to
disclose the manner or circumstances in
which they may exercise discretion. The
Commission believes that such a
disclosure requirement is important to
and arranging bids and offers. For the Commission’s
proposed definition of ‘‘SEF trading specialist,’’ see
infra Section VI.A.3.—§ 37.201(c)—SEF Trading
Specialists.
309 The Commission’s clarification of the SEF
registration requirement, as discussed above, would
require swaps broking entities, including
interdealer brokers, to register as SEFs. Id. The
Commission notes that as a result, a significant
number of personnel at these entities would likely
meet the definition of ‘‘SEF trading specialist.’’
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inform market participants, facilitate an
orderly SEF trading environment, foster
open and transparent markets, and
promote market integrity while
remaining consistent with Core
Principle 2.310 Such information would
help a market participant have
important awareness of how a trading
system or platform is designed, thereby
allowing them to make informed
decisions with respect to swaps trading
on a particular SEF. For example, such
information would help market
participants determine appropriate
parameters or instructions in submitting
their bids and offers to a particular SEF,
as well as inform their expectations
about possible trading outcomes or
objectives on that SEF. The Commission
believes that more informed market
participants would promote fairer and
more efficient trading on SEFs and,
ultimately, make SEFs more robust price
discovery mechanisms.
Pursuant to proposed § 37.201(a)(2),
the Commission intends to require each
SEF to generally disclose the possible
areas in which it may use discretion for
each execution method, rather than
establish exact, pre-determined trading
protocols and procedures. In identifying
those general areas, a SEF’s rules should
disclose sufficient information that a
reasonable market participant would
consider important in deciding whether
to onboard onto the SEF and, once
participating on the SEF, in
understanding how discretion may
affect trading. The proposed rule,
however, does not necessarily require a
SEF to disclose any proprietary or
confidential information in its public
rulebook.311 Based on its experience
with reviewing SEF rulebooks, the
Commission believes that proposed
§ 37.201(a)(2) is consistent with current
market practice and the general level of
information that many SEFs already
provide in their rulebooks.312
310 See FX Global Code at 13–14 (recommending
that trading systems or platforms should make
participants aware of where discretion may exist or
may be expected, and how it may be exercised, as
a way to promote fairness and transparency in
trading).
311 The Commission notes, however, that if a SEF
believes that any such information should be kept
confidential, such that it should be provided to
market participants but not in a public filing, the
SEF may submit a request for confidential treatment
with its respective rule submission. 17 CFR 40.8.
The Commission’s treatment of such information
would be governed by § 145.9, 17 CFR 145.9, and
the Freedom of Information Act. 5 U.S.C. 552.
312 The Commission notes, for example, that SEF
rules have generally specified several areas where
discretion may be exercised in facilitating trading,
such as determining when to enter orders on behalf
of participants; determining when and with which
participants to gauge possible trading interest; and
determining how to calculate mid-market prices for
use in a session-based execution method, i.e.,
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Accordingly, the Commission does not
anticipate that existing SEFs will be
required to adopt material changes to
their rulebooks; rather, the proposed
rule would ensure that both currentlyregistered and new SEFs continue to
provide sufficient transparency and
disclosure.
c. § 37.201(a)(3)—Market Pricing
Information
Proposed § 37.201(a)(3) would require
each SEF to adopt rules that disclose the
general sources and methodology for
generating any market pricing
information that the SEF provides to
market participants to facilitate trading
and execution. The term ‘‘sources’’
would include any general inputs that
the SEF may consider when forming a
price, such as swaps pricing data, e.g.,
the last traded price; historical,
executable, or indicative bids and offers
on the SEF or other trading platforms;
or the views of market participants, who
the SEF may contact to ascertain
interest. The term ‘‘methodology’’
means that a SEF should generally
identify the extent to which it may
formulate a price on its trading systems
or platforms, whether prices generated
by SEFs are based on discretion or some
type of pre-set approach, and how the
information or data sources are
generally applied or weighted within
the SEF’s methodology.
The Commission recognizes that some
SEFs provide participants either an
indicative or executable ‘‘market price’’
to encourage price discovery and
liquidity or otherwise inform trading
interest. The use of market prices is
particularly prevalent in connection
with certain execution methods, such as
auctions and similar matching
sessions.313 SEFs often generate these
prices by considering various sources of
data, including prices from executed
transactions, prices from executable or
indicative bids and offers, publicly
reported swaps data, active market
participant views, or prices from related
instruments in other markets. Based on
the availability of this information at a
given time, a SEF may take one or more
of these factors into account differently
in formulating a single price. These
pricing mechanisms help to initiate the
determining the number of factors to consider in the
calculation of a mid-market price or the weight of
each factor.
313 In a typical SEF auction or matching sessionbased trading functionality, a SEF establishes a
price for a listed swap that is determined through
a variety of different factors. Participants may
submit their trading interest in the swap at the
established price, either within an established time
session or on a continuous basis, and subsequently
execute that swap at the established price, often on
a time-priority basis.
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price discovery process and allow
market participants to formulate views
about the current state of the market. By
relying upon an established price, a
market participant may make trading
decisions without being exposed to
information leakage that might
otherwise cause widened bid-offer
spreads and impose higher transaction
costs.314 Given this unique feature of the
swaps market due to its episodic
liquidity, the Commission recognizes
that SEF pricing practices are an
important element in fostering liquidity
on SEFs and, therefore, in promoting the
Act’s statutory goals of encouraging SEF
trading and pre-trade price
transparency.
Where pricing generated by a SEF in
lieu of pricing based on market
participant bids and offers help to foster
liquidity and price discovery, the
Commission believes that requiring
SEFs to inform market participants as to
their price formation sources and
methodology would foster open and
transparent markets and promote market
integrity and efficiency. Requiring a SEF
to disclose the sources of information
used to generate a price and the
methodology for calculating that price,
for example, would allow market
participants to be aware of prevailing
liquidity and market conditions, thereby
helping them to form views as to
whether that price is an appropriate
indicator of a particular market.
Accordingly, market participants would
be able to make informed trading
decisions, such as whether to
participate in an available trading
session, and if so, the level of
participation, e.g., whether they would
contribute their own information to help
establish a trading price in a particular
execution method.315 The Commission
believes that this information should
build confidence among participants in
the integrity, fairness, and effectiveness
of the SEF as a regulated trading venue.
In turn, a greater level of confidence in
SEFs should lead to increased swaps
trading volume and, ultimately, an
increased potential for higher levels of
pre-trade price transparency through
increased participation.
Similar to proposed § 37.201(a)(2), the
Commission emphasizes that proposed
§ 37.201(a)(3) would establish a general
314 The Commission understands that participants
often avoid acting as a ‘‘first-mover’’ for relatively
less liquid swaps by exercising caution in
displaying their trading interests, i.e., price and
size; accordingly, SEFs—similar to historical OTC
trading environments—utilize these types of
methods to promote trading for particular swaps
and pre-trade price transparency.
315 See supra note 313 (describing mechanics of
a SEF auction or matching session-based trading
functionality).
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approach as to the scope of information
that a SEF must disclose and does not
require the SEF to specify detailed
calculations or algorithms used to
generate pricing information. The
Commission also notes that the
proposed rule would not require SEFs to
disclose the identities of market
participants who provide data used to
formulate prices or to disclose
proprietary aspects of their pricing
methodology.316 Rather, a SEF’s rules
should disclose sufficient information
that a reasonable market participant
would consider important to determine
whether to join the SEF and to generally
understand the nature of the market
pricing information provided by the
SEF. In addition, proposed
§ 37.201(a)(3) would not require a SEF
to provide any proprietary or
confidential information in its public
rulebook. Based on its experience with
reviewing SEF rulebooks submitted via
the part 40 rule filing process, the
Commission believes that proposed
§ 37.201(a)(3) is consistent with current
market practice and the general level of
information that many SEFs already
include in their rulebooks.317
Request for Comment
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The Commission requests comment
on all aspects of proposed § 37.201(a). In
particular, the Commission requests
comment on the following question:
(28) Do the requirements under
proposed §§ 37.201(a)(1)–(3) set an
appropriate level of disclosure by SEFs
to market participants? Are the
requirements too broad? Should the
Commission require additional
disclosures that would be material for
market participants to make an
informed decision to participate on the
SEF? If so, what additional disclosures
should be required? Please provide
specific examples in your responses.
316 The Commission further notes, however, that
regardless of whether market participants
participate in the price-formation process or
whether their identities remain anonymous, all
market participants remain subject to section 9(a)(2)
of the Act. That provision prohibits any attempt to
provide false, misleading, or knowingly inaccurate
reports concerning market information or
conditions that affect or tend to affect the price of
any swap. 7 U.S.C. 13(a)(2).
317 In disclosing the general sources and
methodologies for generating market pricing
information, the Commission notes that such SEF
rules have generally specified (i) the SEF’s ability
to consider either a single or multiple number of
established factors in determining a price; (ii) the
various types of factors that it may take into account
to determine a price; or (iii) other additional
analytical methods that may be used to supplement
a price calculated from existing bids and offers on
the platform.
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2. § 37.203(a)—Pre-Arranged Trading
Prohibition; § 37.9(b) Time Delay
Requirement
Part 37 has permitted market
participants to communicate with one
another away from a SEF in connection
with the eventual execution of swap
transactions via the SEF’s trading
systems or platforms.318 The
Commission has observed that such
communications, which commonly
occur on a direct basis between swap
dealers and their clients in the dealerto-client market, vary in nature and
scope. Such communication may, for
example, include communications to
discern trading interest prior to trading
on the SEF, e.g., obtaining market color,
identifying potential trades, and
locating interested counterparties. Such
communications, however, may also
consist of the actual negotiation or
arrangement of a swap transaction’s
terms and conditions prior to execution
on a SEF. Such communications are
permitted through several provisions in
the current regulatory framework, as
described below, based in part on
whether the transaction qualifies for an
exception to the prohibition on prearranged trading under § 37.203(a); or
whether the swap is otherwise not
subject to the trade execution
requirement.
The Commission notes that ‘‘prearranged trading’’ is prohibited as an
abusive trading practice under
§ 37.203(a). This prohibition generally
applies to market participants who
communicate with one another to prenegotiate the terms of a trade away from
a SEF’s trading system or platform, but
then execute the trade on such system
or platform in a manner that appears
competitive and subject to market risk.
The Commission has intended for this
prohibition to maintain the integrity of
price competition and market risk that
is incident to trading in the market.319
Notwithstanding this prohibition, SEFs
318 SEF
Core Principles Final Rule at 33503.
Commission generally considers prearranged trading to be a form of ‘‘fictitious’’ trading
that is prohibited pursuant to CEA section 4c(a)(1),
which makes it unlawful for any person to offer to
enter into, or confirm the execution of a fictitious
sale. 7 U.S.C. 6c(a)(1), 6c(a)(2)(A)(ii). Specifically,
pre-arranged trading involves ‘‘the use of trading
techniques that give the appearance of submitting
trades to the open market while negating the risk
of price competition incident to such a market.’’
Harold Collins, [1986–1987 Transfer Binder] Comm.
Fut. L. Rep. (CCH) 22982, 31902 (CFTC Apr. 4,
1986). Generally, pre-arranged trading creates a
false impression to the market that an executed
transaction is indicative of a competitive trading
environment. Id. at 31903 (‘‘By determining trade
information such as price and quantity outside the
pit, then using the market mechanism to shield the
private nature of the bargain from public scrutiny,
both price competition and market risk are
eliminated.’’).
319 The
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61985
have permitted pre-arranged trading on
their facilities in certain instances.
For Required Transactions executed
via an Order Book, a SEF may permit
market participants to communicate
with one another and pre-arrange or prenegotiate a swap transaction away from
its trading system or platform, subject to
a time delay requirement and facility
rules on pre-execution communications.
Section 37.9(b)(1) currently permits a
broker or dealer to engage in preexecution communications to prearrange or pre-negotiate a swap, as long
as one side of the resulting transaction
is entered into the Order Book for a 15second delay before the second side is
entered for execution against the first
side (the ‘‘time delay requirement’’).
The Commission defined ‘‘preexecution communications’’ as
communications between market
participants to discern interest in the
execution of a transaction prior to the
exposure of the market participants’
orders (e.g., price, size, and other terms)
to the market; such communications
include discussion of the size, side of
market, or price of an order, or a
potentially forthcoming order.320 To the
extent that SEFs would allow their
market participants to engage in such
pre-execution communications, the
Commission required SEFs to adopt
associated rules.321
The Commission implemented
§ 37.9(b) to ensure a minimum level of
pre-trade price transparency for orders
based on pre-execution communications
that occur away from the SEF, and to
incentivize price competition between
market participants for orders entered
into an Order Book.322 The Commission
320 SEF Core Principles Final Rule at 33503. In
light of the Commission’s general prohibition on
pre-arranged trading under § 37.203(a), the
Commission defined this term to clarify the
permissible types of communications in which
market participants can pre-arrange or pre-negotiate
a transaction consistent with § 37.9(b)(1). The
Commission currently requires that SEFs that
choose to allow their market participants to engage
in pre-execution communications prior to executing
such transactions must do so pursuant to their
rules. 17 CFR 37.203(a). Such communications may
constitute an element of pre-arranged trading,
which is an abusive trading practice prohibited
under existing § 37.203(a).
321 SEF Core Principles Final Rule at 33509.
322 Id. at 33503. The Commission modeled the
time delay requirement after similar DCM rules that
have imposed time delays on cross trades involving
futures and options on futures. Pursuant to these
rules, market participants are permitted to conduct
pre-execution communications with respect to
orders that are later exposed to the market for a
certain period of time prior to execution on the
DCM’s trading system or platform. As DCM Core
Principle 9 requires DCMs to provide a competitive,
open, and efficient market and mechanism for
executing transactions that protects the price
discovery process of trading in the centralized
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anticipated that disclosing one side of a
pre-arranged transaction in the Order
Book first would provide other market
participants with an opportunity to
execute against that side prior to entry
of the second side in the Order Book.323
A similar requirement, however, was
not applied to Required Transactions
executed through a SEF’s RFQ System.
The Commission noted that the
requirement to send an RFQ to three
other market participants already
provides pre-trade price transparency,
thereby obviating the need for a
corresponding time delay.324
In addition to the time delay
requirement, § 37.203(a) also specifies
that a SEF may choose to permit prearranged trading in other instances.
First, a SEF may permit a swap that it
lists to be executed as a block trade
away from a SEF pursuant to part 43.
This exception allows such large-sized
transactions to be privately negotiated to
avoid potentially significant and
adverse price impacts that would occur
if traded on trading systems or platforms
with pre-trade price transparency.325
Second, a SEF may permit pre-arranged
trading for ‘‘other types of transactions’’
through rules that are filed with the
Commission pursuant to part 40. These
rules permit pre-arranged trading with
respect to Required Transactions that
are intended to resolve error trades 326
market of the DCM, 7 U.S.C. 7(d)(9)(A), DCMs have
implemented certain time delay procedures that
establish a ‘‘safe harbor’’ for orders resulting from
pre-execution communications that would
otherwise be considered pre-arranged trading. To
protect price discovery, such orders must be
exposed to the market for a minimum amount of
time prior to allowing such orders to match against
one another on a DCM. This time delay generally
provides other participants with an opportunity to
execute against the initial order. See, e.g., CME
Group, Rule 539.C (rules on pre-execution
communications regarding Globex trades).
323 17 CFR 37.9(b)(1).
324 SEF Core Principles Final Rule at 33504. The
SEF Core Principles Final Rule did not explicitly
require a SEF to adopt pre-execution
communication rules for swaps executed using its
RFQ System. Nevertheless, the Commission has
observed that some SEFs have self-certified rules
under § 40.6 to allow their market participants to
engage in pre-execution communication prior to
transmitting an RFQ through the facility’s RFQ
System.
325 As defined under § 43.2, a ‘‘block trade’’
involves a SEF-listed swap transaction with a
notional amount that meets the corresponding
appropriate minimum block size and is executed
away from the SEF’s trading system or platform, but
pursuant to the SEF’s rules and procedures. 17 CFR
43.2. The Commission is proposing to amend that
definition to specify that block trades must be
executed on a SEF. See infra Section XXII.—Part
43—§ 43.2—Definition of ‘‘Block Trade.’’
326 Based on time-limited no-action relief issued
by DMO, a SEF may submit pre-arranged Required
Transactions for execution on the SEF that resolve
error trades, i.e., correct transactions to offset an
initial transaction executed on the SEF containing
a clerical or operational error, and where necessary,
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or are executed as a component of
certain categories of package
transactions.327
In the preamble to the SEF Core
Principles Final Rule, the Commission
did not discuss the issue of preexecution communications regarding
swaps that are not subject to the trade
execution requirement, i.e., Permitted
Transactions, but the Commission has
permitted SEFs to adopt a more flexible
approach to the use of communications
away from the SEF. This approach
corresponds to the Commission’s
approach to Permitted Transactions,
which are not required to be executed
on a SEF and otherwise may be
executed on a SEF through flexible
execution methods.328 Under a more
flexible approach, the Commission has
observed that SEFs—both those that
facilitate trading in the dealer-to-client
market and those that facilitate trading
in the dealer-to-dealer market—have
consequently adopted rules to allow
their market participants to engage in a
variety of pre-execution
communications away from their
respective trading systems or platforms
prior to executing Permitted
Transactions on SEFs. The Commission
notes in particular that some methods
allow counterparties to submit prenegotiated terms and conditions of a
transaction to a SEF ‘‘order entry’’
system for execution and related posttrade processing.329
a. § 37.201(b)—Pre-Execution
Communications
The Commission proposes several
amendments under the proposed
framework that would broadly apply to
pre-execution communications that
occur away from a SEF. For swaps
subject to the trade execution
requirement, proposed § 37.201(b)
would require a SEF to prohibit its
participants from engaging in preexecution communications away from
its facility, including negotiating or
arranging the terms and conditions of a
swap prior to its execution on the SEF,
a new transaction that reflects the terms to which
the counterparties had originally assented. See infra
note 433 and accompanying discussion.
327 Based on time-limited no-action relief issued
by DMO, a SEF may submit pre-arranged Required
Transactions for execution on SEFs that are
components of certain categories of package
transactions. See infra note 334.
328 SEF Core Principles Final Rule at 33504.
329 As noted above, several SEFs affiliated with
interdealer brokers offer this type of functionality.
As participants affiliated with a SEF, interdealer
brokers have arranged Permitted Transactions on
behalf of dealer clients through ‘‘communications’’
on their trading systems or platforms and submitted
those transactions to a SEF for execution without
being subject to any corresponding order exposure.
See supra note 88 and accompanying discussion.
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i.e., via the SEF’s methods of execution.
This prohibition would be subject to
certain proposed exceptions discussed
further below. Given this general
prohibition, the Commission also
proposes to eliminate the existing
exceptions to the pre-arranged trading
prohibition, including (i) the time delay
requirement under § 37.9(b); (ii) the
exception for block trades under
§ 37.203(a) as part of the Commission’s
proposed amendments to the ‘‘block
trade’’ definition under § 43.2; 330 and
(iii) the exception for ‘‘other types of
transactions’’ under § 37.203(a).
Proposed § 37.203(a), as discussed
below, would continue to require a SEF
to prohibit abusive trading practices,
including pre-arranged trading, as
appropriate to its trading systems or
platforms. Therefore, a SEF would not
be allowed to provide rules that allow
market participants to pre-negotiate or
pre-arrange a transaction and submit the
sides of the transaction to an order book
pursuant to a time delay.
In eliminating the prescriptive
execution methods and allowing more
flexible execution for swaps subject to
the trade execution requirement, the
Commission believes that pre-execution
communications, including the
negotiation or arrangement of those
swaps, would be able to occur entirely
within a SEF’s trading system or
platform. Such negotiation or
arrangement, regardless of the method
through which they may occur, i.e.,
among participants themselves or
through a swaps broking entity,
constitutes ‘‘trading’’ that should occur
on a SEF. The Commission notes that
‘‘trading,’’ as discussed above, includes
the negotiation or arrangement of
transactions through the interaction of
bids and offers.331 Based on its
experience with implementing part 37,
the Commission believes that the broad
scope of pre-execution communications
that have been allowed to occur away
from the SEF under the existing
framework has undermined a
meaningful role of the SEF in
facilitating trading activity and liquidity
formation.
Accordingly, the Commission believes
that these proposed changes are an
important element of the proposed SEF
regulatory framework and are intended
330 See infra Section XXII.—Part 43—§ 43.2—
Definition of ‘‘Block Trade.’’
331 With respect interdealer brokers, the
Commission believes that their trading systems or
platforms facilitate ‘‘trading’’ between multiple
participants in conformance with the statutory SEF
definition and, therefore, are subject to the SEF
registration requirement. See supra Section
IV.C.1.c.(2)—SEF Registration Requirement for
Swaps Broking Entities, Including Interdealer
Brokers.
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to enhance this framework, such that a
broader range of swaps trading activity
would be occurring on SEFs and
creating a vibrant and liquid
marketplace for swaps trading. For
example, the Commission notes the
likely increase in the number of swaps
that would become subject to the trade
execution requirement under this
proposal. Currently, many of those
swaps are Permitted Transactions
submitted to a SEF for execution after
negotiation or arrangement away from
the facility, or are negotiated and
executed on an OTC basis. With an
expanded scope of swaps subject to the
trade execution requirement, the
Commission is concerned that allowing
a disproportionate amount of SEF
transactions to be pre-arranged or prenegotiated away from the facility under
the pretense of trading flexibility would
undercut the import of the expansion of
the requirement. Without a limitation
on pre-execution communications that
occur away from the SEF, the SEF’s role
in facilitating swaps trading is also
diminished and would undermine the
statutory goals of promoting greater
swaps trading on SEFs and promoting
pre-trade price transparency.
The Commission also notes that its
proposed approach to pre-execution
communications, as applied to SEFs in
the dealer-to-dealer market, is consistent
with the application of the SEF
registration requirement to swaps
broking entities, e.g., interdealer brokers
that facilitate swaps trading activity
between market participants. As
discussed above, the Commission
believes that brokers, who facilitate
trading communications between
market participants away from a SEF
and subsequently submit pre-negotiated
or pre-arranged trades to the SEF for
execution, relegate the SEF to a de facto
post-trade processing venue. Requiring
these entities to register as SEFs would
ensure that this type of liquidity
formation occurs on a SEF.332 Similarly,
332 As noted above, the Commission recognizes
that domestic swaps broking entities and foreign
swaps broking entities would be subject to a sixmonth and two-year delayed application of the SEF
registration requirement, respectively. These delays
would allow them to continue to negotiate or
arrange swaps transactions between multiple
participants and route them to SEFs or Exempt
SEFs for execution. Accordingly, the compliance
date of any final rule with respect to the prohibition
on pre-execution communication under proposed
§ 37.201(b) and the pre-arranged trading prohibition
under § 37.203(a) for these entities would also be
subject to a delay of six months or two years,
depending on the entity’s domicile and starting
from the effective date of the final rule. See supra
Section IV.C.1.c.—Swaps Broking Entities,
Including Interdealer Brokers and Section
IV.C.1.d.—Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading
Facilities.
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the submission of trade terms negotiated
or arranged via direct communications
between participants, e.g., a swap dealer
and a client, away from a SEF allows
liquidity formation to occur outside of
the SEF regulatory framework, which
undermines the statutory SEF goals.
Limiting the scope of these
communications would also help ensure
that this activity occurs on a registered
SEF via flexible means of execution,
which promotes the statutory goals of
promoting trading on SEFs and
promoting pre-trade price transparency.
(1) Exception for Swaps Not Subject to
the Trade Execution Requirement
The Commission proposes an
exception to the proposed prohibition
on pre-execution communications
under § 37.201(b) for swaps that are not
subject to the trade execution
requirement. The Commission’s
proposed exception recognizes that
market participants do not have to
execute such swaps on SEFs. The
Commission also acknowledges that two
counterparties may initially discuss or
negotiate a potential swap transaction
on a bilateral basis away from a SEF
with the intent to execute the
transaction away from the SEF, but
subsequently determine to submit the
resulting arranged transaction to be
executed on a SEF. The Commission
believes that applying the proposed
§ 37.201(b) prohibition to swaps not
subject to the trade execution
requirement would not be practical,
given that counterparties do not have to
execute these swaps on a SEF. The
Commission emphasizes, however, that
this proposed exception does not affect
the SEF registration requirement under
proposed § 37.3(a), which would specify
that a person operating a facility that
meets the statutory SEF definition must
register as a SEF without regard to
whether the swaps that it lists for
trading are subject to the trade
execution requirement.333
(2) § 37.201(b)(1)—Exception for
Package Transactions
The Commission also proposes an
exception under § 37.201(b)(1) to the
proposed prohibition on pre-execution
communications for swaps subject to
333 See supra Section IV.C.1.a.—Footnote 88. For
example, the exception would inherently not apply
to a swaps broking entity that conducts preexecution communications to facilitate trading
activity on behalf of multiple participants in swaps
that are not subject to the trade execution
requirement. As noted above, such an entity would
be subject to the SEF registration requirement and
personnel facilitating those communications would
likely be designated as SEF trading specialists that
constitute part of a SEF’s trading system or
platform. See supra notes 308–309.
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61987
the trade execution requirement that are
components of ‘‘package transactions’’
that also include components that are
not subject to the trade execution
requirement.334 For purposes of this
334 The Commission notes that the swap
components of different categories of package
transactions have been subject to time-limited noaction relief provided by Commission staff from the
trade execution requirement and required methods
of execution. These categories of package
transactions include those where (i) each of the
components is a swap subject to the trade execution
requirement (‘‘MAT/MAT’’); (ii) at least one of the
components is subject to the trade execution
requirement and each of the other components is
subject to the clearing requirement (‘‘MAT/NonMAT (Cleared)’’); (iii) each of the swap components
is subject to the trade execution requirement and all
other components are U.S. Treasury securities
(‘‘U.S. Dollar Swap Spreads’’); (iv) each of the swap
components is subject to the trade execution
requirement and all other components are agency
mortgage-backed securities (‘‘MAT/Agency MBS’’);
(v) at least one individual swap component is
subject to the trade execution requirement and at
least one individual component is a bond issued
and sold in the primary market (‘‘MAT/New
Issuance Bond’’); (vi) at least one individual swap
component is subject to the trade execution
requirement and all other components are futures
contracts (‘‘MAT/Futures’’); (vii) at least one of the
swap components is subject to the trade execution
requirement and at least one of the components is
a CFTC swap that is not subject to the clearing
requirement (‘‘MAT/Non-MAT (Uncleared)’’); (viii)
at least one of the swap components is subject to
the trade execution requirement and at least one of
the components is not a swap (excluding
aforementioned categories) (‘‘MAT/Non-Swap
Instruments’’); and (ix) at least one of the swap
components is subject to the trade execution
requirement and at least one of the components is
a swap over which the CFTC does not have
exclusive jurisdiction, e.g., a mixed swap (‘‘MAT/
Non-CFTC Swap’’). See CFTC Letter No. 14–12, NoAction Relief from the Commodity Exchange Act
Sections 2(h)(8) and 5(d)(9) and from Commission
Regulation § 37.9 for Swaps Executed as Part of a
Package Transaction (Feb. 10, 2014) (‘‘NAL No. 14–
12’’); CFTC Letter No. 14–62, No-Action Relief from
the Commodity Exchange Act Sections 2(h)(8) and
5(d)(9) and from Commission Regulation § 37.9 for
Swaps Executed as Part of Certain Package
Transactions and No-Action Relief for Swap
Execution Facilities from Compliance with Certain
Requirements of Commission Regulations
§ 37.9(a)(2), § 37.203(a) and § 38.152 for Package
Transactions (May 1, 2014) (‘‘NAL No. 14–62’’);
CFTC Letter No. 14–121, Extension of No-Action
Relief for Swap Execution Facilities and Designated
Contract Markets from Compliance with Certain
Requirements of Commission Regulations
§ 37.9(a)(2), § 37.203(a) and § 38.152 for Package
Transactions (Sept. 30, 2014) (‘‘NAL No. 14–121’’);
CFTC Letter No. 14–137, Extension of No-Action
Relief from the Commodity Exchange Act Sections
2(h)(8) and 5(d)(9) and from Commission
Regulation § 37.9 and Additional No-Action Relief
for Swap Execution Facilities from Commission
Regulation § 37.3(a)(2) for Swaps Executed as Part
of Certain Package Transactions (Nov. 10, 2014)
(‘‘NAL No. 14–137’’); CFTC Letter No. 15–55,
Extension of No-Action Relief from the Commodity
Exchange Act Sections 2(h)(8) and 5(d)(9) and from
Commission Regulation § 37.9 and No-Action Relief
for Swap Execution Facilities from Commission
Regulation § 37.3(a)(2) for Swaps Executed as Part
of Certain Package Transactions (Oct. 15, 2014)
(‘‘NAL No. 15–55’’); CFTC Letter No. 16–76, Re:
Extension of No-Action Relief from the Commodity
Exchange Act Sections 2(h)(8) and 5(d)(9) and from
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exception, a ‘‘package transaction’’
involves two or more counterparties and
consist of two or more component
transactions whose executions are (i)
contingent upon one another, (ii) priced
or quoted together as one economic
transaction, and (iii) executed
simultaneous or near simultaneous to
each other.335
The Commission recognizes that some
package transactions contain both a
swap that is subject to the trade
execution requirement and other swap
or non-swap components that are not
subject to the requirement. Components
not subject to the requirement include,
for example, swaps not subject to the
clearing requirement, e.g., swaptions,
and various types of securities.336 The
negotiation or arrangement of each of
these components generally occurs
concurrently or on a singular basis; in
particular, negotiations for the pricing of
such package transactions may be
primarily based on the components that
are not subject to the requirement.
Further, the swap components in those
types of transactions that are subject to
the requirement often serve as hedging
tools to other components. For those
components not subject to the
requirement, market participants may
negotiate the terms away from a SEF.
The Commission believes that
imposing a prohibition on swaps subject
to the trade execution requirement that
are part of a package transaction that
includes components not subject to the
requirement would inhibit the ability of
Commission Regulation § 37.9 and No-Action Relief
for Swap Execution Facilities from Commission
Regulation § 37.3(a)(2) for Swaps Executed as Part
of Certain Package Transactions (Nov. 1, 2016)
(‘‘NAL No. 16–76’’); CFTC Letter No. 17–55, Re:
Extension of No-Action Relief from Sections 2(h)(8)
and 5(d)(9) of the Commodity Exchange Act and
from Commission Regulations 37.3(a)(2) and 37.9
for Swaps Executed as Part of Certain Package
Transactions (Oct. 31, 2017) (‘‘NAL No. 17–55’’). To
the extent that counterparties may be facilitating
package transactions that involve a ‘‘security,’’ as
defined in section 2(a)(1) of the Securities Act of
1933 or section 3(a)(10) of the Securities Exchange
Act of 1934, or any component agreement, contract,
or transaction over which the Commission does not
have exclusive jurisdiction, the Commission does
not opine on whether such activity complies with
other applicable law and regulations.
335 The Commission notes that it similarly defines
‘‘package transaction’’ under proposed § 36.1(d)(1)
for purposes of providing an exemption to the trade
execution requirement for swaps that are executed
as part of package that includes a bond issued in
a primary market. See infra Section XXI.A.4.—
§ 36.1(d)—Exemption for Swaps Executed with
Bond Issuance.
336 Based on time-limited no-action relief issued
by DMO, the categories of package transactions that
consist of components not subject to the
requirement include (i) U.S. Dollar Swap Spreads;
(ii) MAT/Agency MBS; (iii) MAT/New Issuance
Bond; (iv) MAT/Futures; (v) MAT/Non-MAT
(Uncleared); (vi) MAT/Non-Swap Instruments; and
(vii) MAT/Non-CFTC Swaps. See supra note 334.
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counterparties to negotiate or arrange
the latter components away from the
SEF.337 Given that components of
package transactions are each priced or
quoted together as part of one economic
transaction, the Commission recognizes
the impracticality of requiring
communications related to the
negotiation or the arrangement of the
swap component that is subject to the
trade execution requirement to occur on
the SEF. Accordingly, an exception from
the prohibition on pre-execution
communications away from the SEF for
swap components subject to the
requirement would be appropriate in
such circumstances.338 Consistent with
its intent to incorporate existing staff
no-action relief into the Commission’s
regulations, the Commission notes that
the proposed exception would codify
some of the relief that currently applies
to certain types of package
transactions.339
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.201(b).
In particular, the Commission seeks
insights regarding market participants’
use of pre-execution communications
and requests comment on the following
questions:
(29) What are market participants’
current pre-execution communication
practices? How often do market
participants currently engage in preexecution communication? What level
of trade detail is discussed during such
pre-execution communications? What
role, if any, should pre-execution
communications continue to have in the
SEF market structure?
(30) Is the Commission’s proposal to
require a SEF to prohibit market
participants from conducting preexecution communications away from a
SEF with respect to swaps that are
subject to the trade execution
337 Package transactions composed entirely of
swaps that are subject to the trade execution
requirement would be subject to the prohibition of
pre-execution communications under proposed
§ 37.201(b) and are not eligible for this proposed
exception.
338 The Commission notes that a swaps broking
entity that facilitates trading in any swap
component on behalf of multiple participants,
regardless of whether the swap is subject to the
trade execution requirement, would be subject to
the SEF registration requirement. See supra note
333.
339 Swap components in the following categories
of package transactions are currently subject to
relief from the required methods of execution under
existing § 37.9: (i) MAT/Non-MAT (Uncleared); (ii)
MAT/Non-Swap Instruments; and (iii) MAT/NonCFTC Swap. NAL No. 17–55 at app. A. Pursuant to
this relief, the Commission notes that SEFs have
allowed market participants to negotiate or arrange
the swap components away from the SEF and
submit them for execution.
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requirement appropriate? In light of the
Commission’s proposal to allow SEFs to
offer flexible execution methods, are
there any impediments for market
participants to execute those swaps, in
particular those that would become
subject to the Commission’s proposed
approach to the trade execution
requirement?
(31) With respect to swaps that are not
subject to the trade execution
requirement, is the Commission’s
proposal to allow SEFs to permit market
participants to conduct pre-execution
communications away from a SEF
appropriate?
(32) Are there any technical
limitations that a SEF would face to
accommodate pre-execution
communications that would otherwise
impede the ability of market
participants to trade and execute swaps
on a SEF?
(33) Should the Commission allow an
exception to the proposed prohibition
against pre-execution communications
for communications involving ‘‘market
color’’? If so, how should the
Commission define ‘‘market color’’? For
example, should such a definition
consist of views shared by market
participants on the general state of the
market or trading information provided
on an anonymized and aggregated basis?
Should such a definition exclude (i) an
express or implied arrangement to
execute a specified trade; (ii) non-public
information regarding an order; and (iii)
information about an individual trading
position? Are these elements
appropriate and should the Commission
consider additional elements?
(34) Should the Commission allow an
exception to the proposed prohibition
against pre-execution communications
for communications intended to discern
the type of transaction—which may or
may not be a swap—that a market
participant may ultimately execute on a
SEF? The Commission understands that
these types of communications are
common in the dealer-to-client market
and allow a dealer to assist a client with
determining which financial
instruments may be best suited to
manage the client’s risks or to establish
certain market positions. If so, please
describe the nature and scope of these
communications that would support an
exception to the proposed prohibition.
(35) Should the Commission allow an
exception to the proposed prohibition
against pre-execution communications
for all corrective trades intended to
resolve error trades pursuant to the
proposed error trade policy rules under
§ 37.203(e), as discussed further below?
Please explain why or why not.
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(36) The Commission is proposing to
allow market participants to engage in
pre-execution communications away
from a SEF for package transactions in
which at least one component is not
subject to the trade execution
requirement. For the swap components
of some of these package transactions
that are currently traded and executed
on SEFs—for example, those where all
other components are U.S. Treasury
securities—should they not be subject to
this exception? Are there other types of
package transactions for which the
Commission should provide an
exception to the proposed prohibition
on pre-execution communications?
3. § 37.201(c)—SEF Trading Specialists
The Commission notes that a number
of registered SEFs—in particular, those
that operate in the dealer-to-dealer
market—offer voice-based or voiceassisted execution platforms that utilize
natural persons to facilitate trading in
varying degrees. These persons,
commonly referred to as ‘‘trading
specialists’’ or ‘‘execution specialists,’’
perform core functions that facilitate
swaps trading and execution in a
multiple-to-multiple participant
environment, including disseminating
trading interests to the market, e.g.,
transmitting RFQs provided by
participants; matching bids and offers;
and negotiating or arranging transaction
terms and conditions on behalf of
participants.
Many individuals currently carry out
the same functions away from a SEF as
part of a swaps broking entity, such as
an interdealer broker, prior to execution
of the transaction on the SEF.340 These
swaps broking entities are often
registered with the Commission as
IBs 341 and these individuals are
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340 See
supra Section IV.C.1.c.(1)—Structure and
Operations of Swaps Broking Entities, Including
Interdealer Brokers.
341 The Commission notes above that IBs are
registered with the Commission pursuant to CEA
section 4f. See supra note 93 and accompanying
discussion. IBs and their associated persons are
required to register pursuant to registration
procedures set forth by the NFA. 17 CFR 3.10, 3.12.
Section 170.17 requires that each IB becomes and
remains a member of at least one registered futures
association, e.g., the NFA. 17 CFR 170.17. Pursuant
to CEA sections 4p and 17(p), such entities are
subject to, among other requirements administered
by the registered futures association, training
standards and proficiency testing. 7 U.S.C. 6p,
21(p). Depending on the category of intermediary,
registrants may be subject to various financial and
reporting requirements, e.g., 17 CFR 1.10 (financial
reports of FCMs and IBs), 1.17 (minimum financial
requirements for FCMs and IBs), as well as trading
standards, e.g., 17 CFR part 155 (trading standards
for floor brokers, FCMs, and IBs). Pursuant to CEA
section 6c and part 180, all registrants are subject
to prohibitions against fraud and manipulation. 7
U.S.C. 9; 17 CFR part 180. Applicants for
registration are subject to statutory disqualifications
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registered as associated persons of
IBs.342 As associated persons of IBs,
these persons are subject to various
regulatory requirements for
intermediaries aimed at protecting
customers.343 As noted above, the
Commission has proposed that these
swaps broking entities be registered as
a SEF, given that they facilitate
trading.344
The Commission recognizes, however,
that the current regulatory requirements
for swaps broking entities do not
necessarily fully address the unique
functions of trading specialists on a
SEF, which are broader in scope than
the traditional IB functions of
solicitation or acceptance of orders. SEF
trading specialists serve an
intermediary-type role for each market
participant that accesses their SEF by
facilitating fair, orderly, and efficient
trading and overall market integrity.
From a regulatory perspective, the
Commission believes that SEF trading
specialists—whether operating as part of
a fully voice-based system or as a voiceassisted system with electronic-based
features—are an integral part of their
respective SEF’s trading system or
platform.
A voice-based or voice-assisted SEF
trading system or platform is unique
among SEF execution methods. Unlike
a trading system or platform that
executes orders and facilitates trading
through generally automated means,
trading specialists that comprise part of
the voice-based or voice-assisted
systems usually exercise a level of
discretion and judgment in facilitating
interaction between bids and offers from
multiple market participants. That
discretion and judgment is informed by
their knowledge and understanding of
from registration pursuant to CEA section 8a(2)
based on related past convictions that involve fraud
or other acts of malfeasance. 7 U.S.C. 12a(2).
342 Section 1.3 defines an ‘‘associated person’’ of
an IB as any natural person who is associated with
an introducing broker as a partner, officer,
employee, or agent (or any natural person
occupying a similar status or performing similar
functions), in any capacity which involves the
solicitation or acceptance of customers’ orders
(other than in a clerical capacity) or the supervision
of any person or persons so engaged. 17 CFR 1.3.
343 See supra note 341. See also NFA Registration
Rules part 400 (proficiency requirements
established by the NFA for various registered
entities and associated person).
344 Upon adoption of the SEF Core Principles
Final Rule, some swaps broking entities, in
particular interdealer brokers, registered their
operations or components of their operations, i.e.,
trading systems or platforms, as SEFs. See supra
Section IV.C.1.c.(1)—Structure and Operations of
Swaps Broking Entities, Including Interdealer
Brokers. As part of this process, the Commission
understands that some specialists have transitioned
to the SEF from affiliated broker entities, in either
a permanent capacity or pursuant to a secondment
arrangement.
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61989
market conditions, which are based
upon information obtained from
observing historical activity and gauging
potential or actual trading interest from
communications with participants.
By allowing SEFs to offer flexible
methods of execution and broadening
the trade execution requirement to
swaps with more episodic liquidity, the
Commission believes that the proposed
rulemaking would lead to greater
volumes of trading on voice-based
trading systems or platforms that utilize
discretion and judgment. The use of
these methods should increase and
enhance the utility of SEFs in a manner
consistent with the SEF statutory intent
and goals, but the Commission also
believes that the expected increased role
of discretion in SEF trading operations
should be accompanied with a
regulatory approach that aims to
enhance professionalism among trading
specialists and enhance market
integrity. The Commission believes in
particular that such a regulatory
approach should address in particular
the integral role that trading specialists
play in exercising that discretion in a
SEF’s multiple-to-multiple trading
environment.
Therefore, the Commission proposes
to adopt a definition under § 37.201(c)
that would categorize certain persons
employed by a SEF as a ‘‘SEF trading
specialist’’ and require a SEF to ensure
that any such person (i) is not subject to
a statutory disqualification under CEA
sections 8a(2) or 8a(3); (ii) has met
certain proficiency requirements; and
(iii) undergoes ethics training on a
periodic basis. The proposed regulations
would further require a SEF to establish
and enforce a code of conduct for its
SEF trading specialists, as well as
diligently supervise their activities.
These proposed rules are intended to
enhance professionalism in the swaps
market and promote market integrity.
a. § 37.201(c)(1)—Definition of ‘‘SEF
Trading Specialist’’
The Commission proposes to define a
‘‘SEF trading specialist’’ under
§ 37.201(c)(1) as any natural person
who, acting as an employee (or in a
similar capacity) of a SEF, facilitates the
trading or execution of swap
transactions (other than in a ministerial
or clerical capacity), or who is
responsible for direct supervision of
such persons. This proposed definition
would include both persons directly
employed by the SEF and persons who
are not directly employed, such as
independent contractors and persons
who are serving as SEF personnel
pursuant to an arrangement with an
affiliated broker employer, i.e.,
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‘‘seconded’’ persons. Based on the
Commission’s proposed application of
the SEF registration requirement, as
described above, the Commission notes
that this definition would also apply to
those persons who facilitate swaps
trading through swaps broking entities,
including interdealer brokers, who
would be subject to SEF registration.345
As noted above, facilitating the
‘‘trading’’ of swaps means the
negotiating or arranging swaps
transactions; 346 negotiating or arranging
consists of facilitating the interaction of
bids and offers.347 The proposed
definition, however, would exclude SEF
personnel who facilitate trading solely
in a ministerial or clerical capacity
because the activities of such employees
do not involve the level of discretion
and judgement as the activities of SEF
trading specialists and, thus, do not
implicate the same regulatory
concerns.348
b. § 37.201(c)(2)—Fitness
In light of the activities of SEF trading
specialists and the regulatory
considerations discussed above, the
Commission proposes § 37.201(c)(2)(i)
to prohibit a SEF from permitting any
person who is subject to a statutory
disqualification under CEA sections
8a(2) or 8a(3) to serve as a SEF trading
specialist if the SEF knows, or in the
exercise of reasonable care should
know, of the person’s statutory
disqualification.349 CEA sections 8a(2)
and 8a(3) set forth numerous bases upon
which the Commission may refuse to
register a person, including, without
limitation, felony convictions,
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345 See
supra Section IV.C.1.c.(2)—SEF
Registration Requirement for Swaps Broking
Entities, Including Interdealer Brokers and Section
IV.C.1.d.—Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading
Facilities.
346 See supra Section IV.C.1.c.(2)—SEF
Registration Requirement for Swaps Broking
Entities, Including Interdealer Brokers.
347 Id.
348 The Commission notes that persons acting in
a ministerial or clerical capacity are subject to
exceptions from other Commission requirements.
For example, the definition of ‘‘associated person’’
under § 1.3 excludes a person who solicits or
accepts customer orders in a clerical capacity on
behalf of an FCM or IB, or who solicits or accepts
swaps in a clerical or ministerial capacity on behalf
of an SD or MSP. 17 CFR 1.3.
349 The Commission notes that CEA section
4s(b)(6) makes it unlawful for an SD or MSP to
permit any person associated with the SD or MSP
who is subject to a statutory disqualification to
effect or be involved in effecting swaps on behalf
of the SD or MSP, if the SD or MSP knew, or in
the exercise of reasonable care should have known,
of the statutory disqualification. 7 U.S.C. 6s(b)(6).
This prohibition applies with respect to an AP of
an SD or MSP, but does not include an individual
employed in a clerical or ministerial capacity. 17
CFR 23.22(a) (definition of ‘‘person’’ applicable to
the prohibition).
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commodities or securities law
violations, and bars or other adverse
actions taken by financial regulators.350
While SEF trading specialists would not
be required to register with the
Commission, the Commission believes
that given the nature of their interaction
with market participants in facilitating
swaps trading and execution, as well as
the central role they play in maintaining
market integrity and orderly trading, a
SEF should not be permitted to employ
those who are subject to such a statutory
disqualification.
The Commission, however, also
proposes two exceptions to the
proposed prohibition. Under proposed
§ 37.201(c)(2)(ii)(A), the prohibition
would not apply where a person is
listed as a principal 351 or is registered
with the Commission as an AP of a
Commission registrant or as a floor
trader or floor broker, notwithstanding
that the person is subject to a
disqualification from registration under
sections 8a(2) or 8a(3) of the Act.
Pursuant to authority delegated to it by
the Commission,352 the NFA has
permitted a person to be listed as a
principal or registered with the
Commission where, in its discretion, the
NFA has determined that the incident
giving rise to a statutory disqualification
is insufficiently serious, recent, or
otherwise relevant to evaluating the
person’s fitness. Under proposed
§ 37.201(c)(2)(ii)(B), the prohibition also
would not apply where a person subject
to a statutory disqualification is not
registered with the Commission, but
provides a written notice from a
registered futures association (‘‘RFA’’)
stating that if the person were to apply
for registration as an AP, then the RFA
would not deny the application on the
basis of the statutory disqualification.
The Commission believes that a
statutory disqualification that has not or
would not prevent a person from being
listed as a principal or from registering
with the Commission because it is
insufficiently serious, recent, or
otherwise relevant to evaluating the
person’s fitness for registration with the
Commission, as determined by an RFA,
350 7
U.S.C. 12a(2)–(3).
3.10(a)(2) requires each natural person
who is a principal of an applicant for registration
to execute a Form 8–R to, among other things, be
listed as a principal of a registrant. 17 CFR
3.10(a)(2).
352 CEA section 8a(10) enables the Commission to
authorize any person to perform any portion of the
registration functions under the Act. 7 U.S.C.
12(a)(10). The Commission has delegated to the
NFA the authority to perform the full range of
registration functions, including vetting of
applicants for statutory disqualifications. See, e.g.,
50 FR 34885 (Aug. 28, 1985); 57 FR 23136 (Jun. 2,
1992).
351 Section
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should not be a basis for prohibiting a
SEF from employing the person as a SEF
trading specialist.
c. § 37.201(c)(3)—Proficiency
Requirements
The Commission proposes to require
a SEF to maintain proficiency standards
for SEF trading specialists. Proposed
§ 37.201(c)(3)(i) would require a SEF to
establish and enforce standards and
procedures to ensure that its SEF
trading specialists have the proficiency
and knowledge necessary to fulfill their
responsibilities to the SEF and to
comply with the Act, applicable
Commission regulations, and the SEF’s
rules. Further, the Commission proposes
under proposed § 37.201(c)(3)(ii) to
mandate that a SEF require any person
employed as a SEF trading specialist to
have taken and passed a swaps
proficiency examination as
administered by an RFA.353
Accordingly, SEFs would not have to
comply with the examination
requirement until an RFA, such as the
NFA, completes development of the
exam and establishes an administration
process. Pursuant to proposed
§ 37.201(c)(3)(iii), a SEF’s compliance
with the proficiency examination
requirement would constitute
compliance with the general proficiency
requirements upon establishment of an
exam and administration process by the
RFA.354 Additionally, a SEF would
satisfy the examination requirement if a
SEF trading specialist took and passed
the examination once without any
further testing, unless the person has
353 As proposed, the swaps proficiency
examination would have to be developed and
administered by an RFA. The NFA currently
requires persons seeking to become members or
associate members of the NFA, or persons seeking
to register with the Commission as an AP to take
and pass the National Commodity Futures
Examination (‘‘Series 3 Exam’’), which is
administered by FINRA, subject to certain
exceptions. The Series 3 Exam does not test for
swaps proficiency. As a result, NFA Registration
Rule 401(e) currently provides an exception to the
NFA’s qualification testing requirement for a person
applying for registration with the Commission as an
AP, if the applicant’s sole activities subject to
regulation by the Commission are swaps-related.
NFA Registration Rule 401(e). The Commission is
aware that the NFA recently announced that it
would develop a swaps proficiency requirements
program for all APs engaging in swaps activities,
including those of FCMs, IBs, commodity pool
operators (‘‘CPOs’’), commodity trading advisors
(‘‘CTAs’’), and individuals who act as APs at SDs.
NFA, NFA to Develop Swaps Proficiency
Requirements Program,’’ https://www.nfa.futures.
org/news/newsRel.asp?ArticleID=5014 (Jun. 5,
2018).
354 The Commission clarifies, however, that in the
absence of an available examination that meets the
Commission’s requirements, SEFs would still be
required to ensure that their SEF trading specialists
meet the general proficiency requirements set forth
under proposed § 37.201(c)(3)(i).
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not served in such a capacity for a
continuous two-year period. In that
case, the SEF trading specialist would
have to retake and pass the examination.
Given the level of discretion and
judgement that SEF trading specialists
exercise in facilitating swaps trading
and execution, as well as the size and
complexity of the transactions often
executed on a SEF, the Commission
believes that it is essential that a SEF
ensure that its SEF trading specialists
possess appropriate skills and
knowledge. Accordingly, the
Commission believes that demonstrating
such skills and knowledge would be
best achieved through a swaps
proficiency examination regime. The
Commission notes that persons who
intermediate transactions in the futures
markets and securities markets are
already subject to proficiency
requirements that include
examinations.355 The Commission
believes that requiring SEFs to ensure
that their SEF trading specialists have
the necessary skills and proficiency to
perform the key functions of a SEF
would similarly enhance the level of
professionalism and market integrity in
the swaps market.356
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d. § 37.201(c)(4)—Ethics Training
The Commission proposes
§ 37.201(c)(4) to require a SEF to
establish and enforce policies and
procedures to ensure that its SEF
trading specialists receive ethics
training on a periodic basis. Given each
trading specialist’s obligation to
promote a fair and orderly market in
facilitating trading and execution while
also using discretion in handling orders
on behalf of individual market
participants, a SEF must maintain a
training program to ensure that its
trading specialists are aware of and
understand the relevant professional
and ethical standards established by the
SEF.357 Proposed § 37.201(c)(4) is
355 In addition to the Series 3 Exam, which
applies to persons seeking membership with the
NFA as an AP of a registered entity with respect to
futures and options on futures, see supra note 353,
persons who seek registration as a securities
professional must also pass various qualification
exams to demonstrate competency in particular
securities-related areas. See generally FINRA,
Registrations and Qualifications, www.finra.org/
industry/registration-qualification.
356 The Commission notes that this proposed
requirement is analogous to the principles set forth
in the FX Global Code regarding ethics. The code
specifies, among other recommendations, that
operators of trading systems or platforms and their
personnel, have sufficient knowledge of, and
comply with, applicable law and have sufficient
relevant experience, technical knowledge, and
qualifications. FX Global Code at 6–7.
357 As discussed above, this proposed
requirement is similar to one of the leading
principles set forth in the Global FX Code regarding
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consistent with and would further a
SEF’s existing obligation under Core
Principle 12 to establish and enforce
rules that minimize conflicts of
interest.358 Additionally, the proposed
rule corresponds to the existing
requirement under § 37.1501 that a SEF
CCO establish and administer a written
code of ethics for the SEF that is
designed to prevent ethical violations
and promote honesty and ethical
conduct by the SEF’s personnel.359 The
Commission also views ethics training
as a necessary element of a SEF’s
adequate supervision of its trading
specialists and, accordingly, proposes to
require such supervision under
§ 37.201(c)(6), as described below.360
The Commission believes that the
proposed requirement would enhance
professionalism in the overall swaps
market and promote swaps market
integrity.
(1) Guidance to Core Principle 2 in
Appendix B—Ethics Training
The Commission also proposes new
guidance to Core Principle 2 in
Appendix B that would provide the
general objectives for an ethics training
program and examples of topics that
should be addressed.361 The guidance
provides SEFs with the latitude to
determine the appropriate frequency,
duration, and format of ethics training
for its trading specialists, including the
use of qualified third-party providers
and various forms of technology and
media. The proposed guidance,
however, specifies that an ethics
training program is essential to enable
SEF trading specialists to remain
current with respect to the ethical and
regulatory implications of evolving
technology, trading practices, products,
and other relevant changes. For
example, if a SEF’s trading protocols or
operations continue to develop, e.g., the
SEF adopts a new discretionary
approach to prioritizing or managing
competing bids on its voice-based or
ethical standards. The Global FX Code states, in
part, that firms should promote ethical values and
behavior, support efforts to promote such ethical
standards in the wider FX market, and encourage
involvement by personnel in such efforts. FX Global
Code at 6–7.
358 7 U.S.C. 7b–3(f)(12).
359 See infra Section XX.A.3.—§ 37.1501(c)—
Duties of Chief Compliance Officer (requirement
under proposed § 37.1501(c)(6)).
360 See infra Section VI.A.3.f.—§ 37.201(c)(6)—
Duty to Supervise.
361 The Commission proposes to add this
guidance as a new paragraph (a)(1) and eliminate
existing paragraph (a)(1), which states that a SEF’s
rules may authorize its compliance staff to issue
warning letters or recommend that a disciplinary
panel take such action. See infra note 456
(discussing proposed changes to the existing SEF
warning letter requirements).
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voice-assisted trading system, then the
SEF’s ethics training should address
how its trading specialists should
appropriately conduct themselves under
such new protocols. This approach is
generally consistent with the
Commission’s implementation of the
training requirements applicable to
Commission registrants under CEA
section 4p(b), as set forth in acceptable
practices established by the Commission
for ethics training for registered persons
under part 3 of the Commission’s
regulations.362
e. § 37.201(c)(5)—Standards of Conduct
The Commission proposes to require
a SEF to establish and enforce a code of
conduct for its SEF trading specialists.
Like the proposed ethics training
requirement under § 37.201(c)(4), the
proposed code of conduct requirement
aims to ensure that SEFs foster and
maintain a high level of
professionalism, integrity, and ethical
conduct among their trading specialists
when dealing with market participants
and facilitating trading and execution. A
SEF’s code of conduct may provide that,
among other things, a SEF trading
specialist should (i) act in an honest and
ethical manner and observe high
standards of professionalism; (ii) handle
orders with fairness and transparency;
and (iii) not engage in fraudulent,
manipulative, or disruptive conduct.
The Commission includes these items
for SEF consideration, but a SEF may
include different or additional standards
as well. These proposed standards of
conduct are intended to be general and
principles-based, given the many
unique aspects of a SEF trading
specialist’s role in facilitating trading
and execution as part of the SEF’s
particular trading system or platform.
f. § 37.201(c)(6)—Duty To Supervise
To help promote compliance with a
SEF’s professionalism requirements,
including ethics requirements and
standards of conduct, the Commission
also proposes § 37.201(c)(6) to require a
SEF to diligently supervise the activities
of its trading specialists in facilitating
trading and execution on the SEF. While
a SEF is generally responsible for the
actions of its agents pursuant to CEA
section 2(a)(1)(B) and § 1.2,363 proposed
§ 37.201(c)(6) would impose an
affirmative duty of supervision on each
SEF. Given the dynamic manner in
362 17 CFR part 3 app. B (Statement of Acceptable
Practices With Respect to Ethics Training).
363 CEA section 2(a)(1)(B) and § 1.2 establish that
the act, omission, or failure of any official, agent,
or other person acting for a principal within the
scope of his employment or office is imputed to the
principal. 7 U.S.C. 2(a)(1)(B); 17 CFR 1.2.
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which SEF trading specialists may use
discretion to facilitate swaps trading
and execution on behalf of market
participants, a SEF should have an
affirmative obligation to supervise its
trading specialists. The Commission
notes that a similar customer protection
rule currently applies to registered
entities, including IBs—§ 166.3 requires
each Commission registrant to diligently
supervise all the activities of its
partners, officers, employees and agents
(or persons occupying a similar status or
performing a similar function) relating
to its business as a Commission
registrant.364 Therefore, to the extent
that some of these SEFs were previously
registered with the Commission and
operated as IBs, the Commission
believes that proposed § 37.201(c)(6)
would impose certain analogous
requirements.
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g. § 37.201(c)(7)—Additional Sources for
Compliance
The Commission is proposing
§ 37.201(c)(7) to refer SEFs to the new
guidance to Core Principle 2 in
Appendix B as discussed above.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.201(c). In
particular, the Commission requests
comment on the following questions:
(37) Is the proposed definition of the
term ‘‘SEF trading specialist’’ overly
broad or too narrow? Are there
additional activities that SEF trading
specialists engage in that should be
reflected in the definition? Are there
additional natural persons who should
be captured by the proposed definition?
(38) Are the exceptions to the fitness
requirement for SEF trading specialists
under proposed § 37.201(c)(2)(ii)
appropriate? Should the Commission
prohibit a SEF from employing persons
other than those subject to a statutory
disqualification under CEA sections
8a(2) or 8a(3)? If so, what additional
disqualification factors should the
Commission use? In this connection,
should the Commission not rely on any
of the disqualification factors in CEA
sections 8a(2) or 8a(3)?
(39) Should the qualification testing
requirement under proposed
§ 37.201(c)(3)(ii) be broadened to allow
a SEF to employ persons who have
taken and passed a swaps proficiency
examination developed and
administered by parties other than an
RFA? If so, should the Commission then
adopt standards to ensure that such
testing adequately ensures proficiency?
How could the Commission ensure that
the examination meets appropriate
standards and consistency, such that it
could be recognized by all SEFs? Should
the Commission approve each
examination to ensure appropriate
standards are met and consistency is
achieved across different examinations?
(40) Are the ethics training and
standards of conduct requirements
under proposed §§ 37.201(c)(4)–(5),
respectively, overly prescriptive or too
flexible? Should the Commission
provide greater specificity regarding the
standards of conduct that a SEF must
enforce? Are there particular subjects
that should be specifically required as
part of ethics training?
VII. Additional Part 37 Regulations—
Subpart C: Core Principle 2
(Compliance With Rules)
In addition to requiring a SEF to
establish and enforce rules that govern
its facility, Core Principle 2 requires a
SEF to adopt trading, trade processing,
and participation rules that provide
participants with impartial access to the
market and deter abuses; and establish
and enforce compliance with any
limitation on access.365 Further, Core
Principle 2 requires a SEF to have the
capacity to detect, investigate, and
enforce those rules, including the means
to capture information that may be used
in identifying rule violations.366 The
Commission adopted many detailed
regulations in part 37 to further
implement these requirements,
including impartial access requirements
under § 37.202; rule enforcement
program requirements under § 37.203;
third-party service provider
requirements under § 37.204; audit trail
requirements under § 37.205; and
disciplinary procedures and sanctions
requirements under § 37.206.
The Commission is proposing several
new rules and rule amendments under
Core Principle 2, including
clarifications of existing rules where
appropriate, to implement its proposed
swaps regulatory framework. These
proposed amendments would
streamline the SEF rules and allow SEFs
to account for technological
developments, existing market
practices, and costs in their trading and
market operations. Further, the
amendments would codify no-action
relief that has been provided under
several existing Commission staff noaction letters. Among these changes, the
Commission is proposing a modification
to the impartial access requirements
under § 37.202 and several
corresponding amendments, which
U.S.C. 7b–3(f)(2)(B)(i).
366 7 U.S.C. 7b–3(f)(2)(B)(ii).
CFR 166.3.
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A. § 37.202 Access Requirements
The Commission implemented the
statutory impartial access requirement
by adopting § 37.202. Existing
§ 37.202(a)(1) requires a SEF to provide
any ECP and any independent software
vendor (‘‘ISV’’) with impartial access to
its market(s) and market services,
including indicative quote screens or
any similar pricing data displays,
provided that the facility has, among
other things, criteria governing such
access that are ‘‘impartial, transparent,
and applied in a fair and nondiscriminatory manner.’’ 367 In the
preamble to the SEF Core Principles
Final Rule, the Commission stated that
‘‘impartial’’ means ‘‘fair, unbiased, and
unprejudiced.’’ 368 The Commission
further stated that the impartial access
requirement allows ECPs to ‘‘compete
on a level playing field’’ 369 and does
not allow a SEF to ‘‘limit access . . . to
certain types of ECPs or ISVs.’’ 370 The
Commission also noted that each
similarly situated group of ECPs and
ISVs must be treated similarly.371 The
Commission believed that this approach
would increase the number of market
participants on SEFs, which in turn
would increase SEF trading, thereby
improving liquidity and price discovery
in the swaps market.372
Core Principle 2, however, also allows
a SEF to establish and enforce
compliance with any rule of the SEF,
including any limitation on access to
the SEF.373 Accordingly, existing
§ 37.202(c) requires a SEF to establish
and impartially enforce rules that
govern the SEF’s decision to allow,
deny, suspend, or permanently bar
ECPs’ access to the SEF, including when
such decisions are made as part of a
disciplinary or emergency action by the
SEF.374 The Commission further stated
that a SEF may establish different access
criteria for each of its markets, provided
that the criteria are impartial and are not
367 17
CFR 37.202(a)(1).
Core Principles Final Rule at 33508.
368 SEF
369 Id.
370 Id.
371 Id.
372 Id.
365 7
364 17
would provide a SEF with the ability to
devise its participation criteria based on
its own trading operations and market
focus. Further, the Commission is
proposing several amendments to
§§ 37.203–206 that would allow a SEF
to better tailor its own compliance and
regulatory oversight rules to its trading
operations and markets, while still
maintaining a robust compliance
program.
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U.S.C. 7b–3(f)(2)(A)(ii).
CFR 37.202(c).
374 17
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used as a competitive tool against
certain ECPs and ISVs.375 Subject to
these requirements, the Commission
stated that a SEF may ‘‘use its own
reasonable discretion to determine its
access criteria, provided that the criteria
are impartial, transparent and applied in
a fair and non-discriminatory manner,
and are not anti-competitive.’’ 376
Existing § 37.202(a)(3) requires a SEF
to have a comparable fee structure for
ECPs and ISVs receiving comparable
access to, or services from, the SEF.377
The Commission clarified that this
requirement neither sets nor limits fees
that a SEF may charge.378 The
Commission further clarified that a SEF
may establish different categories of
ECPs and ISVs seeking access to, or
services from, the SEF, but may not
discriminate with respect to fees within
a particular category.379 The
Commission stated that existing
§ 37.202(a)(3) is not intended to be a
‘‘rigid requirement that fails to take into
account legitimate business
justifications for offering different fees
to different categories of entities seeking
access to the SEF.’’ 380
Finally, existing § 37.202(a)(2)
requires SEFs to have procedures for
ECPs to provide written or electronic
confirmation of their ECP status with
the SEF prior to obtaining access.381
Under existing § 37.202(b), an ECP must
consent to a SEF’s jurisdiction prior to
obtaining access to the SEF.382
1. § 37.202(a)—Impartial Access to
Markets, Market Services, and
Execution Methods 383
The Commission has applied the
impartial access requirements to various
areas of a SEF’s operations that concern
participant access to the market. These
features include (i) eligibility or
onboarding criteria; (ii) a participant’s
ability to access the SEF’s
functionalities, i.e., trade and execute
on a SEF’s execution methods; (iii) the
manner in which a SEF’s execution
methods treat market participants’ bids
and offers, in particular the use of
discretion; and (iv) participation fee
structures. The Commission’s current
approach to impartial access in these
375 SEF
Core Principles Final Rule at 33508.
376 Id.
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377 17
CFR 37.202(a)(3).
Core Principles Final Rule at 33509.
378 SEF
379 Id.
380 Id.
381 17
CFR 37.202(a)(2).
CFR 37.202(b).
383 The Commission proposes to retitle § 37.202(a)
to ‘‘Impartial access to markets, market services,
and execution methods’’ from ‘‘Impartial access to
markets and market services’’ based on the
proposed changes described below.
382 17
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areas, however, has raised two issues
that have led to certain inconsistencies
in implementation of the requirement.
First, the existing approach has
created uncertainty for SEFs seeking to
establish and apply access criteria in a
consistent manner. The Commission
recognizes that SEF Core Principle 2
requires a SEF to provide impartial
access, but also allows a SEF to
establish limitations on access.
Accordingly, the Commission has
allowed SEFs to establish different
access criteria for different markets, but
has also required each ‘‘similarly
situated’’ group of ECPs and ISVs to be
treated in the same manner.384 The
preamble to the SEF Core Principles
Final Rule also states that SEFs can use
their own reasonable discretion to
determine their access criteria, provided
that they are impartial. In practice,
implementation of the rule has led to
some uncertainty by SEFs as to whether
different access criteria for their
markets, market services, and execution
methods would be allowed or not
allowed under § 37.202.
Second, the manner in which the
Commission has implemented the
existing approach has often favored the
promotion of an ‘‘all-to-all’’ trading
environment and has, thus, limited the
ability of SEFs to adapt their operations
to the characteristics and dynamics of
the swaps market.385 All-to-all trading
environments, such as futures markets,
are generally marked by smaller-sized
products with standardized terms and
conditions that appeal to a broad range
of market participants, including retail
customers. These same characteristics
are also more conducive to continuous
and liquid trading. By contrast, swaps
trading often occurs between a limited
number of ECPs in a broad array of
unique, larger-sized products with more
variable terms that are customized to
address specific and unique hedging
risks. These characteristics result in
episodic market liquidity in many
swaps markets, in contrast to the
continuous liquidity found in all-to-all
trading environments. The Commission
believes that the imposition of features
found in an ‘‘all-to-all’’ trading
environment upon swaps markets is at
odds with general market characteristics
and dynamics of swaps trading.
a. § 37.202(a)(1)—Impartial Access
Criteria
Based on its experience with
implementing part 37, the Commission
proposes to modify its approach to
applying the impartial access
384 SEF
Core Principles Final Rule at 33508.
385 Id.
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61993
requirement. In doing so, the
Commission proposes to streamline and
consolidate the existing language and
relevant preamble discussion from the
SEF Core Principles Final Rule,
including the Commission’s view of
‘‘impartial’’ and the concept of
‘‘similarly situated,’’ to establish a
revised impartial access requirement.
Under proposed § 37.202(a)(1), a SEF
would be required to establish rules that
set forth impartial access criteria for
accessing its markets, market services,
and execution methods, including any
indicative quote screens or any similar
pricing data displays. Such impartial
access criteria must be transparent, fair
and non-discriminatory and applied to
all or similarly situated market
participants.
In proposing this approach, the
Commission believes that criteria that
are ‘‘fair and non-discriminatory’’
would inherently be ‘‘fair, unbiased,
and unprejudiced,’’ which the
Commission previously defined as
‘‘impartial.’’ The Commission also
believes that the proposed rule clarifies
that this criteria must be applied to
market participants in a fair and nondiscriminatory manner, as currently
required under the existing
requirements of § 37.202(a)(1). Finally,
proposed § 37.202(a)(1) would continue
to allow each SEF to determine which
market participants are ‘‘similarly
situated’’ in its market and configure
appropriate access criteria, provided
that such criteria are transparent, fair,
and non-discriminatory to participants.
Applying access criteria in a ‘‘fair and
non-discriminatory’’ manner means that
a SEF should permit or deny access to
a market participant on a non-arbitrary
basis, based on objective, preestablished requirements or limitations.
The Commission emphasizes, however,
that this streamlined approach does not
mean that a SEF must create an ‘‘all-toall’’ trading environment.
The Commission acknowledges that it
has often applied the impartial access
requirement to promote an ‘‘all-to-all’’
trading environment, which is neither
required under Core Principle 2 nor is
consistent with swaps market structure.
Under the proposed approach, the
Commission would not seek to apply
the requirement to mandate that all
participants have access to all SEFs,
which may have circumscribed a SEF’s
ability under Core Principle 2 to set
access limitations. Rather, to allow SEFs
to serve different types of market
participants or have different access
criteria for different execution methods,
the Commission would allow SEFs to
apply access limitations, as long as they
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are applied in a fair and nondiscriminatory manner.
This approach would also align with
swaps market characteristics—in
particular, the episodic nature of swaps
liquidity—that have led to the overall
swaps market being made up of both
dealer-to-client and dealer-to-dealer
markets, as described below. The
Commission believes that the structure
of the swaps market is a natural
outgrowth of certain fundamental
features of swaps trading. The
Commission further believes that all-toall markets are inimical to these
fundamental swaps trading features;
therefore, imposing all-to-all, marketderived requirements on swaps markets
ultimately detracts from achieving the
statutory SEF goals of promoting swaps
trading on SEFs and pre-trade price
transparency in the swaps market.
Accordingly, the Commission believes
that each SEF should be able to use
access criteria to develop its business in
a manner that is both consistent with
the characteristics of swaps markets and
accommodating of the types of
participants that comprise the SEF’s
intended market.
The Commission still believes that
any access criteria intended to prevent
or reduce competition among similarly
situated market participants would be
unfair and discriminatory and,
therefore, inconsistent with proposed
§ 37.202(a)(1). If a market participant is
willing or able to meet the objective,
pre-established, and transparent criteria
for eligibility to onboard to a SEF or
gain additional access to a SEF’s trading
mechanisms, then the SEF should not
preclude that market participant from
onboarding to the SEF or using its
functionalities. Accordingly, such a
market participant should not be subject
to access criteria that are unfair and
discriminatory and are intended to
prevent or dis-incentivize that market
participant’s participation on the
SEF.386
The Commission emphasizes that
under proposed § 37.202(a)(1), any
access criteria—whether it concerns
eligibility or onboarding criteria,
prerequisites for using certain trading
functionalities, or fee schedules—
constitutes a ‘‘rule,’’ as that term is
defined under § 40.1(i), that would be
subject to rule approval or self386 The Commission also notes that such criteria
may be inconsistent with Core Principle 11. Core
Principle 11 prohibits a SEF from adopting
measures that result in any unreasonable restraint
of trade or impose any material anticompetitive
burdens on trading or clearing, unless they are
necessary or appropriate to achieve the purposes of
the CEA and are otherwise consistent with the CEA
and the Commission’s regulations. 17 CFR 37.1100.
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certification procedures under part
40.387 Through the part 40 rule review
process, the Commission would
continue to evaluate a SEF’s compliance
with the impartial access requirements
as proposed.
The Commission also proposes to
eliminate the reference to ‘‘ISVs,’’ which
the Commission notes is not required
under Core Principle 2. Given that a SEF
should be able to set its access criteria
to develop its business based on its
desired market and participant needs,
the Commission also believes that a SEF
should be able to determine an ISV’s
level of access to the SEF. The
Commission previously applied the
impartial access requirement to ISVs on
the basis that such types of vendors
would provide various benefits to the
swaps market and market participants,
such as enhanced transparency and
trading efficiency through the
consolidation of trading data from
multiple venues, analytics, and best
displayed prices.388 Based on the
Commission’s experience and
notwithstanding the existing impartial
access requirement, ISVs have not
established a significant level of
participation on SEFs, nor have they
achieved a broad level of adoption
among market participants. Rather, the
Commission has observed that most
participants access SEFs through means
other than ISV services.389 Therefore,
the Commission believes that the
impartial access requirement should
apply to market participants who are
accessing SEF trading systems or
platforms to trade swaps, rather than
establish requirements for a separate set
of entities that are merely providing
ancillary market services.
(1) Application of Impartial Access
Requirement
Based on the areas in which the
Commission has applied the existing
impartial access requirement to various
aspects of a SEF’s operation during the
part 37 implementation, the
Commission discusses below how the
proposed impartial access approach
would apply to these areas to provide
further clarity, including (i) eligibility
and onboarding; (ii) execution methods;
and (iii) SEF use of discretion.
387 17
CFR 40.5–6.
Commission previously cited examples of
ISVs that included smart order routers, trading
software companies that develop front-end trading
applications, and aggregator platforms. SEF Core
Principles Final Rule at 33508 n.423.
389 See supra notes 52–54 (describing the various
modes of participation on SEFs by market
participants).
388 The
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(i) Eligibility and Onboarding Criteria
The Commission has applied the
impartial access requirement to assess a
SEF’s eligibility and onboarding criteria.
In the preamble to the SEF Core
Principles Final Rule, the Commission
prospectively identified whether or not
certain hypothetical arrangements
would comply with the rulemaking’s
approach to impartial access. Certain
criteria were deemed non-compliant,
such as platforms whose participants
were limited to wholesale liquidity
providers; 390 platforms that imposed
participation limits based on
maintaining financial integrity and
operational safety; 391 platforms that
established objective minimum capital
or credit requirements; 392 and platforms
that limited participation to
sophisticated market participants.393
The Commission generally
characterized these types of criteria as
inconsistent with Core Principle 2
because they would inherently limit
access to certain types of ECPs and
ISVs.394 Subsequent Commission staff
guidance further identified other
eligibility criteria that Commission staff
viewed as inconsistent with impartial
access, based on the view that limiting
access to a SEF’s trading systems or
platforms to certain types of ECPs or
ISVs is inconsistent with Core Principle
2.395
The Commission has realized from
experience that certain criteria
developed by SEFs reflect fundamental
swap market segments. In particular, the
swaps market consists of both a dealerto-client market segment and a dealerto-dealer market segment that are
related, but also differ in important
respects. In the dealer-to-client segment,
corporate end-users and other buy-side
participants access and utilize the
swaps market to manage risk positions
390 SEF
Core Principles Final Rule at 33507–08.
391 Id.
392 Id.
at 33507.
393 Id.
394 Id.
at 33508.
criteria included (i) not providing
access to an ECP that is both a liquidity provider
and taker; (ii) prohibiting individuals from
obtaining access despite their meeting the
requirements to be an ECP; (iii) limiting access to
ECPs that satisfy minimum transaction volume
level requirements; and (iv) requiring an ECP to be
a clearing member or to have an agreement with a
clearing member to access the SEF, even if only for
the purpose of trading swaps that are not intended
to be cleared. Commission staff also expressed
concern that SEFs allowing only either
intermediated access or direct access may impede
impartial access in certain instances. Division of
Clearing and Risk, Division of Market Oversight and
Division of Swap Dealer and Intermediary
Oversight Guidance on Application of Certain
Commission Regulations to Swap Execution
Facilities (Nov. 14, 2013) (‘‘2013 Staff Impartial
Access Guidance’’).
395 These
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that are unique to their particular
circumstances. Swap dealers provide
liquidity to the participants within this
market segment for a fee, which
participants are willing to pay, that
reflects the risks incurred by dealers
from the episodic or relative lack of
liquidity in the swaps market for many
specific swaps. The swap dealers
subsequently offset positions
established through the dealer-to-client
market segment by hedging their swaps
inventories on a portfolio basis in the
dealer-to-dealer market, which is
wholesale in nature. Those dealer-todealer markets consist of other primary
dealers and sophisticated marketmaking participants seeking to fulfill
similar objectives through competitive
execution of large-sized transactions. In
pricing a customer trade, dealers base
their prices on the cost of hedging those
trades in the dealer-to-dealer markets.
The dealer-to-dealer market may
provide benefits to the swaps markets,
in particular to non-dealer clients, by
allowing dealers who provide liquidity
to offload risk from clients. Without this
market, liquidity in the dealer-to-client
market may suffer because the inherent
risks of holding swaps inventory could
arguably dis-incentivize participation by
dealers in the dealer-to-client market or
otherwise require dealers to charge their
customers higher prices for taking on
this risk. Absent the supply of liquidity
providers, non-dealers who are liquidity
takers would have difficulty executing
swaps at competitive pricing. SEFs that
serve the wholesale, dealer-to-dealer
market have stated that using eligibility
or participation criteria to maintain a
dealer-to-dealer market is beneficial,
given that it allows participants who
share similar profiles and trading
interests to interact with each another,
thereby helping to promote liquid
markets with tight pricing.
For the reasons stated above, the
Commission believes that SEF eligibility
and onboarding criteria that would
serve to maintain this market structure
would be appropriate and consistent
with existing market dynamics and may
provide the benefits discussed above.
Accordingly, a SEF could premise these
criteria in different ways, such as
limiting access upon the type of the
market participant or the swap product
itself. For example, a SEF would be able
to calibrate access to serve market
participants within a particular market
segment, such as dealers trading in a
wholesale swaps market, who may be
categorized as ‘‘similarly situated.’’
(ii) Access to Execution Methods
In addition to assessing SEF
onboarding and eligibility, the
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Commission has also applied the
current impartial access standard to
evaluate various SEF-established
prerequisites for trading on certain
platforms or interacting with certain
participants. Some of those
prerequisites reflect the nature of the
swap involved, e.g., whether the swap is
submitted for clearing or is uncleared,
which determines whether certain
market participants are eligible to trade
with one another.396 When a SEF lists
a swap that is traded as a component of
a transaction with other non-swap legs,
the SEF might also establish trading
eligibility criteria that take account of a
participant’s ability to trade the nonswap leg components of such swaps.397
Other prerequisites may be based upon
the prior or ongoing level of trading
activity generated by a particular
participant, e.g., whether the participant
has been actively submitting bids and
offers. During the implementation of
part 37, the Commission has deemed
appropriate certain criteria based on
business or operational justifications,
but also deemed other criteria as
inconsistent with impartial access. For
example, platform access criteria that
require a market participant to
contribute a certain amount of liquidity,
e.g., provide a minimum number of bids
and offers, have been prohibited,
despite the business or operational
justifications offered by SEFs.
SEFs have also argued that requiring
market participants to meet trading
prerequisites or participation criteria to
access certain platforms or trade certain
products can be beneficial to promoting
effective trading markets on SEFs. In
implementing part 37, the Commission
has acknowledged that such criteria
may be beneficial toward maintaining
and promoting orderly trading for
uncleared swaps on SEFs—for example,
where participants must have certain
trading enablements in place prior to
trading uncleared swaps with other
participants on the platform.398
396 Such a situation might result in a SEF limiting
trading access to uncleared swaps to only those
market participants who have existing underlying
documentation to execute such swaps with other
potential counterparties.
397 For example, a SEF could require market
participants (or their clearing members) to have
membership in a particular clearing organization,
e.g., membership with the Fixed Income Clearing
Corporation (‘‘FICC’’), in order to access a method
of execution in which counterparties execute a
package transaction with a non-swap leg that FICC
must clear.
398 The Commission notes that Commission staff
previously used the term ‘‘enablement mechanism’’
in guidance to refer to ‘‘any mechanism, scheme,
functionality, counterparty filter, or other
arrangement that prevents a market participant from
interacting or trading with, or viewing the bids and
offers (firm or indicative) displayed by any other
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Specifically, the Commission has
allowed such types of enablements, e.g.,
trading relationship documentation
with a minimum percentage of trading
participants prior to posting bids and
offers or trading in certain established
minimum sizes, to promote a more
dynamic and liquid trading
environment for uncleared swaps with
active participation.399
The Commission’s current approach
to impartial access, however, has led to
confusion as to whether these types of
criteria are inappropriate because they
do not ensure equal participation by all
market participants; or as to whether
they are appropriate because they reflect
a SEF’s ability to impose limitations on
access and are consistent with the view
that SEFs should have the discretion to
determine the most suitable way to
promote trading on their platforms.
Specifically, the Commission recognizes
that requiring impartial access for
‘‘similarly situated’’ groups of market
participants has currently been
interpreted to require that a SEF allow
all participants in that group to be able
to interact with one another in the same
manner and degree.
The Commission clarifies that a SEF
must have impartial access criteria, i.e.,
transparent, fair, and nondiscriminatory, for trading prerequisites
or participation criteria prior to
accessing certain platforms or trading
certain products. As long as these access
criteria are impartial, such that any
market participant who meets the
criteria is able to utilize a certain
execution method or trade a certain
product, then they would be allowed to
do so under the proposed approach. For
example, if a SEF established a
minimum trade size for its order book
that applied to a market participant’s
orders, then such criteria would be
allowed if any of its market participants
who met these criteria could trade on
the order book. As noted above, Core
Principle 2 does not require a SEF to
create an ‘‘all-to-all’’ marketplace, and
the Commission believes that SEFs
should be allowed to establish criteria
that would facilitate trading based on its
products and the intended trading
environment. As long as a SEF also
market participant on that SEF, whether by means
of any condition or restriction on its ability or
authority to display a quote to any other market
participant or to respond to any quote issued by any
other market participant on that SEF, or otherwise.’’
2013 Staff Impartial Access Guidance at 1.
399 The Commission notes that Commission staff
previously viewed a SEF’s application or support
otherwise for enablement mechanisms with respect
to swaps that were intended to be cleared as
‘‘prohibited discriminatory treatment,’’ that is
inconsistent with the existing impartial access
requirement under § 37.202. Id. at 1–2.
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applies its impartial access criteria in a
fair and non-discriminatory manner, as
described above, the Commission
believes that such criteria would
comply with § 37.202(a)(1).
(iii) Use of Discretion
The Commission has also previously
determined whether a SEF complies
with the impartial access requirement
based on how the SEF’s trading systems
or platforms handle participant orders.
For example, a SEF’s voice-based or
voice-assisted execution methods
involve the exercise of ‘‘discretion’’ by
a SEF trading specialist in managing the
interaction of multiple bids and offers
from multiple participants. As described
above, SEF trading specialists solicit
orders on behalf of the SEF and seek to
arrange transactions by matching those
orders with reciprocal trading
interests.400 Given the variability in how
participant orders may be handled
through the use of discretion, the
Commission has sought to ensure that
market participants are receiving
‘‘impartial access’’ in the manner in
which their orders are handled while
also acknowledging that discretion is
inherent to these types of systems or
platforms.
The Commission also recognizes that
its current approach to impartial access
may be in tension with its proposal to
allow more flexible execution methods
on SEFs, particularly those that involve
discretion and are prevalent in the
dealer-to-dealer market. While some
SEF execution methods facilitate trading
and execution on a non-discretionary
basis, e.g., electronic trading systems,
including Order Books and RFQ
Systems, some execution methods rely
upon the ability of a SEF trading
specialist to ascertain liquidity for
particular products and manage
multiple competing bids and offers, e.g.,
voice-based platforms. To facilitate
trading and execution in such a trading
environment, SEF trading specialists
must account for a host of changing
market conditions, such as available
pricing, product complexity, prevailing
trade sizes, and market participant
needs. The Commission recognizes that
SEF trading specialists may apply these
factors differently among different
participants during different periods of
trading. In contrast to prevailing
practices among swaps broking entities,
such as interdealer brokers that have
400 For the Commission’s previous description of
the role of SEF trading specialists, who function as
part of a SEF’s voice-based or voice-assisted trading
system or platform, and their use of discretion, see
supra Section VI.A.1.b.—§ 37.201(a)(2)—Discretion
and Section VI.A.3.—§ 37.201(c)—SEF Trading
Specialists.
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operated outside of the SEF regulatory
framework,401 the Commission has
scrutinized similar practices on SEF
voice-based platforms against the
impartial access requirements. The
Commission acknowledges that its
application of impartial access at times
has constrained the ability of SEFs to
establish trading systems or platforms
that serve particular segments of the
swaps marketplace.
The Commission also believes that the
trading discretion exercised by SEF
trading specialists may affect the
manner in which market participants
are treated on a facility, but would not
necessarily be inconsistent with the
Commission’s proposed approach to
impartial access. The Commission
believes that to the extent that the
exercise of discretion furthers a SEF’s
ability to facilitate trading and
execution on its system or platform—
including identifying trading interest in
a discrete manner or managing bids and
offers to maintain accurate market
pricing—it should be viewed as being
consistent with impartial access. The
Commission also notes that proposed
§ 37.201(a)(2) would support the use of
discretion in a manner consistent with
impartial access; as discussed above, the
proposed rule would provide
transparency into the use of discretion
by requiring each SEF to disclose the
general manner and circumstances
behind its use within each execution
method.402 Notwithstanding proposed
§ 37.201(a)(2), however, the Commission
emphasizes that a SEF would still be
required to ensure that any use of
trading discretion occurs in a fair and
non-discriminatory manner.
b. § 37.202(a)(2)—Fees
Based on its experience in reviewing
fee structures for SEFs, the Commission
proposes to eliminate the requirement
under § 37.202(a)(3) that a SEF must
establish ‘‘comparable fee structures’’
for ECPs and ISVs receiving
‘‘comparable access’’ to the SEF or
services from the SEF. In practice, this
requirement has not fully accounted for
the market practices described above.
Instead, the Commission proposes
§ 37.202(a)(2) to require a SEF to
401 As discussed above, the Commission is
clarifying the application of the SEF registration
requirement in this notice to specify that these
types of entities are subject to SEF registration
based on their activity in facilitating trading and
execution in swaps on a multiple-to-multiple basis
between market participants. See supra Section
IV.C.1.c.(2)—SEF Registration Requirement for
Swaps Broking Entities, Including Interdealer
Brokers.
402 See supra Section VI.A.1.b.—§ 37.201(a)(2)—
Discretion and Section VI.A.3.—§ 37.201(c)—SEF
Trading Specialists.
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establish and apply fee structures and
fee practices in a fair and nondiscriminatory manner to its market
participants.403
Currently, SEFs have established
different fee levels for different
categories of market participants or
different types of trading activity,
whether imposed directly through a
trading fee schedule or indirectly
through the use of trading incentive or
discount programs.404 The Commission
has observed that SEFs have generally
based their fees or discounts on a host
of different considerations, such as
technological costs attributable to
facilitating a particular method of
accessing the platform or a listed
product’s complexity. In particular, feesetting arrangements for swaps trading
in the dealer-to-dealer segment, which
includes interdealer broker operations
that would become subject to the
proposed SEF registration
requirement,405 may differ, even in
instances where market participants are
receiving comparable access or services
from the SEF. Rather, fee arrangements
in the dealer-to-dealer market are often
subject to individualized negotiations
between a particular market participant
and its broker, often involving a
combination of different factors and
business considerations that can lead to
different fees for market participants
who could otherwise be characterized as
similarly situated.406 The Commission
has observed that these factors or
considerations may include discounts
based on past or current trading volume
attributable to the market participant,
market maker participation, or pricing
arrangements related to services
403 To further streamline the other existing
impartial access requirements, the Commission
proposes to renumber existing paragraph (a)(2),
which requires confirmation of a participant’s ECP
status, to subsection (c); and to renumber existing
paragraph (a)(3), which addresses SEF fee
requirements, to paragraph (a)(2). The Commission
also proposes to renumber subsection (c)—
‘‘Limitations on access’’—to subsection (b) and to
amend that existing language, as described below.
Accordingly, the Commission also proposes to
renumber existing subsection (b)—‘‘Jurisdiction’’—
to subsection (d).
404 With respect to trading incentive or discount
programs, the Commission has observed various
types of arrangements, such as discounts from
trading fees that vary in size and scope based on
the method of execution utilized and the relative
rank of a SEF participant vis a vis other participants
in terms of quoting frequency and number of
products quoted.
405 See supra Section IV.C.1.c.(2)—SEF
Registration Requirement for Swaps Broking
Entities, Including Interdealer Brokers.
406 In some instances, swap trading fees comprise
part of a larger overall negotiated fee that is agreed
upon between a market participant and a broker for
broking services in a broad range of other products,
including other fixed income instruments and
equities.
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provided by a SEF-affiliated entity
involving other non-swap products. The
confluence of such factors, and the
varying degrees to which they help
inform swap trading fee determinations,
have been difficult to distill into fee
structures applicable to categories of
market participants.
Based on this practical difficulty, the
Commission is proposing to allow SEFs
and market participants the flexibility to
determine fees based on legitimate
business negotiations. In this proposal,
the Commission does not intend to limit
the scope of business-related factors that
a SEF may continue to consider in
establishing participation fee
arrangements. Proposed § 37.202(a)(2) is
intended to provide market participants
and SEFs with the flexibility to
negotiate fee arrangements on an
individualized basis based on legitimate
business justifications. The Commission
emphasizes, however, that consistent
with the impartial access requirement
under proposed § 37.202(a)(1), a SEF
should not use fees to discriminate
against certain market participants.
2. § 37.202(b)—Limitations on Access
The Commission proposes to require
a SEF to maintain documentation of any
decision to deny, suspend, permanently
bar, or otherwise limit a market
participant’s access to the SEF.407 The
Commission believes that such
documentation is important to assisting
a SEF’s CCO in reviewing the SEF’s
adherence to its access criteria rules and
determining whether the SEF is
applying its access criteria in a manner
that meets § 37.202. This documentation
can further assist the Commission in
reviewing any limitation on access
determinations for a market participant
during rule enforcement reviews or in
the event that a market participant or
the Commission challenges a SEF’s
access decision.
The Commission also proposes nonsubstantive amendments to the existing
provision, including amending the
existing reference to ‘‘eligible contract
participant’’ to ‘‘market participant’’ to
provide greater clarity.
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3. § 37.202(c)—Eligibility
The Commission proposes under
§ 37.202(c) to maintain the existing
requirement that a SEF must require its
market participants to provide a written
confirmation (electronic or otherwise) of
their ECP status prior to obtaining
access to the SEF. The Commission also
407 The Commission proposes to renumber
existing subsection (c)—‘‘Limitations on access’’—
to subsection (b) and amend the requirement as
described above.
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proposes to make minor non-substantive
revisions to the current language.408
4. § 37.202(d)—Jurisdiction
The Commission proposes under
§ 37.202(d) to maintain the existing
requirement that a SEF must require
that a market participant consent to its
jurisdiction prior to granting any market
participant access to its facilities. The
Commission also proposes to make
minor non-substantive revisions to the
current language.409 In addition, the
Commission confirms that consistent
with prior Commission staff guidance, a
SEF does not need to obtain consent to
its jurisdiction through an affirmative
writing, and a SEF may obtain consent
through a notification in its rulebook.410
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.202. In
particular, the Commission requests
comment on the following questions:
(41) Should the Commission specify a
basis for how it would determine that a
SEF’s access criteria are unfair and
discriminatory? Should a SEF be limited
in the type of justifications that it may
provide for its access criteria to
demonstrate that they are impartial, e.g.,
such criteria are intended to promote
participation and/or liquidity? If so,
what would those justifications be?
(42) What should be the bases or
factors for determining whether market
participants are ‘‘similarly situated’’?
(43) Should enablements be allowed
as a type of access criteria for cleared
swaps, in addition to their usage for
uncleared swaps? Is this consistent with
the Commission’s proposed approach to
impartial access? Why or why not? If so,
please provide examples of enablements
for cleared swaps that are consistent
with the Commission’s proposed
approach to impartial access.
B. § 37.203—Rule Enforcement Program
Section 37.203 implements certain
aspects of Core Principle 2, which
requires a SEF to (i) establish and
enforce trading, trade processing, and
participation rules to deter abuses; and
(ii) have the capacity to detect,
investigate, and enforce those rules,
including the ability to capture
information to identify rule
violations.411 The regulation sets forth
the requirements of an acceptable SEF
408 The Commission proposes to renumber
existing paragraph (a)(2) to subsection (c) and adopt
a new title—‘‘Eligibility.’’
409 The Commission proposes to renumber
existing subsection (b)—‘‘Jurisdiction’’ to
subsection (d).
410 2014 Staff Jurisdiction Guidance at 2.
411 7 U.S.C. 7b–3(f)(2).
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rule enforcement program, including
requirements related to prohibiting
abusive trading practices; detecting and
investigating rule violations;
maintaining sufficient staffing and
resources; maintaining an automated
trade surveillance system; conducting
real-time market monitoring; and
conducting investigations.
During the part 37 implementation
process, the Commission has acquired
greater experience with the swaps
markets, in particular related to SEF
compliance and regulatory oversight
requirements. The Commission
acknowledges that the existing swaps
regulatory framework was developed
based in part on the futures regulatory
framework. As a result, the current part
37 regulations do not sufficiently
account for differences between futures
and swaps markets, in particular the
differences in the complexity and size of
transactions, the number and
sophistication of market participants,412
and the variations in the methods of
execution offered. Within the swaps
market, the Commission also recognizes
that product offerings, execution
methods, types of market participants,
and liquidity may even vary among
SEFs.
Accordingly, the Commission believes
that instead of prescribing a limited
approach to compliance and regulatory
oversight requirements, a SEF should be
enabled to tailor its compliance and
oversight program to fit its respective
operations and market.413 Further, the
Commission seeks to ensure that SEF
rule enforcement requirements are
consistent with the ability of a SEF to
offer flexible execution methods for any
of its listed swaps. Therefore, as
described below, the Commission
proposes to amend § 37.203 to enable a
SEF to establish a rule enforcement
program that is best suited to its trading
systems and platforms, as well as its
market participants, while still ensuring
the ability to fulfill its self-regulatory
obligations. The Commission believes
that these proposed amendments would
also reduce certain complexities, costs,
and burdens, while still continuing to
implement the Core Principle 2
requirements and require a robust
compliance program.
412 The Commission notes that CEA section 2(e)
limits swaps trading to ECPs, as defined by section
1a(18) of the Act. 7 U.S.C. 2(e).
413 The Commission proposes to eliminate the
introductory sentence under § 37.203, which states
that a SEF shall establish and enforce trading, trade
processing, and participation rules that will deter
abuses and it shall have the capacity to detect,
investigate, and enforce those rules. This language
is duplicative of the existing requirements under
Core Principle 2.
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1. § 37.203(a)—Abusive Trading
Practices Prohibited
Section 37.203(a) requires a SEF to
generally prohibit abusive trading
practices on its markets by members and
market participants, but also enumerates
specific practices that a SEF must
specifically prohibit, including frontrunning, wash trading, pre-arranged
trading (except for block trades or other
types of transactions certified or
approved by the Commission under part
40), fraudulent trading, money passes,
and any other trading practice that the
SEF deems to be abusive.414 Section
37.203(a) further requires a SEF to
prohibit any other manipulative or
disruptive trading practices prohibited
by the Act or Commission regulations.
SEFs permitting intermediation must
also prohibit customer-related abuses,
such as trading ahead of customer
orders, trading against customer orders,
accommodation trading, and improper
cross trading.
The Commission proposes a nonsubstantive amendment to § 37.203(a) to
eliminate the term ‘‘members.’’ The
Commission notes that its proposed
definition of ‘‘market participant’’ under
§ 37.2(b) would capture the universe of
persons and entities that could engage
in abusive trading practices, including a
SEF’s members.415
As discussed above in conjunction
with the proposed prohibition on preexecution communications under
§ 37.201(b), the Commission is also
proposing to eliminate exceptions to the
pre-arranged trading prohibition under
§ 37.203(a).416
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.203(a). In
particular, the Commission requests
comment on the following questions:
(44) Are there any abusive trading
practices enumerated under proposed
§ 37.203(a) that are not applicable to
swaps trading on a SEF, on certain SEF
markets, or through certain methods of
execution?
(45) Are there other abusive trading
practices that could potentially occur in
the swaps markets that the Commission
should enumerate as a required
prohibition under § 37.203(a), e.g.,
intradesk and intracompany trading;
order flashing; a failure to honor firm
prices; attempting to change the general
conditions of a swap transaction after
price has been agreed upon; or potential
414 17
CFR 37.203(a).
supra Section IV.B.2.—§ 37.2(b)—
Definition of ‘‘Market Participant.’’
416 See supra Section VI.A.2.a.—§ 37.201(b)—PreExecution Communications.
415 See
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abuses at those points in the day when
options are settled against swaps levels?
2. § 37.203(b)—Authority To Collect
Information 417
Section 37.203(b) currently requires a
SEF to have arrangements and resources
for effective enforcement of its rules,
which includes the authority to collect
information and examine books and
records of SEF members and persons
under investigation. A SEF must also
facilitate direct supervision of the
market and analysis of data collected to
determine whether a rule violation has
occurred.418
The Commission proposes several
amendments to the existing
requirements. First, the Commission
proposes to eliminate the requirement
that a SEF’s arrangements and resources
must facilitate the direct supervision of
the market and the analysis of data
collected to determine whether a rule
violation has occurred. The Commission
views the language of this requirement
as superfluous because other regulations
already set forth these requirements in
greater specificity, such as § 37.203(d),
which requires a SEF to maintain an
automated trade surveillance system
that is capable of detecting and
reconstructing potential trade practice
violations.419
Second, the Commission proposes to
eliminate the requirements that SEFs
have the authority to collect documents
on a routine and non-routine basis and
examine books and records kept by
members and persons under
investigation. Instead, the Commission
proposes to require that each SEF have
the authority to collect information
required to be kept by persons subject
to the SEF’s recordkeeping rules.420 The
Commission recognizes that the existing
requirement does not provide clarity as
to the meaning of collecting of
documents on a ‘‘routine and nonroutine’’ basis and how a SEF can
417 The Commission proposes to retitle
§ 37.203(b) to ‘‘Authority to collect information’’
from ‘‘Capacity to detect and investigate rule
violations’’ based on the proposed changes
described below.
418 17 CFR 37.203(b).
419 17 CFR 37.203(d). The Commission also notes
that other part 37 regulations require a SEF to
supervise the market and analyze data, including
regulations that implement Core Principle 4. As
amended, § 37.401(a) would require a SEF to
conduct real-time market monitoring of all trading
activity on the SEF to identify disorderly trading,
any market or system anomalies, and instances or
threats of manipulation, price distortion, and
disruption. See infra Section IX.A.—§ 37.401—
General Requirements.
420 A SEF’s recordkeeping rules are established
by, among other provisions, § 37.404(b), which
requires a SEF to have rules that require its market
participants to keep records of their trading. 17 CFR
37.404(b).
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collect information from ‘‘persons under
investigation.’’ 421 Based on the
Commission’s experience in
implementing part 37, the Commission
believes that SEFs are better suited to
determine what recordkeeping rules are
appropriate based on the products that
it offers for trading and the types of
participants on its market, among other
considerations.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.203(b).
3. § 37.203(c)—Compliance Staff and
Resources
Section 37.203(c) currently requires a
SEF to establish and maintain sufficient
compliance staff and resources to
conduct a number of enumerated tasks,
such as audit trail reviews, trade
practice surveillance, market
surveillance, and real-time monitoring.
The rule further requires that such staff
must be sufficient to address unusual
market or trading events and to conduct
investigations in a timely manner.422
The Commission proposes to
eliminate the enumerated tasks and
replace them with the phrase ‘‘selfregulatory obligations under the Act and
Commission regulations.’’ The proposed
amendment is intended to apply the
requirement to all of the SEF’s
applicable self-regulatory functions and
clarify that the existing requirement is
not limited to the enumerated tasks.
Similarly, the Commission also
proposes to eliminate the language that
requires staffing to be sufficient to
address unusual market or trading
events and to complete investigations in
a timely manner, given that these
enumerated requirements are an
inherent part of a SEF’s existing selfregulation obligations. As the
Commission noted in the SEF Core
Principles Final Rule, a SEF may also
take into account the staff and resources
of any third-party entities it uses under
§ 37.204 to provide regulatory services
when evaluating the sufficiency of its
compliance staff.423 Further, the
Commission reiterates that as stated in
the preamble to the SEF Core Principles
421 The Commission notes that this lack of clarity
existed during the adoption of part 37. For example,
one commenter previously requested clarity
regarding the scope of the rule. SEF Core Principles
Final Rule at 33511.
422 17 CFR 37.203(c).
423 The Commission notes that a SEF must, at all
times, maintain sufficient internal compliance staff
to oversee the quality and effectiveness of the
regulatory services provided, as required by
§ 37.204. As discussed below, the Commission
proposes to expand § 37.204(a) to allow a SEF to
use a non-registered entity approved by the
Commission for the provision of regulatory services.
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Final Rule, some SEF compliance staff
can be shared among affiliated entities
as appropriate.424
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Request for Comment
The Commission requests comment
on all aspects of proposed § 37.203(c).
4. § 37.203(d)—Automated Trade
Surveillance System
Section 37.203(d) requires a SEF to
maintain an automated trade
surveillance system capable of detecting
potential trade practice violations.425
The rule also requires that the system
load and process daily orders and trades
no later than twenty-four hours after the
completion of the trading day. Given
that this requirement applies to all
orders and trades regardless of the type
of execution method, § 37.203(d)
requires orders that are not submitted to
an electronic trading system, e.g., orders
submitted by voice or certain other
electronic communications, such as
instant messaging and email, also be
loaded and processed into an automated
trade surveillance system. Such a
system, among other requirements, must
have the capability to detect and flag
specific trade execution patterns and
trade anomalies; compute, retain, and
compare trading statistics; compute
trading gains and losses and swapequivalent positions; and reconstruct
the sequence of trading activity.
The Commission proposes to
eliminate the specific automated trade
surveillance system capabilities
enumerated under § 37.203(d), except
for the ability of a SEF to reconstruct the
sequence of market activity.
Specifically, the Commission proposes
to retain this concept by amending the
remaining rule language to require that
a SEF’s automated trade surveillance
system be capable of detecting potential
trade practice violations and
reconstructing the sequence of market
activity and trading. The Commission
believes that an automated trade
surveillance system must be able to
reconstruct both the sequence of market
activity and trading in order to detect
such violations.
The Commission recognizes based on
its experience with implementing the
existing requirement that a SEF’s
automated trade surveillance system
cannot perform all of the enumerated
capabilities under the existing rule,
such as computing trade gains, losses,
and swap equivalent positions. The
Commission also acknowledges that it
has not clarified the enumerated
capabilities, which has led to some
424 SEF
425 17
Core Principles Final Rule at 33511.
CFR 37.203(d).
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confusion.426 As amended, the rule
would provide each SEF with the ability
to tailor its automated trade surveillance
system requirements as needed to fulfill
its compliance responsibilities, thereby
allowing the SEF to account for the
nature of its trading systems or
platforms. The Commission believes
that this proposed approach is
consistent with the reasonable
discretion given to a SEF under Core
Principle 1 to establish the manner in
which it complies with the SEF core
principles.
The Commission also proposes to
amend § 37.203(d) to clarify that all
trades executed by voice or by entry into
a SEF’s electronic trading system or
platform, as well as orders that are
‘‘entered into an electronic trading
system or platform,’’ must be loaded
and processed into the automated trade
surveillance system. This proposed
amendment reflects the Commission’s
recognition that no cost-effective and
efficient means currently exists that
would provide a SEF with the capability
to load and process orders that are not
initially entered into an electronic
trading system or platform, e.g., orders
entered by voice or certain other
electronic communications, such as
instant messaging and email, given that
those orders are in different formats.
The Commission notes that this
proposed change is consistent with the
proposed amendments to
§§ 37.205(b)(2)–(3), as discussed below,
that would similarly limit a SEF’s
electronic transaction history database
and electronic analysis capability
requirements.427 The Commission,
however, emphasizes that a SEF must
continue to have the capability to load
and process all executed trades,
including those resulting from orders
entered by voice or certain other
electronic communications, such as
instant messaging and email. The
Commission also emphasizes that under
proposed § 37.205(a), a SEF must
continue to capture all orders entered by
voice (i.e., oral communications) or
certain other electronic
communications, such as instant
messaging and email.
Finally, the Commission proposes to
clarify that the term ‘‘trading day’’—on
which such data must be loaded into the
automated trade surveillance system—
means the day ‘‘on which such trade
426 The Commission notes that some commenters
previously expressed concern about the clarity of
the enumerated capabilities. SEF Core Principles
Final Rule at 33512.
427 See infra Section VII.D.2.a.—§ 37.205(b)(1)—
Original Source Documents; § 37.205(b)(2)—
Transaction History Database; § 37.205(b)(3)—
Electronic Analysis Capability.
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was executed or such order was
entered.’’
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.203(d).
5. § 37.203(e)—Error Trade Policy 428
Section 37.203(e) currently requires a
SEF to conduct real-time market
monitoring of all trading activity on its
system(s) or platform(s) to identify
disorderly trading and any market or
system anomalies.429 The regulation
further requires a SEF to have the
authority to adjust prices and cancel
trades when needed to mitigate ‘‘market
disrupting events’’ caused by SEF
trading system or platform malfunctions
or errors in orders submitted by market
participants. Further, any trade price
adjustments or trade cancellations must
be transparent to the market and subject
to standards that are clear, fair, and
publicly available.
a. Error Trades—Swaps Submitted for
Clearing
In 2013, the Division of Clearing and
Risk (‘‘DCR’’) and DMO (together, the
‘‘Divisions’’) issued guidance (the ‘‘2013
Staff STP Guidance’’) to address
‘‘straight-through processing’’
requirements that, among other things,
expressed the view that SEFs should
have rules stating that trades that are
rejected from clearing are ‘‘void ab
initio.’’ 430 According to the Divisions,
swap transactions that are executed and
subsequently rejected by the DCO from
clearing would be considered void, even
where the rejection is attributable to an
operational or clerical error from the
SEF or market participants.431
428 The Commission also proposes to retitle
§ 37.203(e) to ‘‘Error trade policy’’ from ‘‘Real-time
market monitoring’’ based on the proposed changes
described below.
429 17 CFR 37.203(e).
430 Staff Guidance on Swaps Straight-Through
Processing at 5 (Sept. 26, 2013) (‘‘2013 Staff STP
Guidance’’). In addition to discussing the void ab
initio concept, as discussed below, the 2013 Staff
STP Guidance also discussed ‘‘straight-through
processing’’ for swap transactions. See infra Section
XII.B.2.—§ 37.702(b) and § 39.12(b)(7)—Time Frame
for Clearing. The Commission notes that to the
extent that error trades leading to a rejection from
clearing could be corrected without the execution
of a new trade, such methods would depart from
the void ab initio concept articulated by the
Divisions.
431 As previously stated by Commission staff for
purposes of granting time-limited no-action relief,
an operational or clerical error is any type of error
other than a rejection from clearing due to credit
reasons. CFTC Letter No. 17–27, Re: No-Action
Relief for Swap Execution Facilities and Designated
Contract Markets in Connection with Swaps with
Operational or Clerical Errors Executed on a Swap
Execution Facility or Designated Contract Market
(May 30, 2017) at 1 n.2 (‘‘NAL No. 17–27’’).
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SEFs and market participants raised
concerns that considering such
transactions to be void ab initio under
the guidance would impede their ability
to correct trades that were rejected from
clearing at the DCO on the basis of such
errors. For example, some transactions
submitted for clearing may fail to match
a specified term due to a clerical error,
e.g., counterparty names; as a result, the
trades would be rejected from clearing
and deemed void ab initio, even though
the error would be readily
correctable.432 The Divisions’ view on
void ab initio would compel
counterparties to execute a new trade
with the corrected terms, rather than
allow a SEF to identify and correct the
error through other established
protocols and procedures.
For those SEFs that apply the concept
of void ab initio, however, the
Commission’s current execution method
requirements have inhibited the ability
to correct errors through subsequent
trades, where a swap has been rejected
from clearing due to the error or where
a swap containing an error has been
accepted for clearing by a DCO. For
swaps that are Required Transactions,
market participants have been otherwise
prohibited from determining how to
resolve the error between themselves by
entering into an offsetting trade or a new
trade with the correct terms due to (i)
the execution method requirements
under § 37.9(a)(2), which requires that
all Required Transactions be traded via
either an Order Book or RFQ System;
and (ii) the corresponding prohibition
on pre-arranged trading under
§ 37.203(a). In response to these
concerns related to void ab initio,
Commission staff has provided timelimited no-action relief.433
432 The Commission understands that when a
swap trade that is intended to be cleared has an
operational or clerical error, a DCO will reject that
trade, even if it otherwise complies with the riskbased limits established for the respective
counterparties. As DCOs do not distinguish clearing
rejections for credit reasons from clearing rejections
due to clerical or operational errors, error trades are
treated as void ab initio.
433 CFTC Letter No. 13–66, Time-Limited NoAction Relief for Swap Execution Facilities from
Compliance With Certain Requirements of
Commission Regulation 37.9(a)(2) and 37.203(a)
(Oct. 25, 2013) (‘‘NAL No. 13–66’’). In April 2015,
staff issued additional no-action relief, which
reinstated the previous time-limited no-action relief
from NAL No. 13–66 for SEFs from § 37.9(a)(2) and
§ 37.203(a) for swaps rejected from clearing due to
an operational or clerical error. Under the expanded
no-action relief, SEF market participants have
resolved error trades accepted for clearing at the
DCO, among other types of transaction. CFTC Letter
No. 15–24, Re: No-Action Relief for Swap Execution
Facilities and Designated Contract Markets in
Connection with Swaps with Operational or
Clerical Errors Executed on a Swap Execution
Facility or Designated Contract Market (Apr. 22,
2015) (‘‘NAL No. 15–24’’). Commission staff
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Based on this no-action relief, SEFs
have allowed market participants to prearrange corrective trades for execution
and submission to a DCO for clearing
through means not prescribed under
§ 37.9 for Required Transactions. Such
trades include a new trade with the
corrected terms, where an error trade
has been rejected from clearing. Such
trades also include a new trade to offset
an error trade accepted for clearing and
a second subsequent trade with the
corrected terms, as originally intended
between the counterparties. This relief
has enabled counterparties to address
error trades, but has required SEFs to
adopt mechanisms to identify these
corrective trades and additional related
rules and procedures for their respective
market participants.
In light of the challenges described
above, the Commission proposes
clarifications and amendments to
address the role of void ab initio with
respect to error trades for SEFs as
described below.434 The Commission
notes that void ab initio is a
determination made by a SEF, and not
by a DCO, which merely accepts or
rejects a trade from clearing.
Additionally, consistent with the 2013
Staff STP Guidance,435 the Commission
notes that void ab initio does not apply
to back-loaded trades, i.e., trades
originally executed without an intent to
clear, which the parties subsequently
decided to clear.
b. Current SEF Error Trade Policies
SEFs have adopted rules and
protocols to address other general
aspects of correcting an error trade.
These factors, among the many specified
across all SEFs, include a definition of
‘‘error trade’’; the circumstances to
which the SEF’s error trade rules would
apply; the process for a market
participant to report an alleged error
trade; the process through which a SEF
may review and determine that an error
trade has occurred; notification
procedures; and the possible courses of
action that a SEF may take (or allow its
market participants to take) to correct
the error trade. The Commission
subsequently extended the relief provided in NAL
No. 15–24 in June 2016. CFTC Letter No. 16–58, Re:
No-Action Relief for Swap Execution Facilities and
Designated Contract Markets in Connection with
Swaps with Operational or Clerical Errors Executed
on a Swap Execution Facility or Designated
Contract Market (June 12, 2016). This relief has
been most recently extended by NAL No. 17–27 in
May 2017.
434 The Commission notes that it is also proposing
certain clarifications and amendments related to the
2013 Staff STP Guidance with respect to straightthrough processing of swaps. See infra Section
XII.B.2.b.—Proposed Approach to Straight-Through
Processing.
435 2013 Staff STP Guidance at 5.
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believes that the adoption of such error
trade policies by SEFs reflects their
understanding that such policies are a
beneficial practice that promotes a fair
and orderly trading market for their
market participants.436
Notwithstanding the existence of error
trade rules and protocols across
different SEFs, market participants have
stated that those rules and protocols,
and the manner in which they are
applied, have been inconsistent in some
respects. Participants have cited a
number of such examples, including
inconsistent approaches to notifying
SEFs of alleged error trades; the varying
factors that SEFs consider in evaluating
alleged error trades; and the level of
notification provided to other market
participants regarding alleged errors.
Therefore, some market participants—
particularly those that are participants
of multiple SEFs—have recommended
that the Commission adopt some general
error trade policy requirements to
promote a more consistent approach.
Based on the feedback received and its
own observations during the part 37
implementation, the Commission
proposes to refine its approach to SEF
error trade policies in a manner that
would benefit market participants.
c. § 37.203(e)—Error Trade Policy 437
The Commission proposes to
eliminate the real-time market
monitoring requirement, which is
duplicative of Core Principle 4, and
adopt a refined approach to SEF error
trade policies under proposed
§ 37.203(e) that would allow a SEF to
implement its own protocols and
processes to correct error trades with
respect to swaps (i) rejected by a DCO
due to an operational or clerical error or
(ii) accepted for clearing by a DCO that
contains an operational or clerical
error.438 Therefore, the Commission’s
436 The Commission notes that the guidance to
Core Principle 4 in Appendix B cites ‘‘clear errortrade and order-cancellation’’ policies as a type of
trading risk control that could be part of an
acceptable program for preventing market
disruptions. 17 CFR part 37 app. B (guidance to
Core Principle 4—paragraph (a)(5)—‘‘Risk controls
for trading’’).
437 The Commission proposes to retitle § 37.203(e)
to ‘‘Error trade policy’’ from ‘‘Real-time market
monitoring.’’
438 The Commission notes that the real-time
market monitoring requirement is duplicative of
Core Principle 4, which requires a SEF to conduct
real-time monitoring of trading and comprehensive
and accurate trade reconstructions. To account for
the minor difference between the real-time
monitoring requirements under § 37.203(e), which
requires a SEF’s monitoring to ‘‘identify disorderly
trading,’’ and § 37.401, which currently does not
specify that requirement, the Commission is
proposing to amend § 37.401 to incorporate this
requirement. See infra Section IX.A.—§ 37.401—
General Requirements.
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proposal would explicitly permit a SEF
to establish its own rules regarding error
trades rejected from clearing, which the
Commission believes would facilitate a
SEF’s ability to establish its own error
trade procedures that it believes is best
suited to its particular market, including
whether to maintain an approach based
on the void ab initio concept for trades
rejected from clearing due to non-credit
related errors.
Consistent with proposed
§ 37.702(b)(1),439 however, the
Commission notes that SEFs would now
be required to deem any swap submitted
for clearing as void ab initio if a DCO
rejects the trade from clearing due to
credit reasons. Under this scenario,
clearing members for the executing
counterparties to the rejected trade must
resolve the outstanding credit issue that
prevented a DCO from accepting the
trade for clearing. The ability for a
clearing member to resolve credit issues,
a process which is outside of a SEF’s
purview, is inconsistent with the SEF’s
ability to provide for the financial
integrity of swaps entered into on the
SEF in contravention of Core Principle
7 and proposed § 37.702(b)(1), which
would require a SEF to coordinate with
a DCO to facilitate prompt, efficient, and
accurate processing and routing of
transactions to the DCO.440 In contrast,
a SEF’s role in this context is limited to
controlling the process of correcting an
operational or clerical error within the
terms of a swap using the SEF’s error
trade-related rules and procedures.
Therefore, a SEF should not rely upon
a clearing member to resolve such credit
issues, but instead must declare a swap
that is rejected from clearing for credit
reasons as void ab initio.
In addition to allowing a SEF to
configure an approach to correcting
non-credit related error trade swaps
submitted to a DCO for clearing,
however, the Commission emphasizes
that proposed § 37.203(e) would
generally require a SEF to establish
baseline procedural requirements for an
error trade policy for all swaps executed
on its facility. The proposed approach
would permit a SEF to develop and
adopt a more efficient approach based
on the nature of the transaction and
error, as well as the SEF’s own
operational and technological
439 The
Commission proposes to renumber
§ 37.702(b)(2) to § 37.702(b)(1). See infra Section
XII.B.2.b.(1)—§ 37.702(b)(1) and
§ 39.12(b)(7)(i)(A)—‘‘Prompt, Efficient, and
Accurate’’ Standard.
440 In some cases, clearing members and the DCO
may not be able to resolve an outstanding credit
issue, but the swap nevertheless remains void ab
initio.
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capabilities.441 Given that market
participants often execute subsequent
swaps to hedge the risk of an initial
transaction, this approach would help
mitigate the potential exposure to
market and execution risk that arises if
such hedge positions are established
against a swap that has been deemed
void ab initio. Accordingly, a SEF may
reduce that risk by facilitating a more
targeted and timely correction of errors
in the initial transaction that would not
necessitate the resubmission of an entire
transaction that has been voided.442
The proposed approach, in
conjunction with the proposed adoption
of more flexible methods of execution,
would also render the current no-action
relief unnecessary for those SEFs that
choose to deem error trades as void ab
initio.443 For example, if a SEF
maintains an approach similar to the
current no-action relief, then the
elimination of the prescriptive
execution methods under § 37.9 would
allow counterparties to execute a
corrective trade via flexible methods of
execution offered by the SEF.444 Under
the proposed approach, however, a SEF
also may not choose to follow the void
ab initio approach for non-credit related
errors and instead adopt operational
protocols or procedures to resolve an
error trade that do not require the
execution or resubmission of a
corrective trade. Relief from the prearranged trading prohibition under
§ 37.203(a) would also be unnecessary;
under the proposed approach, a SEF
could allow counterparties to use
441 See 17 CFR part 37 app. B (guidance to Core
Principle 4—paragraph (a)(5)—‘‘Risk controls for
trading’’) (noting that risk controls such as error
trade policies should be adapted to the unique
characteristics of the trading platform and of the
markets to which they apply). The Commission
notes that based on its proposal to adopt separate
error trade policy rules under § 37.205(e), it also
proposes to eliminate the guidance to Core
Principle 4 in Appendix B that specifies error trade
policies as a type of risk control that a SEF may
adopt. See infra Section IX.E.—§ 37.405—Risk
Controls for Trading.
442 The Commission notes, however, that to the
extent that a DCO has its own protocols and
policies for resolving error trades—both for error
trades that are rejected for clearing due to noncredit related errors and for error trades that have
been accepted for clearing—a SEF should
coordinate its own approach with the DCO,
pursuant to the requirements of proposed
§ 37.702(b)(1) (existing § 37.702(b)(2)), which
requires a SEF to coordinate with a DCO, to which
it submits transactions for clearing, to develop rules
and procedures to facilitate prompt and efficient
transaction processing in accordance with
§ 39.12(b)(7).
443 NAL No. 17–27.
444 To the extent that a SEF currently maintains
a similar approach as set forth in the no-action
relief, however, the Commission clarifies that a SEF
could maintain those protocols and procedures,
notwithstanding the adoption of the proposed
version of § 37.203(e).
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flexible means of execution to execute a
corrective trade.445
In conjunction with the proposed
flexibility to correcting error trades,
§ 37.203 would also set forth general
requirements that are intended to create
a baseline consistency among SEF error
trade policies. Proposed § 37.203(e)(1)
defines an ‘‘error trade’’ as any swap
transaction executed on a SEF that
contains an error in any term, including
price, size, or direction.446 Proposed
§ 37.203(e)(2) would require a SEF to
establish and maintain rules and
procedures to help resolve error trades
in a ‘‘fair, transparent, consistent, and
timely manner.’’ At a minimum, such
rules would be required to provide the
SEF with the authority to adjust trade
terms and cancel trades; and specify the
rules and procedures for market
participants to notify the SEF of an error
trade, including any time limits for
notification. While the Commission is
providing SEFs with flexibility in
designing their error trade policies, the
Commission believes that fairness,
transparency, consistency, and
timeliness should be key principles in a
SEF’s error trade policy.
Further, proposed § 37.203(e)(3)
would establish a minimum set of
notification requirements for a SEF. A
SEF would be required to notify all of
its market participants, as soon as
practicable, of (i) any swap transaction
that is under review pursuant to the
SEF’s error trade rules and procedures;
(ii) a determination that the trade under
review is or is not an error trade; and
(iii) the resolution of any error trade,
including any trade term adjustment or
cancellation. The Commission proposes
an ‘‘as soon as practicable’’ standard
based on competing considerations,
such as the need to maintain orderly
trading versus the need for timely
transparency. Under this proposed
approach, a SEF may determine that
making error trade information available
at a particular point in time is not
practicable, given the countervailing
concerns of potential market disruptions
caused by the announcement of a
potentially erroneous trade that has
been disseminated to the SEF’s
participants.
Proposed § 37.203(e)(4) would allow a
SEF to establish non-reviewable ranges.
445 See infra note 319 and accompanying
discussion (noting that the pre-arranged trading
prohibition is intended to maintain the integrity of
price competition and market risk that is incident
to trading in the market).
446 This definition, however, would not include a
swap trade that is rejected from clearing for credit
reasons, as discussed above. Therefore, the
Commission notes that proposed § 37.203(e) would
not apply to such trades.
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The Commission has observed that in
the interests of minimizing market
disruption and maintaining orderly
trading, many SEFs have established
non-reviewable ranges during the course
of trading. Therefore, the Commission
believes that to allow SEFs to maintain
existing beneficial market practices, a
SEF should continue to be able to
establish such ranges, which may be
adjusted based on market conditions.
Pursuant to proposed § 37.203(e)(2),
however, the Commission emphasizes
that such ranges must be established
and administered in a fair, transparent,
consistent, and timely manner.
The Commission recognizes that
identifying and resolving error trades in
a timely manner is important to promote
market integrity and efficiency and
ensure that trade data, which market
participants rely upon to inform their
swaps trading decisions, accurately
reflects prevailing market pricing at any
given time. The Commission believes
that proposed § 37.203(e) would
accomplish these goals for market
participants and the market as a whole.
Request for Comment
The Commission requests comments
on all aspects of proposed § 37.203(e).
The Commission may consider
alternatives to its proposed error trade
policy requirements and requests
comment on the following questions:
(46) Does the lack of a void ab initio
requirement for non-credit related errors
create concerns about market risk with
respect to error trades that have been
executed, but have not been voided
despite the rejection from clearing? If so,
should a SEF be limited in the types of
errors that may be corrected without
void ab initio, e.g., errors that do not
create market risk? Should the
Commission adopt a mandatory void ab
initio requirement that certain types of
errors, e.g., those that do cause market
risk, must be resolved via a corrective
trade approach? Or should
counterparties otherwise have the
ability to maintain breakage agreements
to address such risks?
(47) Is the Commission’s proposed
definition of ‘‘error trade’’ overly broad
or narrow? Should the definition or
requirement specifically address certain
types of errors, such as the wrong
affiliate counterparty or the wrong
product identified?
(48) Is the Commission’s proposed
definition of ‘‘error trade’’ sufficient to
include those trades where an incorrect
term (e.g., incorrect notional amount)
results in a rejection by a DCO
ostensibly due to credit reasons, but
where the DCO otherwise would have
accepted the trade had the trade
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included the correct terms? If not, then
how should the term ‘‘error trade’’ be
defined to better discern this situation
from a situation where a true rejection
for credit reasons has occurred?
Similarly, is the Commission’s proposed
definition of ‘‘error trade’’ sufficiently
clear so that the SEF knows which
errors are required to be treated as error
trades and which errors are required to
be treated as void ab initio? If not,
please explain. Should the
Commission’s definition of ‘‘error trade’’
specifically state that it does not include
rejections from clearing for credit
reasons?
(49) Should trades that are rejected by
a DCO for insufficient credit be required
to be deemed to be void ab initio by
SEFs? If so, should the Commission
codify such a requirement under
proposed § 37.203(e) or elsewhere in the
Commission’s regulations?
(50) Are SEFs and DCOs able to
distinguish between trades that are
rejected from clearing due to
insufficient credit from those trades that
are rejected because they are error
trades? Why or why not?
(51) The proposed regulations require
that error trades be resolved in a timely
manner, recognizing that a SEF may not
be in a position to resolve every error
trade within a specific time frame.
Would requiring resolution of an error
trade ‘‘as soon as practicable’’ or within
a specific time frame lead to quicker
resolutions and reduce risk for market
participants? If so, what time frame
would be appropriate and should it vary
based on other factors, such as the
nature of the product or transaction
type, whether the error was a
participant error or system error, or
whether the error was discovered before
or after the trade was cleared?
(52) Should a SEF be permitted to
adjust or cancel an error trade without
consulting with the parties to the trade
in some or all circumstances, or should
the Commission require a SEF to
consult with or obtain the consent of the
parties to an error trade in some or all
circumstances?
(53) Should market participants be
required to report all errors to a SEF or
are there certain errors that are
immaterial and do not otherwise require
correction?
(54) What type of error trade policy
should a SEF be required to adopt for
swap transactions that are subject to an
exception to the prohibition on preexecution communications under
proposed § 37.201(b), given that such
swaps may be negotiated or arranged
away from the SEF’s trading system or
platform?
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(55) Should a SEF be required to
specify who may request a review of a
trade as a potential error trade? Should
the ability to request a review be limited
to the parties to a trade or should market
participants affected by the trade also
have the ability to request a review?
(56) Are there alternative
requirements that would enhance
efficiency and transparency in the error
trade resolution process?
(57) Should the Commission require
SEFs to notify all market participants of
an error trade and the resolution of such
trade or only a smaller subset of
participants? Should the Commission
provide any time frame for such notice?
(58) Should a DCO be required to
notify a SEF of the reason why a trade
was rejected from clearing? If so, what
type of information should the
Commission require the DCO to provide
to the SEF in such a circumstance?
6. § 37.203(f)—Investigations 447
Existing § 37.203(f) currently sets
forth requirements for SEFs with respect
to conducting investigations of their
market participants for potential rule
violations.448 Existing § 37.203(f)(1)
requires a SEF to have procedures that
require its compliance staff to conduct
investigations of possible rule
violations.449 The rule further requires
that an investigation be commenced
upon Commission staff’s request or
upon discovery of information by a SEF
that indicates a reasonable basis for
finding that a violation has occurred or
will occur. Existing § 37.203(f)(2)
requires that investigations be
completed in a timely manner, defined
as twelve months after an investigation
is opened, absent enumerated mitigating
circumstances.450 Existing § 37.203(f)(3)
requires a SEF’s compliance staff to
submit an investigation report for
disciplinary action any time staff
determines that a reasonable basis exists
for finding a rule violation,451 while
existing § 37.203(f)(4) requires
compliance staff to prepare an
investigation report upon concluding an
investigation and determining that no
reasonable basis exists for finding a rule
violation.452 Existing §§ 37.203(f)(3)–(4)
enumerate the items that must be
included in the investigation report.
Finally, existing § 37.203(f)(5) prohibits
a SEF from issuing more than one
447 The Commission proposes to retitle § 37.203(f)
to ‘‘Investigations’’ from ‘‘Investigations and
investigation reports’’ based on the proposed
changes described below.
448 17 CFR 37.203(f).
449 17 CFR 37.203(f)(1).
450 17 CFR 37.203(f)(2).
451 17 CFR 37.203(f)(2).
452 17 CFR 37.203(f)(4).
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warning letter to the same person or
entity for the same rule violation during
a rolling twelve-month period.453
The Commission proposes to amend
existing § 37.203(f) to simplify and
streamline the procedures for SEFs to
conduct investigations and prepare
investigation reports. First, the
Commission proposes to amend
§ 37.203(f)(1) to state that each SEF must
establish and maintain procedures
requiring compliance staff to conduct
investigations, including the
commencement of an investigation
upon the receipt of a request from
Commission staff or upon the discovery
or receipt of information by the SEF that
indicates the existence of a reasonable
basis for finding that a violation may
have occurred or will occur (emphasis
added). This proposed amendment
reflects the Commission’s view that
SEFs may, and should have the right to,
choose to initiate investigations under
broader circumstances than the two
instances identified in the existing
provision.
Second, the Commission proposes to
amend § 37.203(f)(2) to eliminate the
twelve-month requirement for
completing investigations and instead
provide SEFs with the ability to
complete investigations in a timely
manner taking into account the facts
and circumstances of the investigation.
Based on its experience, the
Commission recognizes that each
investigation raises unique issues, facts,
and circumstances that affect the time
that it takes to complete the
investigation. A SEF may complete
some investigations in less than twelve
months and complete some
investigations in more than twelve
months. The Commission also
recognizes that the list of mitigating
factors in the existing rule is not
comprehensive, and other factors may
affect the time of an investigation.
Rather than prescribe a singular
requirement, the Commission believes
that it is more appropriate to establish
general parameters for completing
investigations. In conjunction with this
amendment, the Commission also
proposes guidance to Core Principle 2 in
Appendix B to provide SEFs with
reasonable discretion to determine that
time frame.454
453 17
CFR 37.203(f)(5).
Commission proposes to add this
guidance as paragraph (a)(2) to Core Principle 2 in
Appendix B and eliminate the existing guidance,
which currently states that a SEF should adopt and
enforce any additional rules it believes are
necessary to comply with § 37.203. The
Commission views this guidance as unnecessary
based on the proposed changes to § 37.203(f).
454 The
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Third, the Commission proposes to
streamline the requirements that apply
to all SEF investigation reports,
regardless of whether a reasonable basis
exists for finding a violation, by
consolidating the provisions under
existing § 37.203(f)(4) into a new
proposed § 37.203(f)(3). Accordingly,
proposed § 37.203(f)(3) would require a
SEF’s compliance staff to prepare a
written investigation report to document
the conclusion of each investigation.
The proposed rule would maintain the
existing requirement that each
investigation report contain the
following information: (i) The reason
the investigation was initiated; (ii) a
summary of the complaint, if any; (iii)
the relevant facts; (iv) the compliance
staff’s analysis and conclusions; and (v)
a recommendation as to whether
disciplinary action should be pursued.
To provide further clarity regarding the
actions that a SEF may take once the
investigation report is completed, the
Commission proposes adding guidance
to Core Principle 2 in Appendix B to
provide that compliance staff should
submit all investigation reports to the
CCO or other compliance department
staff responsible for reviewing such
reports and determining next steps in
the process; and the CCO or other
responsible staff should have reasonable
discretion to decide whether to take any
action, such as presenting the
investigation report to a disciplinary
panel for disciplinary action.455
As part of the Commission’s proposal
to consolidate multiple existing warning
letter requirements into a single
provision under proposed § 37.206(c)(2),
the Commission also proposes to
eliminate the warning letter requirement
under existing § 37.203(f)(5).456
455 The Commission proposes to add this
guidance as paragraph (a)(3) to Core Principle 2 in
Appendix B. The Commission notes that it
provided similar clarification in the preamble to the
SEF Core Principles Final Rule. SEF Core Principles
Final Rule at 33515. As discussed below, the
Commission proposes to renumber the existing
language in paragraph (a)(3) to paragraph (a)(6), see
infra Section VII.E.1.—§ 37.206(a)—Enforcement
Staff; and eliminate the existing language in
paragraph (a)(6), see infra Section VII.E.2.—
§ 37.206(b)—Disciplinary Program.
456 The Commission proposes to streamline and
consolidate multiple existing provisions that
address the SEF’s use of warning letters—under
existing § 37.203(f)(5), existing § 37.205(c)(2) with
respect to audit trail violations, and existing
§ 36.206(f) with respect to rule violations—into a
single provision under proposed § 37.206(c)(2), as
discussed below. See infra Section VII.E.3.—
§ 37.206(c)—Hearings. Further, the Commission
proposes to eliminate the existing language under
paragraph (a)(1) of the guidance to Core Principle
2 in Appendix B, which states that a SEF’s rules
may authorize its compliance staff to issues
warning letters or recommend that a disciplinary
panel take such action. The Commission views this
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62003
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.203(f)
and the associated guidance to Core
Principle 2 in Appendix B.
7. § 37.203(g)—Additional Sources for
Compliance
The Commission is not proposing any
amendments to § 37.203(g).
C. § 37.204—Regulatory Services
Provided by a Third Party
Section 37.204, among other things,
permits a SEF to contract with an RFA,
another registered entity, or the
Financial Industry Regulatory Authority
(‘‘FINRA’’) for the provision of
regulatory services, subject to the
requirement that the SEF supervises its
regulatory service provider and retains
exclusive authority over substantive
decisions. As described below, the
Commission proposes a series of
amendments that would provide a SEF
with further options in choosing and
utilizing a regulatory service provider to
assist with fulfilling its regulatory
obligations, while still maintaining
regulatory protections that relate to the
use of an external services provider.
1. § 37.204(a)—Use of Regulatory
Service Provider Permitted
Section 37.204(a) permits a SEF to
contract with an RFA, another registered
entity, or FINRA to assist the SEF in
complying with the Act and
Commission regulations, as approved by
the Commission.457 A SEF that elects to
use the services of a regulatory service
provider must ensure that the provider
has the capacity and resources to
provide timely and effective regulatory
services.458 A SEF remains responsible
at all times for the performance of any
regulatory services received, compliance
with its obligations under the Act and
Commission regulations, and the
regulatory service provider’s
performance on its behalf.459
Based upon its experience with
implementing part 37, the Commission
is proposing to expand the scope of
entities that may provide regulatory
services under § 37.204(a) to include
any non-registered entity approved by
the Commission.460 The Commission
believes that this proposed expansion
would be appropriate and notes that the
Act does not address or proscribe the
guidance as unnecessary based on the proposed
changes to § 37.203(f).
457 17 CFR 37.204(a).
458 Id.
459 Id.
460 The Commission proposes to amend
‘‘Financial Industry Regulatory Authority’’ in the
text of § 37.204(a) to ‘‘any non-registered entity.’’
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types of entities that SEFs may use for
the provision of regulatory services; for
example, the Commission used this
basis originally to include FINRA
among the list of entities that could
provide regulatory services. Therefore,
consistent with the statute, SEFs would
be allowed to choose from a greater
number of potential third-party
providers. The Commission believes
that this change would potentially
increase competition among existing
and potential regulatory service
providers and, thus, reduce operating
costs for SEFs, encourage innovation
and technological developments, and
mitigate barriers to entry for new SEFs.
Section 37.204(a), however, would
also continue to be subject to important
protections to ensure that a regulatory
service provider provides effective
regulatory services. To ensure each
SEF’s compliance with §§ 37.203(c)–(d),
among other provisions, the
Commission would continue to evaluate
the sufficiency of a provider’s
compliance staff and resources and the
capabilities of its automated trade
surveillance system, and other
capabilities.461 Section 37.204(a) would
still require each SEF to be responsible
at all times for the performance of the
regulatory services received, for
compliance with the SEF’s obligations
under the Act and Commission
regulations, and for the provider’s
performance on its behalf. Further, as
discussed below, § 37.204(b) would still
impose a duty to supervise the provider.
Accordingly, the Commission believes
that these protections, combined with
the Commission’s prior evaluation of
any provider, support the ability of a
SEF to consider an entity outside of an
RFA, a registered entity, or FINRA.
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Request for Comment
The Commission requests comment
on all aspects of proposed § 37.204(a).
2. § 37.204(b)—Duty To Supervise
Regulatory Service Provider
Existing §§ 37.204(b)–(c) generally set
forth a SEF’s oversight responsibilities
with respect to a regulatory service
provider. Existing § 37.204(b) requires a
SEF to retain sufficient compliance staff
to supervise the quality and
effectiveness of the services performed
by a regulatory service provider; hold
regular meetings with the regulatory
service provider to discuss ongoing
investigations, trading patterns, market
participants, and any other matters of
461 The
Commission would evaluate a provider
with respect to these requirements prior to
approving any arrangement between a SEF and the
provider, or during the course of conducting routine
oversight of a SEFs self-regulatory program.
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regulatory concern; and conduct and
document periodic reviews of the
adequacy and effectiveness of services
provided on its behalf.462 Existing
§ 37.204(c), however, requires a SEF to
retain exclusive authority over all
substantive decisions made by its
regulatory service provider, such as
decisions involving trade cancellations,
issuance of disciplinary charges, and
access denials.463 A SEF is also required
to document any instance where its
actions differ from those recommended
by its regulatory service provider,
including the reasons for the course of
action recommended by the regulatory
service provider and the reasons why
the SEF chose a different course of
action.464
The Commission proposes to combine
and streamline the requirements of
existing §§ 37.204(b)–(c) into a new
proposed § 37.204(b). The Commission
further proposes to maintain a SEF’s
duty to supervise its regulatory service
provider, but to eliminate the
requirement that the SEF hold regular
meetings and conduct periodic reviews
of the provider. Instead, the
Commission proposes that a SEF be able
to determine the necessary processes for
supervising their regulatory service
providers. Consistent with this
proposed change, the Commission also
proposes to provide each SEF with the
option to allow its regulatory service
provider to make substantive decisions,
provided that, at a minimum, the SEF is
involved in such decisions. Therefore, a
SEF would have the discretion to
determine how they are involved in
such decisions. The proposed rule
would keep the existing examples of
substantive decisions, including the
adjustment or cancellation of trades, the
issuance of disciplinary charges, and
denials of access to the SEF for
disciplinary reasons. Finally, the
Commission proposes to eliminate the
requirement that a SEF document where
its actions differ from the regulatory
service provider’s recommendations,
deferring instead to the SEF and its
regulatory service provider to mutually
agree on the method that they will use
to document substantive decisions.
Based on its experience implementing
the SEF regulatory framework, the
Commission believes that some of the
specific requirements currently
prescribed under existing §§ 37.204(b)–
(c) are unnecessary and overly
prescriptive because SEFs, consistent
with their position as self-regulatory
organizations, remain ultimately
462 17
463 17
CFR 37.204(b).
CFR 37.204(c).
464 Id.
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responsible for the performance of any
regulatory services received, for
compliance with their obligations under
the Act and Commission regulations,
and for the regulatory service providers’
performance on their behalf. Given a
SEF’s ultimate responsibility, the
Commission believes that the SEF
should be allowed to determine how
best to supervise its regulatory service
provider based on the services it
receives and the nature of the SEF’s
operations and markets. The
Commission also notes that this
proposed approach is consistent with a
SEF’s discretion under Core Principle
1.465 The Commission further believes
that the discretion that SEFs and their
regulatory service providers would have
under § 37.204(b) to determine a
mutually acceptable process may enable
more timely decision making regarding
substantive matters.466
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.204(b).
3. § 37.204(c)—Delegation of Authority
The Commission proposes a new
§ 37.204(c) to delegate to DMO the
authority to approve any regulatory
service provider chosen by a SEF. This
does not, however, prohibit the
Commission from exercising authority
to approve any third party regulatory
service provider. The Commission
anticipates that expanding the scope of
entities that may provide regulatory
services under proposed § 37.204(a) may
lead to a greater number of approval
requests for such entities. Therefore, the
Commission proposes to delegate this
authority to ensure that such a review
is conducted in an efficient manner.
Such approval would require, at a
minimum, that each regulatory service
provider demonstrate that it has the
capabilities and resources necessary to
provide timely and effective regulatory
services on behalf of the SEF, including
adequate staff and automated
surveillance systems, as required under
proposed § 37.204(a).
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.204(c).
D. § 37.205—Audit Trail
Section 37.205 sets forth a SEF’s audit
trail requirements and generally
requires a SEF to establish procedures to
465 7
U.S.C. 7b–3(f)(1)(B).
Commission notes that a commenter to
the SEF Core Principles Final Rule stated that
entrusting greater discretion to a regulatory service
provider would provide for prompt decisionmaking. SEF Core Principles Final Rule at 33517.
466 The
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capture and retain information that may
be used in establishing whether rule
violations have occurred. Specifically,
§ 37.205(a) requires a SEF to have an
audit trail; § 37.205(b) prescribes the
elements of an acceptable audit trail
program; and § 37.205(c) requires a SEF
to enforce its audit trail requirements.467
Based on the Commission’s
experience with implementing part 37,
including the SEF registration process,
the Commission has observed that
technology limitations have impacted
SEFs’ ability to comply with all of the
audit trail requirements, particularly for
orders submitted by voice and certain
electronic communications that include
instant messages and emails. Based on
these observations, as well as the
proposed ability for a SEF to offer
flexible execution methods, the
Commission proposes amendments to
the audit trail requirements that seek to
strike the appropriate balance between
offering SEFs the ability to adopt such
requirements that are best suited to their
respective trading systems or platforms,
while also ensuring that such programs
enable SEFs to fulfill their selfregulatory obligations. The Commission
believes that the proposed changes are
consistent with Core Principle 2, which
generally requires a SEF to capture
information that may be used in
establishing whether rule violations
have occurred.468
1. § 37.205(a)—Audit Trail Required
Section 37.205(a) requires a SEF to
capture and retain all audit trail data
necessary to detect, investigate, and
prevent customer and market abuses.469
Such audit trail data must be sufficient
to reconstruct all indications of interest,
requests for quotes, orders, and
trades.470 The audit trail must also
permit a SEF to track a customer order
from the time of receipt through fill,
allocation, or other disposition.471
The Commission proposes several
amendments to streamline the existing
requirements, account for different
execution methods and swaps market
practices, and eliminate redundancies
with other part 37 requirements.
Notwithstanding the proposed changes
described above, the Commission
emphasizes that the type of execution
method offered by a SEF does not alter
the obligation to capture all audit trail
data necessary to detect, investigate, and
enforce its rules pursuant to Core
Principle 2.
467 17
CFR 37.205(a)–(c).
U.S.C. 7b–3(f)(2).
469 17 CFR 37.205(a).
470 Id.
471 Id.
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First, the Commission proposes to
clarify the existing language to specify
that a SEF must capture and retain all
audit trail data necessary to reconstruct
all trading on its facility, detect and
investigate customer and market abuses,
and take appropriate disciplinary action
(emphasis added).472 By replacing the
requirement to ‘‘prevent’’ customer and
market abuses with the requirement to
‘‘take appropriate disciplinary action’’
and specifying that the data must enable
the SEF to reconstruct all trading on its
facility, the Commission believes that
§ 37.205(a) would more accurately
reflect the capabilities for which a SEF
may use its audit trail data. The
Commission notes that an audit trail
cannot ‘‘prevent’’ customer and market
abuses and the ability to ‘‘reconstruct’’
trading is already required under
existing § 37.205(a), as described below.
Second, the Commission proposes to
move the requirement that audit trail
data shall be sufficient to reconstruct all
indications of interest, requests for
quotes, orders, and trades to the
guidance to Core Principle 2 in
Appendix B.473 Given the proposal to
allow each SEF to offer flexible methods
of execution, as well as continuing
advances in technology, the
Commission believes that enumerating
specific audit trail data in the regulatory
language may unnecessarily limit the
universe of data relevant to a SEF’s
audit trail. The Commission emphasizes
that a SEF must capture all audit trail
data related to each offered execution
method that is necessary to reconstruct
all trading on its facility, detect and
investigate customer and market abuses,
and take disciplinary action as noted
above. The Commission also believes
that SEFs must capture such a data set
to be able to detect, investigate and
enforce its rules under Core Principle 2,
to reconstruct all trading under Core
Principle 4, and to comply with the
audit trail reconstruction program under
proposed 37.205(c), as described below.
Third, the Commission proposes to
eliminate the requirement that a SEF
capture post-execution allocation
information in its audit trail data.
During the SEF registration process,
numerous SEFs indicated that post472 The
Commission proposes to eliminate the
introductory sentence under § 37.205, which states
that a SEF shall establish procedures to capture and
retain information that may be used in establishing
whether rule violations have occurred, given that
this language is duplicative of the audit trail
requirements under § 37.205(a).
473 The Commission proposes to add this
guidance to paragraph (a)(4) to Core Principle 2 in
Appendix B. As discussed below, the Commission
proposes to eliminate the existing language in
paragraph (a)(4), see infra Section VII.E.2.—
§ 37.206(b)—Disciplinary Program.
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62005
execution allocations normally occur
between the clearing firm or the
customer and the DCO, or at the
middleware provider.474 Therefore,
these SEFs represented that they
typically do not have access to postexecution allocation information, and
are unable to obtain such data from
third parties, such as DCOs and SDRs,
due to confidentiality concerns. Based
on these representations, Commission
staff has issued continuing no-action
relief to SEFs from this requirement.475
Based on its experience, the
Commission understands that SEFs are
still routinely unable to obtain this
information pursuant to the
requirements of §§ 37.205(a) and
(b)(2).476 Accordingly, in lieu of
requiring that the audit trail track a
customer order through ‘‘fill, allocation,
or other disposition,’’ the Commission
proposes to require SEFs to capture the
audit trail data only through execution
on the SEF. The Commission
understands that this proposed change
is consistent with current swap market
practices.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.205(a). In
particular, the Commission requests
comment on the following questions:
(59) Is the scope of the proposed audit
trail requirements sufficiently clear? If
not, then please explain. Is the scope
overly broad or narrow to enable a SEF
to comply with its obligations under the
Act? If so, please explain. Would a
SEF’s audit trail obligations be impacted
by the Commission’s proposed approach
to pre-execution communications? If so,
then how?
(60) What challenges, if any, do SEFs
encounter in capturing or retaining
audit trail data?
(61) Are there any specific audit trail
data points that are too costly or
burdensome for a SEF to capture or
maintain?
(62) Is the proposed guidance to this
section appropriate? Are SEFs currently
capturing all indications of interest,
requests for quotes, orders, and trades?
Is the meaning of ‘‘indications of
474 CFTC Letter No. 17–54, Re: No-Action Relief
for Swap Execution Facilities from Certain Audit
Trail Requirements in Commission Regulation
37.205 Related to Post-Execution Allocation
Information at 2 (Oct. 31, 2017).
475 Id.
476 The Commission notes that § 37.205(b)(2) also
requires a SEF’s audit trail to include an electronic
transaction history database that captures, among
other elements, the identity of each account to
which fills are allocated. 17 CFR 37.205(b)(2). As
discussed below, the Commission proposes to
eliminate this requirement. See infra note 484 and
accompanying discussion.
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interest’’ sufficiently clear? If not, please
provide suggestions on how to clarify
this term. Should a SEF be required to
capture all indications of interest and
requests for quotes to enable it to
comply with its obligations under the
Act? Are there other data points that
should be added to the guidance?
2. § 37.205(b)—Elements of an
Acceptable Audit Trail Program
Section 37.205(b) requires, among
other things, that SEFs retain all original
source documents; maintain a
transaction history database; conduct
electronic analysis; and safely store all
audit trail data.477 Section 37.205(b)(1)
requires that a SEF’s audit trail include
original source documents and specifies
the nature and content of such
documents.478 Section 37.205(b)(2)
requires a SEF’s audit trail program to
include an electronic transaction history
database and specifies the required
elements of an adequate database.479
Section 37.205(b)(3) requires a SEF’s
audit trail program to include electronic
analysis capability with respect to all
audit trail data in the transaction history
database.480 Section 37.205(b)(4)
requires a SEF’s audit trail program to
safely store all audit trail data retained
in the transaction history database.481
a. § 37.205(b)(1)—Original Source
Documents; § 37.205(b)(2)—Transaction
History Database; § 37.205(b)(3)—
Electronic Analysis Capability
The Commission proposes to
eliminate certain elements of the
original source documents requirement
under § 37.205(b)(1) that specify the
nature and content of the original source
documents,482 as such requirements
may not capture the appropriate
universe of content. The Commission
also believes that the detailed
requirements are not necessary; as
discussed above, the general
requirement that a SEF must capture all
audit trail data necessary to reconstruct
all trading on its facility, detect and
investigate customer and market abuses,
and take disciplinary action is sufficient
to guide a SEF as to the content of its
477 17
CFR 37.205(b).
CFR 37.205(b)(1).
479 17 CFR 37.205(b)(2).
480 17 CFR 37.205(b)(3).
481 17 CFR 37.205(b)(4).
482 Section 37.205(b)(1) requires, among other
things, that records for customer orders (whether
filled, unfilled, or cancelled, each of which shall be
retained or electronically captured) shall reflect the
terms of the order, an account identifier that relates
back to the account(s) owner(s), the time of order
entry, and the time of trade execution. A SEF must
also require that all orders, indications of interest,
and requests for quotes be immediately captured in
the audit trail. 17 CFR 37.205(b)(1).
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original source documents, which
would be based on the SEF’s execution
methods, trading operations, and
markets. Section 37.205(b)(1), however,
would maintain that the SEF’s audit
trail must include original source
documents, including unalterable,
sequentially-identified records on
which trade execution information is
originally recorded, whether recorded
manually or electronically.
The Commission further proposes to
amend § 37.205(b)(2) to revise the scope
of audit trail data that must be captured
in a SEF’s electronic transaction history
database. Specifically, the Commission
proposes to eliminate the requirement
that the database include all indications
of interest, requests for quotes, orders,
and trades entered into a SEF’s trading
system or platform. Instead, the SEFs
would be required to include (i) trades
executed by voice or by entry into a
SEF’s electronic trading system or
platform; and (ii) orders that are entered
into its electronic trading system or
platform. Similar to proposed
§ 37.203(d), this proposed amendment
recognizes that a SEF may not have a
cost-effective and efficient method for
inputting orders submitted by voice or
certain other electronic
communications, such as instant
messaging and email, into an electronic
transaction history database, given that
they are not in the same format as orders
and trades that are entered into a SEF’s
electronic trading system or platform.483
As noted above, the Commission
emphasizes that a SEF must continue to
keep a record of all orders entered by
voice (i.e., oral communications) or
certain other electronic
communications, such as instant
messaging and email. Such a record,
however, would not need to be included
in the SEF’s electronic transaction
history database given the formatting
challenges.
The Commission additionally
proposes to eliminate the remaining
requirements of § 37.205(b)(2) that detail
the information that must be included
in transaction history database, given
that these requirements are already
captured in other audit trail
requirements or do not comport with
existing swaps market practices.484
Consistent with the proposed
amendments to § 37.205(b)(2), the
Commission further proposes to amend
§ 37.205(b)(3) to clarify that a SEF’s
electronic analysis capability must
enable the SEF to reconstruct ‘‘any trade
executed by voice or by entry into a
swap execution facility’s electronic
trading system or platform and any
order entered into its electronic trading
system or platform’’ rather than
‘‘indications of interest, requests for
quotes, orders, and trades.’’
These proposed amendments are
consistent with feedback received
regarding the audit trail requirements
during the SEF registration process.
Some SEFs that offer voice-based
trading systems or platforms stated that
they do not have the requisite
technology to conduct an electronic
analysis of audit trail data that is not
entered into a SEF’s electronic trading
system or platform, such as oral
communications, electronic instant
messages, and emails. The Commission
understands that during that time, such
technology, if available, would have
been costly for SEFs to adopt and would
not have been fully capable of digitizing
oral communications in a sufficiently
accurate manner to conduct effective
surveillance.
While the Commission is aware that
promising technologies are developing
in this area, it does not believe that a
viable, cost-effective automated
technology solution currently exists.
Currently, SEFs that offer any form of
voice-based trading system or platform
are required, as a condition to their
registration, to establish voice audit trail
surveillance programs to ensure that
they can reconstruct a sample of voice
trades and review such trades for
possible trading violations. The
proposed amendments to
§§ 37.205(b)(2)–(3) would relieve a SEF
from establishing or maintaining such a
program, but the proposed audit trail
reconstruction requirement under
§ 37.205(c), as discussed below, would
apply instead. Nonetheless, a SEF must
continue to conduct electronic analysis,
using an automated trade surveillance
system that meets the requirements of
proposed § 37.203(d).
483 See supra Section VII.B.4.—§ 37.203(d)—
Automated Trade Surveillance System.
484 For example, customer type indicator code
(‘‘CTI’’) is used in futures trading to designate the
capacity in which the person was executing a
trade—for the person’s own account; for a
proprietary account; on behalf of another member;
or for a customer. Many DCM-based automated
trade surveillance systems are programmed to
detect aberrations in CTI code usage that may
indicate potential rule violations. The Commission
understands, however, that a SEF’s automated trade
surveillance system does not use CTI codes to
detect potential rule violations. Therefore, the
Commission proposes to eliminate this
requirement. Further, as discussed above, since
SEFs cannot routinely obtain post-execution
allocation information, it is not possible to identify
‘‘each account to which fills are allocated.’’ See
supra note 476 and accompanying discussion.
Therefore, the proposed amendment to
§ 37.205(b)(2) would also eliminate the requirement
to include post-execution allocation information in
a SEF’s transaction history database.
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The Commission further proposes to
eliminate the safe storage requirement
under § 37.205(b)(4), given that it is
generally duplicative of the
requirements under Core Principle 14
and related regulations.485 As discussed
below, however, the Commission
proposes a non-substantive amendment
to move the requirement that a SEF
must protect audit trail data from
unauthorized alteration, accidental
erasure, or other loss to § 37.1401(c),
which addresses system safeguard
requirements.486
Request for Comment
The Commission requests comment
on all aspects of proposed
§§ 37.205(b)(1)–(3).
3. § 37.205(c)—Audit Trail
Reconstruction 487
Section 37.205(c) generally requires a
SEF to enforce its audit trail and
recordkeeping requirements.488 Section
37.205(c)(1) requires enforcement
through annual reviews and prescribes
the minimum components that must be
included in such reviews.489 Section
37.205(c)(2) requires that a SEF
establish an enforcement program and
to impose meaningful sanctions against
persons and firms where deficiencies
are found.490
The Commission proposes to
eliminate the existing audit trail
enforcement requirements under
§ 37.205(c) and adopt an audit trail
reconstruction requirement instead.491
The Commission believes that the
primary goal of audit trail enforcement
is to ensure that a SEF’s audit trail
enables it to reconstruct trading and
conduct effective surveillance to fulfill
its Core Principle 2 obligations. To that
end, audit trail enforcement focuses on
reviewing certain components of the
485 7
U.S.C. 7b–3(f)(14); 17 CFR 37.1401.
infra Section XIX.A.—§ 37.1401(c).
487 The Commission proposes to retitle § 37.205(c)
to ‘‘Audit trail reconstruction’’ from ‘‘Enforcement
of audit trail requirements’’ based on the proposed
changes described below.
488 17 CFR 37.205(c).
489 17 CFR 37.205(c)(1).
490 17 CFR 37.205(c)(2). The Commission notes
that § 37.205(c)(2) also imposes a warning letter
requirement for audit trail violations. As discussed
below, the Commission proposes to streamline and
consolidate this provision into proposed
§ 37.206(c)(2). See infra Section VII.E.6.—
§ 37.206(f)—Warning Letters.
491 Notwithstanding these proposed changes, the
Commission notes that to comply with the general
audit trail requirement under proposed § 37.205(a),
which requires a SEF to capture all audit trail data
related to each offered execution method that is
necessary to reconstruct all trading on its facility,
detect and investigate customer and market abuses,
and take disciplinary action, the SEF must ensure
that market participants are submitting accurate and
complete audit trail data.
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486 See
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audit trail data to ensure that a SEF’s
audit trail data is complete and
accurate. Existing audit trail reviews
include a (1) review of randomly
selected samples of front-end audit trail
data; (2) review of the process by which
user identifications are assigned and
records relating to user identifications
are maintained; (3) review of the usage
patterns of user identifications to
identify violations of user identification
rules; and (4) review of account
numbers and CTI codes for accuracy
and proper use. The Commission
understands that these reviews focus on
components of the audit trail that are
generally not relevant to SEFs. For
example, SEFs have represented that
there is little, if any, ‘‘front-end audit
trail data’’ that is not already captured
by the SEF, and that many of the data
points for review, such as user
identifications, account numbers, and
CTI codes, are not used in the same
manner as they are for DCMs. Therefore,
the Commission believes that requiring
SEFs to conduct an audit trail
enforcement program based on the
requirements of existing § 37.205(c)
serves a limited purpose.
The Commission believes that
ensuring a SEF’s audit trail is accurate
and sufficient to conduct effective
surveillance—the primary goals of audit
trail enforcement—would be better
served through an audit trail
reconstruction program that focuses on
verifying the accuracy of audit trail data
and a SEF’s ability to comprehensively
and accurately reconstruct all trading on
its facility in a timely manner. As
discussed above, the Commission is
aware that SEFs that offer any form of
a voice-based trading system or platform
do not currently have cost-effective
solutions for consolidating certain types
of data, such as oral communications,
electronic instant messages, and emails,
inputting them into an electronic
transaction history database, and
loading and processing them into an
automated system to reconstruct
trading. Given that the ability to
reconstruct all trading is an essential
component to conducting effective
surveillance and is currently not being
conducted in a routine, automated
manner for certain key data, the
Commission proposes to require that a
SEF establish a program to verify its
ability to comprehensively and
accurately reconstruct all trading on its
facility in a timely manner. The
Commission also proposes to adopt
guidance to Core Principle 2 in
Appendix B specifying that an effective
audit trail reconstruction program
should annually review an adequate
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sample of executed and unexecuted
orders and trades from each execution
method offered to verify compliance
with § 37.205(c).492
Since SEFs that offer only electronic
trading systems or platforms can use
their automated trade surveillance
systems to reconstruct trading, the
reconstructions under proposed
§ 37.205(c) would serve to verify the
accuracy of their audit trail data. A SEF
that offers any form of voice-based
trading could comply with proposed
§ 37.205(c) by conducting manual
reconstructions, including orders
entered by oral communications, instant
messages, and email, and trades
executed by voice that are captured by
the SEF’s electronic transaction history
database. In addition to verifying the
accuracy of the audit trail data for SEFs
that offer electronic trading systems or
platforms, these reconstructions would
help ensure that in the absence of such
an automated solution, a SEF that offers
voice-based trading is able to
reconstruct trading as necessary,
including when they are investigating
problematic trading activity.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.205(c)
and the associated guidance to Core
Principle 2 in Appendix B. In particular,
the Commission requests comment on
the following questions:
(63) What factors should a SEF
consider in selecting an adequate
sample of orders and trades for
reconstruction?
(64) Should SEFs be required to
annually reconstruct a minimum
number or orders and trades? If so, what
is the minimum number?
(65) Should SEFs be required to
conduct annual audit trail reviews of
their members and firms that are subject
to recordkeeping requirements? If so,
what should these reviews include?
E. § 37.206—Disciplinary Procedures
and Sanctions
Section 37.206 generally requires a
SEF to establish rules that deter abuses
and have the capacity to enforce those
rules though prompt and effective
disciplinary action. The disciplinary
rules that implement this requirement
require a SEF to maintain sufficient
enforcement staff, establish disciplinary
panels, follow certain disciplinary
492 The Commission proposes to add this
guidance to paragraph (a)(5) to Core Principle 2 in
Appendix B. 17 CFR part 37 app. B. As discussed
below, the Commission proposes to eliminate the
existing language in paragraph (a)(5). See infra
Section VII.E.2.—–§ 37.206(b)—Disciplinary
Program.
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procedures that afford respondents
procedural safeguards, and impose
sanctions that are commensurate to the
violations committed.493 The rules
prescribe the use of various sanctions,
including suspension or expulsion of
members or market participants;
customer restitution; and issuance of
warning letters.494
Since the adoption of § 37.206, the
Commission has considered whether
alternative cost-effective methods exist
for complying with Core Principle 2’s
requirement to establish and enforce
trading, trade processing, and
participation rules that deter abuses,
and have the capacity to investigate and
enforce such abuses.495 Based on its
experience with the part 37
implementation, the Commission
believes that alternative disciplinary
methods exist that would ensure that
SEFs maintain robust disciplinary
structures necessary to enforce
compliance with their rules and deter
abusive trading to promote market
integrity. The Commission
acknowledges that § 37.206 is a limited
approach that is based in many respects
on its experience with oversight of DCM
disciplinary programs.496 While the
Commission believes that all SEFs
should be subject to certain threshold
requirements, it also believes that SEFs
should be able to use their experience
and knowledge to establish disciplinary
procedures that are appropriate for their
own markets and market participants.
The Commission notes that this
approach is consistent with the
reasonable discretion afforded to SEFs
under Core Principle 1.497 Therefore,
the Commission proposes to streamline
the SEF disciplinary program rules,
discussed further below.498
1. § 37.206(a)—Enforcement Staff
Section 37.206(a) requires a SEF to
establish and maintain sufficient
enforcement staff and resources to
effectively and promptly prosecute
493 17
CFR 37.206(a)–(f).
CFR 37.206(e)–(f).
495 7 U.S.C. 7b–3(f)(2)(B).
496 See SEF Core Principles Final Rule at 33520–
21 (noting that the disciplinary procedures in the
part 37 proposed rules paralleled the procedures for
DCMs).
497 7 U.S.C. 7b–3(f)(1)(B).
498 The Commission proposes to eliminate the
introductory sentence under § 37.206, which states
that a SEF shall establish trading, trade processing,
and participation rules that will deter abuses and
have the capacity to enforce such rules through
prompt and effective disciplinary action, including
suspension or expulsion of members or market
participants who violate the rules of the swap
execution facility, given that this language is
duplicative of requirements elsewhere in this part,
including Core Principle 2 and various provisions
under § 37.206.
possible rule violations within the
disciplinary jurisdiction of the SEF.499
The Commission proposes to change
the word ‘‘prosecute’’ to ‘‘enforce’’ to
more accurately describe the
requirements under § 37.206(a), given
that every rule violation may not lead to
a prosecution.
The Commission also proposes to
amend the guidance to Core Principle 2
in Appendix B that addresses a SEF’s
enforcement staff.500 The Commission
proposes eliminating the language
stating that a SEF’s enforcement staff
may operate as part of the SEF’s
compliance staff. The Commission no
longer believes this language is
necessary, given that SEFs should have
the option to determine the appropriate
structure for their disciplinary
programs, including their enforcement
staff, discussed further below with
respect to § 37.206(b).
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.206(a)
and the associated guidance to Core
Principle 2 in Appendix B.
2. § 37.206(b)—Disciplinary Program 501
Section 37.206(b) currently requires
SEFs to establish one or more
disciplinary panels that meet the
composition requirements of part 40
and do not include a SEF’s compliance
staff or any person involved in
adjudicating any other stage of the same
proceeding.502
The Commission proposes to amend
§ 37.206(b) to permit a SEF to
administer its disciplinary program
through not only one or more
disciplinary panels, as currently
allowed, but also through its
compliance staff. As discussed above,
this amendment provides SEFs with the
ability to adopt a cost-effective
disciplinary structure that best suits
their markets and market participants,
while still effectuating the requirements
and protections of Core Principle 2
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494 17
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499 17
CFR 37.206(a).
Commission proposes to renumber
paragraph (a)(3) to paragraph (a)(6) of the guidance
to Core Principle 2 in Appendix B and adopt the
amendments described above. 17 CFR part 37 app.
B.
501 The Commission proposes to retitle
§ 37.206(b) to ‘‘Disciplinary program’’ from
‘‘Disciplinary panels’’ based on the proposed
changes described below.
502 17 CFR 37.206(b). The Commission proposed
composition requirements for disciplinary panels,
but has not adopted those requirements in a final
rule. Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and
Swap Execution Facilities Regarding the Mitigation
of Conflicts of Interest, 75 FR 63732, 63752 (Oct.
18, 2010).
500 The
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through compliance staff, disciplinary
panels, or some combination of both.503
The Commission also proposes other
amendments to § 37.206(b), including
non-substantive revisions, to streamline
certain existing composition
requirements for disciplinary panels.504
For SEFs that elect to administer their
disciplinary program though
compliance staff, the Commission
proposes to amend § 37.206(b) to
exclude compliance staff from the
requirements under § 1.64(c)(4). Section
1.64, among other things, prescribes
rules that govern the composition of an
SRO’s major disciplinary committee.505
The Commission recognizes that a SEF’s
compliance staff could qualify as a
‘‘[m]ajor disciplinary committee’’ 506
under § 1.64(a)(2) when imposing
sanctions under the proposed rule;
therefore, the staff would otherwise be
subject to the composition requirement
of § 1.64(c)(4), which requires
‘‘sufficient different membership
503 While the participation of SEF compliance
staff could present a possible conflict of interest, the
Commission believes that this concern is
adequately addressed through the SEF’s CCO.
Under proposed § 37.1501(c)(2), a CCO would be
required to take reasonable steps to resolve any
material conflicts of interest. See infra Section
XX.A.3.—§ 37.1501(c)—Duties of Chief Compliance
Officer. Further, a CCO would be required to
conduct an annual assessment of the SEF’s policies
on the handling of conflicts of interest. See infra
Section XX.A.4.—§ 37.1501(d)—Preparation of
Annual Compliance Report. The Commission also
notes that the SEF’s disciplinary practices are
within the scope of the Commission’s examinations.
504 The Commission proposes to amend the panel
composition language by replacing the reference to
part 40 with ‘‘applicable Commission regulations.’’
Additionally, paragraph (a)(11)(ii) of the guidance
to Core Principle 2 in Appendix B currently
specifies that the composition of the appellate
panels should be consistent with part 40 and
should not include any members of the SEF’s
compliance staff or any person involved in
adjudicating any other stage of the same
proceeding. 17 CFR part 37 app. B. To avoid
duplicative language, the Commission proposes to
consolidate these provisions under § 37.206(b) to
require that any disciplinary panel or appellate
panel established by a SEF must meet the
composition requirements of applicable
Commission regulations, and shall not include any
member of the SEF’s compliance staff or any person
involved in adjudicating any other stage of the same
proceeding (emphasis added). The Commission also
proposes to eliminate paragraph (a)(11) of the
guidance to Core Principle 2 in Appendix B as
noted below. 17 CFR part 37 app. B.
505 17 CFR 1.64.
506 Section 1.64(a)(2) defines ‘‘major disciplinary
committee’’ as a committee of persons authorized
by a self-regulatory organization to conduct
disciplinary hearings, settle disciplinary charges, or
impose disciplinary sanctions. Such a committee
may also hear appeals of cases involving any
violation of a SRO’s rules, except for rules related
to decorum or attire; financial requirements;
reporting or recordkeeping; and violations that do
not involve fraud, deceit or conversion. 17 CFR
1.64(a)(2). Under § 37.2, SEFs are subject to all
applicable Commission regulations, including
§ 1.64.
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interests.’’ 507 Accordingly, the
Commission believes these amendments
are necessary to effectuate the proposed
rule of allowing compliance staff to
administer a SEF’s disciplinary
program.
Consistent with the Commission’s
intention to streamline requirements
while still effectuating the Core
Principle 2 requirements, the
Commission proposes to eliminate the
guidance to Core Principle 2 in
Appendix B that specifies protocols for
the SEF to handle charges and
settlement offers.508 Given that
proposed § 37.206(b) would permit SEFs
to administer their disciplinary program
through compliance staff, the
Commission does not believe that this
detailed guidance is necessary. Instead,
the Commission proposes new guidance
to specify that a SEF’s rules governing
the adjudication of a matter by the SEF’s
disciplinary panel should be fair,
equitable, and publicly available.509
Request for Comment
3. § 37.206(c)—Hearings
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Section 37.206(c) requires a SEF to
adopt rules that provide certain
minimum procedural safeguards for any
hearing. In general, the rule requires a
fair hearing, promptly convened after
reasonable notice to the respondent; and
a copy of the hearing to be made and be
a part of the record of the proceeding if
the respondent requested the hearing.510
The Commission proposes to
eliminate § 37.206(c). First, the detailed
hearing procedures under existing
§ 37.206(c) are not necessary, as SEFs
that choose to establish a disciplinary
panel have reasonable discretion to do
so pursuant to Core Principle 1.511
Second, the Commission notes that
requirements for hearings under
§ 37.206(c) would not apply to SEFs that
choose to administer their disciplinary
program through compliance staff.
Third, as noted above, the Commission
507 Section 1.64(c)(4) requires that each major
disciplinary committee, or hearing panel thereof,
include sufficient different membership interests so
as to ensure fairness and prevent special treatment
or preference for any person in the conduct of a
committee’s or panel’s responsibilities. 17 CFR
1.64(c)(4).
508 The Commission proposes to eliminate
paragraphs (a)(4)–(9) of the guidance to Core
Principle 2 in Appendix B. 17 CFR part 37 app. B.
509 The Commission proposes to add this
guidance as paragraph (a)(7) to Core Principle 2 in
Appendix B. 17 CFR part 37 app. B.
510 17 CFR 37.206(c).
511 7 U.S.C. 7b–3(f)(1)(B).
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Request for Comment
The Commission requests comment
on all aspects of the proposed
elimination of § 37.206(c) and the
associated guidance to Core Principle 2
in Appendix B.
4. § 37.206(d)—Decisions
The Commission requests comment
on all aspects of proposed § 37.206(b)
and the associated guidance to Core
Principle 2 in Appendix B.
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proposes to add guidance to Core
Principle 2 in Appendix B that a SEF’s
rules relating to disciplinary panel
procedures should be fair, equitable,
and publicly available.512 The
Commission believes this guidance
adequately captures the principal
procedural objectives when SEFs are
conducting disciplinary hearings and
obviates the need for the otherwise
prescriptive regulatory requirements.
Consistent with the Commission’s
elimination of § 37.206(c), the
Commission also proposes to eliminate
the guidance to Core Principle 2 in
Appendix B that specifies detailed
guidelines for disciplinary hearing
protocols.513
Section 37.206(d) requires a
disciplinary panel to render a written
decision promptly following a
hearing.514 The rule also provides
detailed items to be included in the
decision, such as a notice or summary
of charges, the answer, and a statement
of finding and conclusions with respect
to each charge.515
The Commission proposes to
eliminate the prescriptive requirements
under § 37.206(d). This proposed
elimination is consistent with other
proposed amendments to § 37.206 that
would allow a SEF to exercise
discretion in establishing its
disciplinary procedures pursuant to
Core Principle 2. The Commission,
however, also proposes to add guidance
to Core Principle 2 in Appendix B to
specify that a SEF’s rules should require
the disciplinary panel to promptly issue
a written decision following a hearing or
the acceptance of a settlement offer.516
Consistent with the Commission’s
elimination of the requirements under
§ 37.206(d), the Commission also
proposes to eliminate the guidance to
Core Principle 2 in Appendix B that
specifies guidelines for a SEF’s ability to
512 See
supra note 509.
Commission proposes to eliminate
paragraph (a)(10) of the guidance to Core Principle
2 in Appendix B. 17 CFR part 37 app. B.
514 17 CFR 37.206(d).
515 Id.
516 The Commission proposes to add this
guidance as part of paragraph (a)(7) to Core
Principle 2 in Appendix B. 17 CFR part 37 app. B.
513 The
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62009
provide rights of appeal to respondents
and issue a final decision.517
Request for Comment
The Commission requests comment
on all aspects of the proposed
elimination of § 37.206(d) and the
associated guidance to Core Principle 2
in Appendix B.
5. § 37.206(e)—Disciplinary Sanctions
Existing § 37.206(e) requires that all
disciplinary sanctions imposed by a SEF
must be commensurate with the
violations committed and must be
clearly sufficient to deter recidivism or
similar violations by other market
participants.518 A SEF is also required
to consider a respondent’s disciplinary
history when evaluating appropriate
sanctions.519 In the event of
demonstrated customer harm, any
disciplinary sanction must include full
customer restitution, except where the
amount of restitution, or to whom it
should be provided, cannot be
reasonably determined.520
The Commission proposes to
consolidate the requirements that apply
to disciplinary sanctions and warning
letters, under existing § 37.206(e) and
existing § 37.206(f),521 respectively, into
a new proposed § 37.206(c).522
Consistent with the Commission’s goal
to provide SEFs with a greater ability to
develop cost-effective approaches to
administer their disciplinary programs
based on their markets and market
participants, the Commission believes
that a SEF should have greater
discretion to choose between taking
disciplinary action or issuing a warning
letter. Accordingly, as discussed below,
the Commission proposes under
§ 37.206(c)(2) to expand the current use
of warning letters by allowing a SEF to
issue more than one warning letter over
a rolling twelve-month period for
violations that involve minor
recordkeeping or reporting infractions.
To balance the expanded authority to
issue warning letters and ensure their
proper use by SEFs, the Commission
also proposes under § 37.206(c)(1) to
extend the existing criteria for issuing
disciplinary sanctions to warning
letters. Specifically, proposed
517 The Commission proposes to eliminate
paragraphs (a)(11)–(12) of the guidance to Core
Principle 2 in Appendix B. 17 CFR part 37 app. B.
518 17 CFR 37.206(e).
519 Id.
520 Id.
521 Existing § 37.206(f) states that where a rule
violation is found to have occurred, no more than
one warning letter may be issued per rolling twelvemonth period for the same violation.
522 The Commission proposes to retitle § 37.206(c)
to ‘‘Warning letters and sanctions’’ from ‘‘Hearings’’
based on the proposed changes described below.
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§ 37.206(c)(1) would require that all
warning letters and sanctions imposed
by a SEF must be commensurate with
the violations committed and shall be
clearly sufficient to deter recidivism or
similar violations by other market
participants. Further, all warning letters
and sanctions, including summary fines
and sanctions imposed pursuant to an
accepted settlement offer, must take into
account the respondent’s disciplinary
history.523
The Commission also proposes
several amendments to related guidance
to Core Principle 2 in Appendix B that
are consistent with the proposed
changes and are intended to allow a SEF
to determine how to issue warning
letters and sanctions. First, the
Commission proposes to adopt guidance
to Core Principle 2 in Appendix B to
state that SEFs should have reasonable
discretion in determining when to issue
warning letters and apply sanctions.524
Second, the Commission also proposes
to eliminate detailed guidance regarding
the procedures for taking emergency
disciplinary action. The guidance,
however, would maintain that a SEF
may impose a sanction or take summary
action as necessary to protect the best
interest of the marketplace.525
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.206(c)(1)
and the associated guidance to Core
Principle 2 in Appendix B. In particular,
the Commission requests comment on
the following question:
(66) Should the Commission provide
further explanation regarding the
meaning of ‘‘minor’’ recordkeeping or
reporting infractions?
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6. § 37.206(f)—Warning Letters
Existing § 37.206(f) states that where a
rule violation is found to have occurred,
no more than one warning letter may be
issued per rolling twelve-month period
for the same violation.526
As part of a new proposed
§ 37.206(c)(2) noted above, the
Commission proposes to amend this
provision to establish a more practical
approach to the use of warning letters.
Under the proposed approach, a SEF
would be allowed to issue more than
523 The Commission proposes to add the term
‘‘summary fine’’ to clarify that summary fines are
among the types of disciplinary sanctions that may
be issued and would be subject to the requirements
of the proposed rule.
524 The Commission proposes to add this
guidance as paragraph (a)(9) to Core Principle 2 in
Appendix B. 17 CFR part 37 app. B.
525 The Commission proposes to renumber
paragraph (a)(14) to paragraph (a)(8) to Core
Principle 2 in Appendix B. 17 CFR part 37 app. B.
526 17 CFR 37.206(f).
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one warning letter over a rolling twelvemonth period for violations that involve
minor recordkeeping or reporting
infractions. Given the de minimis nature
of such infractions, the Commission
believes that a SEF should have the
ability to determine whether they merit
the issuance of a warning letter or
sanction. The Commission also
proposes to clarify that the twelvemonth limitation on warning letters
applies to the same individual who is
found to have committed the same rule
violation, rather than an entity. The
Commission acknowledges that
applying the limitation to subject
entities is not practical because many of
them have hundreds of employees
trading on behalf of the entity.527
Further, the Commission notes that the
rolling twelve-month period begins
tolling once the SEF finds that a
violation occurred, rather than the date
that the subject activity occurred.
The Commission also proposes to
eliminate guidance to Core Principle 2
in Appendix B that currently specifies
that a SEF may adopt summary fines for
violations of rules related to the failure
to timely submit accurate records
required for clearing or verifying each
day’s transactions.528 The Commission
notes that § 37.206(c)(1) as proposed
would already specify that a SEF may
issue summary fines as a sanction.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.206(c)(2)
and the associated guidance to Core
Principle 2 in Appendix B. In particular,
the Commission requests comment on
the following question:
(67) Is the Commission’s approach to
warning letters appropriate? Should the
Commission allow SEFs to issue more
than one warning letter to the same
individual within a rolling twelvemonth period for other rule violations in
addition to minor recordkeeping or
reporting infractions? If so, should the
Commission specify which rule
violations? If so, identify those rule
violations and explain why.
7. § 37.206(g)—Additional Sources for
Compliance
The Commission is not proposing any
amendments to § 37.206(g).529
527 The Commission notes, however, that this
provision would be evaluated in conjunction
proposed § 37.206(c)(1).
528 The Commission proposes to eliminate
paragraph (a)(13) of the guidance to Core Principle
2 in Appendix B. 17 CFR part 37 app. B.
529 The Commission proposes to renumber
§ 37.206(g) to § 37.206(d) based on the proposed
changes described above.
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F. Part 9—Rules Relating to Review of
Exchange Disciplinary, Access Denial or
Other Adverse Actions
Part 9 of the Commission’s regulations
details the process and procedures for
the Commission’s review of exchange
disciplinary, access denial, or other
adverse actions.530 The rules also
address the procedures and standards
governing filing and service, motions,
and settlement; the process that
exchanges must follow in providing
notice of a final disciplinary action to
the subject of the action and to the
Commission; and the publication of
such notice.531
The Commission is proposing several
non-substantive amendments to part 9
that correspond to certain proposed
amendments to the Core Principle 2
regulations under part 37.532 As
discussed above, the Commission
proposes to eliminate various
disciplinary procedures under proposed
§ 37.206 and the applicable guidance to
Core Principle 2 in Appendix B to part
37 to streamline existing Core Principle
2 requirements and provide SEFs with
discretion in administering their
disciplinary programs.533 These
proposed changes include eliminating
requirements concerning disciplinary
decisions under § 37.206(d) and
eliminating various procedures detailed
in guidance to Core Principle 2
concerning settlement offers; 534
sanctions upon persons who impede the
progress of disciplinary hearings; 535 the
right to appeal adverse actions; 536 and
summary fines for violations of rules
regarding the timely submission of
records.537 To the extent that the part 9
regulations contain cross-references to
these part 37 provisions, the
Commission proposes to eliminate those
references.538
Specifically, the Commission
proposes to eliminate those references
under § 9.11(b)(2), which govern the
content requirements for SEF
530 17 CFR part 9. For these purposes, the
Commission interprets references to ‘‘exchange’’ to
part 9 to mean DCMs and SEFs.
531 Id.
532 The Commission also proposes to renumber
§ 9.1(b)(4) to § 9.1(c) and § 9.1(c) to § 9.1(d).
533 See supra Section VII.E.—§ 37.206—
Disciplinary Procedures and Sanctions.
534 See supra note 508 (elimination of paragraph
(a)(9)).
535 See supra note 513 (elimination of paragraph
(a)(10)(vi)).
536 See supra note 517 (elimination of in
paragraph (a)(11)(iv)).
537 See supra note 528 (elimination of paragraph
(a)(13)).
538 The Commission also proposes to renumber
the cross-references under § 9.2(k), § 9.12(a)(1), and
§ 9.24(a)(2) from paragraph (a)(14) to paragraph
(a)(8) of the guidance to Core Principle 2 in
Appendix B. See supra note 525.
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disciplinary and access denial notices
that must be filed with the person
subject to the action. Currently, the
notice of such actions must be provided
as a copy of a written decision, which
accords with § 37.206(d) and guidance
to Core Principle 2 in Appendix B
relating to the use of written decisions
where a disciplinary panel accepts a
settlement offer; 539 and paragraph
(a)(11)(iv), where an appellate panel
responds to appeals of adverse decisions
by a disciplinary panel.540
Alternatively, § 9.11(b)(2) provides that
SEFs may file a written notice that
includes the items listed under
§§ 9.11(b)(3)(i)–(vi).541 Given the
proposed elimination of § 37.206(d) and
associated guidance to Core Principle 2,
the Commission proposes that the
contents of the SEF disciplinary or
access denial notice be limited to the
information specified under
§§ 9.11(b)(3)(i)–(vi).
Under § 9.1(b)(2), § 9.2(k), and
§ 9.12(a)(3), the Commission also
proposes to eliminate references to
paragraph (a)(13) of the guidance to
Core Principle 2 in Appendix B, which
addresses the issuance of summary fines
for failing to submit certain records in
a timely manner. To replace those
references, the Commission proposes to
add new regulatory language that
accounts for summary fines being
permitted under the rules of the SEF for
recordkeeping or reporting violations.
Under § 9.2(k) and § 9.12(a)(2), the
Commission further proposes to
539 17 CFR part 37 app. B (guidance to Core
Principle 2—paragraph (a)(9)(iii)—‘‘Settlement
offers’’).
540 17 CFR part 37 app. B (guidance to Core
Principle 2—paragraph (a)(11)(iv)—‘‘Right to
appeal’’).
541 Section 9.11(b)(3) requires that the notice of a
disciplinary action or access denial action include
the following: (i) The name of the person against
whom the disciplinary action or access denial
action was taken; (ii) a statement of the reasons for
the disciplinary action or access denial action,
detailing the exchange product which was
involved, as applicable, and whether the violation
that resulted in the action also resulted in financial
harm to any customers together with a listing of any
rules which the person who was the subject of the
disciplinary action or access denial action was
charged with having violated or which otherwise
serve as the basis of the exchange action; (iii) a
statement of the conclusions and findings made by
the exchange with regard to each rule violation
charged or, in the event of settlement, a statement
specifying those rule violations which the exchange
has reason to believe were committed; (iv) the terms
of the disciplinary action or access denial action; (v)
the date on which the action was taken and the date
the exchange intends to make the disciplinary or
access denial action effective; and (vi) except as
otherwise provided under § 9.1(b), a statement
informing the party subject to the disciplinary
action or access denial action of the availability of
Commission review of the exchange action
pursuant to section 8c of the Act and this part. 17
CFR 9.11(b)(3).
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eliminate references to paragraph
(a)(10)(vi) of the guidance to Core
Principle 2 in Appendix B, which
addresses the use of sanctions for
persons who impede the progress of
disciplinary hearings. To replace those
references, the Commission proposes
new regulatory language that accounts
for SEFs imposing disciplinary action
on a person for impeding the progress
of a hearing under the rules of the SEF.
VIII. Part 37—Subpart D: Core
Principle 3 (Swaps Not Readily
Susceptible to Manipulation)
Core Principle 3 specifies that a SEF
shall permit trading only in swaps that
are not readily susceptible to
manipulation.542
A. § 37.301—General Requirements
Section 37.301 further implements
Core Principle 3 by requiring a SEF, at
the time that it submits a new swap
contract to the Commission, to
demonstrate that the swap is not readily
susceptible to manipulation by
providing the information required in
Appendix C to part 38.543 Section
37.301 also states that in addition to
referring to Appendix C to part 38, a
SEF may refer to the guidance to Core
Principle 3 in Appendix B.544 With
respect to swaps, this guidance is
similar in scope to the guidance to
Appendix C to part 38.
Appendix C to part 38 for DCMs, as
applied by § 37.301 to SEFs, provides
guidance regarding the relevant
considerations for evaluating if a new or
existing swap contract is readily
susceptible to manipulation.545 The
objective of this guidance, which
applies the guidance for futures
contracts to swaps as applicable, is
intended to ensure that a given contract
is not readily susceptible to
542 The Commission codified Core Principle 3
under § 37.300. 17 CFR 37.300.
543 Appendix C to part 38—‘‘Demonstration of
Compliance That a Contract Is Not Readily
Susceptible to Manipulation’’—provides guidance
regarding (i) the information that a new futures
contract submission should include; (ii) estimations
of deliverable supplies; (iii) contract terms and
conditions that should be specified for physicallydelivered contracts; (iv) demonstration that a cashsettled contract is reflective of the underlying cash
market and is not readily subject to manipulation
or distortion; (v) contract terms and conditions that
should be specified for cash-settled contracts; (vi)
requirements for options on futures contracts; (vii)
the terms and conditions for non-price based
futures contracts; and (vii) the terms and conditions
for swap contracts. 17 CFR part 38 app. C
(‘‘Appendix C to part 38’’). The Commission
amended and updated this guidance to address
swap transactions in 2012 as part of a part 38
rulemaking for designated contract markets. Core
Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612 (Jun. 19, 2012).
544 17 CFR 37.301.
545 See generally Appendix C to part 38.
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manipulation and will provide a reliable
pricing basis, as well as promote cash
and swaps price convergence. Among
other things, the guidance states that a
swap contract submitted under part 40
should conform to prevailing
commercial practices, such that the
settlement or delivery procedures
adopted for a swap contract should
reflect the underlying cash market.546
For cash-settled swap contracts, the
guidance explains that the cash
settlement index should be based on a
reliable price reference series that
accurately reflects the underlying
market value, is not readily susceptible
to manipulation, and is highly regarded
by industry/market participants.547 For
physically-settled swap contracts, the
guidance explains that the terms and
conditions should provide for adequate
deliverable supply and be designed to
avoid impediments to the delivery of
the commodity.548
1. Appendix C to Part 37—
Demonstration of Compliance That a
Swap Contract Is Not Readily
Susceptible to Manipulation
The Commission proposes to
eliminate the existing cross-reference to
Appendix C to part 38 under § 37.301
and establish a separate Appendix C to
part 37 to provide specific guidance to
SEFs for complying with the
requirements of Core Principle 3.549 In
conjunction with the Commission’s
proposal to create a separate Appendix
C to part 37, the Commission also
proposes to adopt conforming changes
to the guidance to Core Principle 3 in
Appendix B.550
546 See paragraph (g)(4) of Appendix C to part 38,
which references various provisions related to
contract terms and conditions requirements for
futures contracts.
547 See paragraph (g)(1) of Appendix C to part 38.
548 Paragraph (g)(4) of Appendix C to part 38,
which applies to swaps, refers to paragraph (b)(2),
which specifies contract term and condition
requirements for futures contracts settled by
physical delivery. Paragraph (b)(2) specifies various
criteria related to quality standards of the
underlying commodity, delivery point/area
specifications, and specification of the delivery
period. The Commission notes that paragraph (b)(1)
generally specifies that the terms and conditions
should be designed to avoid any impediments to
delivery so as to promote convergence between the
price of the futures contract and the cash market
value of the commodity at the expiration of the
contract. Paragraph (b)(1)(i)(A) specifies that the
terms and conditions should result in a deliverable
supply that is sufficient to ensure that the contract
is not susceptible to price manipulation or
distortion.
549 The Commission also proposes a conforming
non-substantive amendment to § 37.301 to update
the reference to Appendix C to part 37.
550 The proposed amendments to Appendix B
would eliminate the existing explanatory guidance
to Core Principle 3, which the Commission is
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Specifically, proposed Appendix C to
part 37 specifies (1) measures that a SEF
should take to determine that a cashsettled swap contract is reflective of the
underlying cash market, is not readily
subject to manipulation or distortion,
and is based on a cash price series that
is reliable, acceptable, publicly
available, and timely; (2) terms and
conditions that should be specified for
cash-settled swap contracts; (3) terms
and conditions that should be specified
for physically-settled swap contracts; (4)
methodologies that should be utilized in
estimating deliverable supplies; (5)
terms and conditions that should be
specified for options on swap contracts;
and (6) guidance for options on
physicals contracts.551
The Commission believes that the
proposed amendments would
streamline the guidance to Core
Principle 3 in a single appendix that is
dedicated to part 37. A separate
appendix for SEFs and swaps trading
from the guidance provided in
Appendix C to part 38, which primarily
applies to DCMs and futures trading,
reflects good regulatory practice that
provides greater clarity and certainty.
The proposed Appendix C to part 37
would serve as a streamlined source of
guidance for new and existing SEFs
when developing new swap products to
list for trading and when monitoring
their existing swap products.552 Based
on the number of swap contracts that
SEFs currently list for trading and will
likely submit in the future, the
Commission believes that a separate
guidance in part 37 is appropriate for
SEFs.
The Commission believes that the
proposed Appendix C to part 37 also
clarifies a SEF’s obligations pursuant to
Core Principle 3 because the guidance
specifically addresses swap contracts
and reflects the diverse and nonstandardized nature of the swaps
market, including swaps traded on
SEFs. In particular, the guidance
provides SEFs with additional
flexibility for certain terms and
proposing to address in the proposed Appendix C
to part 37; and replace the existing cross-reference
to sections of Appendix C to part 38 with a general
reference to Appendix C to part 37.
551 ‘‘Options on physicals’’ refers to option
contracts that do not provide for exercise into an
underlying futures contract. Upon exercise, options
on physicals can be settled via physical delivery of
the underlying commodity or by a cash payment.
See proposed Appendix C to part 37—paragraph
(d)—‘‘Guidance for options on physicals contracts.’’
552 The guidance in Appendix C to this part is
based on best practices that were developed over
the past three decades by the Commission and other
market regulators in their review of product
submissions. See Core Principles and Other
Requirements for Designated Contract Markets, 75
FR 80572, 80582 (proposed Dec. 22, 2010).
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conditions for non-standardized swap
contracts.553 This flexibility reflects the
negotiated nature of non-standardized
swap contracts. Similarly, the proposed
Appendix C includes specific guidance
for options on swap contracts. This
guidance is not currently included in
Appendix C to part 38, which focuses
primarily on futures products. This
proposed guidance, however, is
consistent with previous Commission
expectations with respect to contract
design and transparency of option
contract terms.
Request for Comment
The Commission requests comments
on all aspects of the proposed guidance
to Core Principle 3 in Appendix C to
part 37. In particular, the Commission
requests comment on the following
questions:
(68) Is the scope and content of the
proposed guidance appropriately
tailored for swap contracts? If not, then
please explain any changes.
(69) Is the additional flexibility for
certain terms and conditions for nonstandardized swap contracts
appropriate? If not, please explain why.
IX. Part 37—Subpart E: Core Principle
4 (Monitoring of Trading and Trade
Processing)
Core Principle 4 requires a SEF to
establish and enforce rules or terms and
conditions that define, or specifications
that detail, the trading procedures to be
used in entering and executing orders
traded on or through the facilities of the
SEF and procedures for trade processing
of swaps on or through the facilities of
the SEF.554 Core Principle 4 also
requires a SEF to monitor trading in
swaps to prevent manipulation, price
distortion, and disruptions of the
delivery or cash settlement process
through surveillance, compliance, and
disciplinary practices and
procedures.555 As part of its monitoring
responsibilities, a SEF must establish
methods for conducting real-time
monitoring of trading and
comprehensive and accurate trade
reconstructions.556 As described below,
§§ 37.401–408 further implement Core
553 The Commission notes that for purposes of
establishing the terms and conditions of a swap that
it lists for trading, a SEF has discretion to determine
whether the swap is standardized or nonstandardized in nature. For example, the
Commission understands that the swaps subject to
the current trade execution requirement are
generally standardized swaps. See supra notes 33–
34 (describing the characteristics of the swaps that
have been submitted as ‘‘available to trade’’).
554 7 U.S.C. 7b–3(f)(4). The Commission codified
Core Principle 4 under § 37.400. 17 CFR 37.400.
555 Id.
556 Id.
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Principle 4 by establishing requirements
that a SEF monitor trading activity on
its facility and beyond its own market
in certain circumstances.
The Commission received feedback
from SEFs during the part 37
implementation that certain Core
Principle 4 requirements are
unnecessarily broad and create
impracticable monitoring burdens upon
SEFs, especially those requiring a SEF
to monitor activity beyond its own
markets. Based on its experience, the
Commission has assessed this feedback
and proposes amendments that would
establish more practical monitoring
requirements. These amendments,
which in many cases would narrow a
SEF’s monitoring obligations to trading
activity on its own facility, allow a SEF
greater discretion to devise its own
monitoring systems and protocols to
suit the products that it offers for
trading in a manner compliant with
Core Principle 4. The Commission also
proposes several amendments to the
regulations under Core Principle 4 to
conform to the proposed Appendix C to
part 37, which sets forth guidance for
SEFs to mitigate a swap contract’s
susceptibility to manipulation when
developing new products and
monitoring existing products.557
A. § 37.401—General Requirements
Section 37.401 currently implements
Core Principle 4 by setting forth
requirements for SEFs to monitor
market activity for the purpose of
detecting manipulation, price
distortions, and disruptions.558 Existing
§ 37.401(a) creates an ongoing obligation
for a SEF to collect and evaluate data on
its market participants’ market activity
to detect and prevent, among other
things, disruptions to the physicaldelivery or cash-settlement process
where possible.559 Existing § 37.401(b)
requires a SEF to examine general
market data in order to detect and
prevent manipulative activity that
would result in the failure of market
prices to reflect the normal forces of
supply and demand.560 Existing
§ 37.401(c) requires a SEF to
demonstrate an effective program for
conducting real-time monitoring of
trading for the purpose of detecting and
resolving abnormalities.561 Existing
557 See supra Section VIII.A.1.—Appendix C—
Demonstration of Compliance that a Swap Contract
is Not Readily Susceptible to Manipulation.
558 17 CFR 37.401.
559 17 CFR 37.401(a).
560 17 CFR 37.401(b).
561 17 CFR 37.401(c). The guidance to Core
Principle 4 in Appendix B provides that an
acceptable program may include some monitoring
on a T+1 basis. 17 CFR part 37 app. B (guidance
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§ 37.401(d) requires a SEF to
demonstrate the ability to
comprehensively and accurately
reconstruct daily trading activity.562
In the preamble to the SEF Core
Principles Final Rule, the Commission
clarified that § 37.401(a) requires a SEF
to monitor its market participants’
trading activity and reference data
beyond its own market on an ongoing
basis in certain instances.563 The
Commission also clarified that
§ 37.401(b) requires a SEF to monitor
and evaluate ‘‘general market data,’’
such as the pricing of the underlying
commodity or a third-party index or
instrument used as a reference price of
its swaps.564 The Commission further
clarified that the requirements with
respect to ‘‘general market data’’ means
that a SEF shall monitor and evaluate
general market conditions related to its
swaps.565 Despite commenters’ concerns
about the lack of available information
to meet the scope of these requirements,
the Commission stated that such
monitoring would be necessary to
comply with Core Principle 4.566
The Commission proposes to amend
§ 37.401 to establish more practical
trade monitoring requirements that are
based on information about trading
activity that is actually accessible to
SEFs and, therefore, are more consistent
with current practice in swaps and other
derivatives markets. First, the
Commission proposes to clarify under
proposed § 37.401(a) that a SEF must
conduct real-time market monitoring of
‘‘trading activity’’ on its own facility to
identify (i) disorderly trading; (ii) any
market or system anomalies; and (iii)
instances or threats of manipulation,
price distortion, and disruption.567 This
proposed amendment, among other
things, incorporates the existing
requirement under § 37.203(e) that
requires a SEF to conduct real-time
market monitoring.568 Second, the
to Core Principle 4—paragraph (a)(1)—‘‘General
requirements’’).
562 17 CFR 37.401(d).
563 SEF Core Principles Final Rule at 33528,
33530.
564 Id. at 33528.
565 Id.
566 Id. at 33527–28. See also ISDA, Path Forward
for Centralized Execution of Swaps 6 (2015)
(explaining that a SEF should not be required to
monitor other markets for manipulation because
SEFs do not have, and cannot be expected to obtain,
sufficient information about other marketplaces).
567 The Commission also proposes to renumber
subsection (c) to subsection (a) and amend the
requirement as described.
568 The Commission notes that existing
§ 37.203(e) specifies that a SEF must conduct realtime market monitoring of all trading activity on its
system(s) or platform(s) to identify ‘‘disorderly
trading and any market or system anomalies.’’ As
discussed above, the Commission is proposing to
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Commission proposes to specify under
proposed § 37.401(b) that a SEF has
discretion to determine when to collect
and evaluate data on its market
participants’ trading activity beyond its
own market, i.e., as necessary to detect
and prevent manipulation, price
distortion, and, where possible,
disruptions of the physical-delivery or
cash-settlement process, rather than on
an ‘‘ongoing basis.’’ 569 This data would
include market participants’ trading in
(i) the index or instrument used as a
reference price; (ii) the underlying
commodity for the listed swap; and (iii)
any related derivatives markets.
In proposing these changes, the
Commission recognizes that Core
Principle 4 does not explicitly mandate
the existing requirements under
§§ 37.401(a)–(b) and has also learned
that requiring a SEF to monitor trading
activity beyond its own market on an
‘‘ongoing basis’’ has imposed
impractical burdens, particularly given
that many swaps trade both on multiple
SEFs and on an OTC basis. For a swap
subject to the trade execution
requirement, a SEF is currently required
to continually monitor trading for the
same or similar swap listed on multiple
SEFs. For a listed swap not subject to
the requirement, the SEF must
additionally monitor trading for the
same swap or similar swap traded
bilaterally away from a SEF.570 Given
that many SEFs list the same or similar
swaps that are traded bilaterally—with
a large amount of related trading activity
occurring away from a SEF’s own
market—expecting each SEF to maintain
an ongoing collection and monitoring
program for these elements is
impractical and not consistent with
current practice in other derivatives
markets.571 SEFs have also
demonstrated that this scope and
frequency of monitoring is difficult
eliminate this provision and establish those
requirements under proposed § 37.401(a) to
streamline the existing regulations. See supra note
438.
569 The Commission proposes to renumber
existing subsection (a) to subsection (b) and amend
the requirement as described. In the adopting part
37, the Commission also clarified that ‘‘market
activity’’ in existing § 37.401(a) means the ‘‘trading
activity’’ of a SEF’s market participants. SEF Core
Principles Final Rule at 33528. The Commission
proposes a non-substantive revision to replace
‘‘market activity’’ with ‘‘trading activity.’’
570 For example, the Commission notes that
multiple SEFs offer the same fixed-to-floating USDdenominated IRS in standard benchmark tenors that
are currently subject to the trade execution
requirement.
571 For example, a SEF offering an FX nondeliverable forward cannot reasonably monitor over
a dozen SEFs that offer equivalent non-deliverable
forward products and the market participants
engaging in hundreds of equivalent bilateral
transactions away from a SEF.
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because they currently lack the
capability to obtain sufficient trading
information. Accordingly, the
Commission’s proposed changes are
intended to align a SEF’s obligation to
monitor beyond its own market more
closely with current practice and
obligations in other derivatives markets,
where there is not an ongoing
monitoring requirement.
Given the practical challenges
discussed above in complying with the
existing Core Principle 4 monitoring
requirements, the Commission believes
that a SEF should monitor beyond its
own market as necessary to detect and
prevent manipulation, price distortion,
and, where possible, disruptions of the
physical-delivery or cash-settlement
processes. Further, such monitoring
should be conducted when necessary to
detect manipulative activity that would
result in the failure of the market price
to reflect the normal forces of supply
and demand. In such cases, the SEF
should be able to determine the
instances in which it needs to collect
and evaluate data related to that
activity. As proposed, the scope of this
data corresponds to the existing
requirements of § 37.404, which require
a SEF to have the ability to obtain this
trading information.572 These
amendments would ensure that SEFs
can still collect additional information
based on a legitimate need, but would
also reduce the significant and
otherwise duplicative effort among SEFs
to collect and evaluate trading and other
information on an ongoing basis. The
Commission believes that these revised
monitoring requirements not only
reflect current practice in other markets,
but also would continue to protect the
integrity of the swaps markets.
The Commission also proposes to
amend § 37.401(c) to establish more
practical monitoring requirements with
respect to a SEF’s obligation to monitor
general market data. The Commission
proposes to clarify that a SEF has the
discretion to determine when to monitor
and evaluate such data beyond its own
market, i.e., as necessary to detect and
prevent manipulative activity that
would result in the failure of the market
572 The Commission notes that a SEF may collect
this data on market participants’ trading activity
directly from its market participants pursuant to
Core Principle 5, which requires a SEF to establish
and enforce rules that provide the authority to
obtain information from its participants. 17 CFR
37.501. Further, § 37.503 requires a SEF to share
information, as required by the Commission or as
necessary and appropriate, to fulfill its regulatory
responsibilities. 17 CFR 37.503. The Commission
notes that it is proposing various amendments to
the Core Principle 5 regulations, as discussed
below, but is maintaining these requirements. See
infra Section X.—Part 37—Subpart F: Core
Principle 5 (Ability to Obtain Information).
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price to reflect the normal forces of
supply and demand.573 The
Commission notes that the existing
provision does not specify the required
scope or frequency of monitoring such
data, which is used to evaluate market
conditions and includes, among other
things, pricing in a third-party index or
instrument used as a reference price. As
noted further below with respect to
monitoring requirements for cashsettled swaps, the Commission has
observed that SEFs do not have full
access to certain types of data, such as
the pricing of proprietary third-party
indexes.574 Therefore, providing a SEF
with the discretion to monitor and
evaluate general market data on an asneeded basis would align the
requirement to SEF capabilities and
current market practices.
Finally, the Commission proposes to
consolidate the trade reconstruction
requirements under existing § 37.401(d)
and existing § 37.406 into a new
proposed § 37.401(d), which would
require a SEF to have the ability to
comprehensively and accurately
reconstruct all trading activity on its
facility for the purpose of detecting
instances or threats of manipulation,
price distortion, and disruptions.
The Commission also proposes
certain non-substantive changes to
eliminate demonstration-based
requirements under existing
§§ 37.401(c)–(d). As noted above, the
Commission proposes to set forth an
affirmative monitoring requirement,
rather than a demonstration
requirement. The Commission notes
that demonstration of compliance could
otherwise be required upon Commission
request under § 37.5(b), which requires
a SEF to provide a written
demonstration that it is in compliance
with its obligations under the Act.575
The Commission further proposes to
eliminate duplicative language and
adopt various conforming changes to the
guidance to Core Principle 4 in
Appendix B.576
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Request for Comment
The Commission requests comment
on all aspects of proposed § 37.401 and
the associated guidance to Core
Principle 4 in Appendix B. In particular,
573 The Commission proposes to renumber
existing subsection (b) to subsection (c) and amend
the requirement as described.
574 See infra Section IX.C.—§ 37.403—Additional
Requirements for Cash-Settled Swaps (discussing
the proposed elimination of the requirement to
monitor the pricing of the reference price where a
third-party index or instrument is used).
575 17 CFR 37.5(b).
576 The Commission proposes these changes in
paragraph (a)(1) to the guidance to Core Principle
4 in Appendix B. 17 CFR part 37 app. B.
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the Commission requests comment on
the following question:
(70) The Commission has observed
that SEFs may provide input into
market pricing information, such as
third-party indexes, that is available to
market participants, which includes
executed prices, prices from executable
or indicative bids and offers, views of
trading specialists, or prices from
related instruments in other markets.
Should the Commission’s general
market monitoring requirements require
SEFs to monitor this type of
information—for example, pricing
provided by its own trading specialists?
B. § 37.402—Additional Requirements
for Physical-Delivery Swaps
For swaps settled by physical
delivery, § 37.402 requires that a SEF
monitor each swap’s terms and
conditions as they relate to the
underlying commodity market and
monitor the ‘‘availability of supply’’ of
the underlying commodity, as specified
by the swap’s delivery requirements.577
The Commission also provided
additional guidance to Core Principle 4
in Appendix B to specify that a SEF
should monitor the general
‘‘availability’’ of the commodity
specified by the swap; the commodity’s
characteristics; the delivery locations;
and if available, information related to
the size and ownership of deliverable
supplies.578 In the SEF Core Principles
Final Rule, the Commission explained
that using the phrase ‘‘availability of
supply’’ and providing the associated
guidance was intended to provide a SEF
with additional flexibility in response to
commenter feedback that the proposed
regulation was, among other things,
duplicative, unmanageable, and created
the risk of conflicting conclusions.579
The Commission proposes to clarify a
SEF’s monitoring obligations with
respect to physical-delivery swaps
under § 37.402 to be consistent with the
guidance in proposed Appendix C to
part 37 and ensure that the SEF can
comply with Core Principles 3 and 4.580
577 17
CFR 37.402.
CFR part 37 app. B (guidance to Core
Principle 4—paragraph (a)(2)—‘‘Physical-delivery
swaps’’).
579 See SEF Core Principles Final Rule at 33529
(explaining the Commission’s revision of the
proposed requirement that a SEF monitor whether
the supply is ‘‘adequate’’ to the ‘‘availability’’ of the
supply; and replacing detailed proposed
requirements to monitor the supply, marketing, and
ownership of the commodity to be physically
delivered with similar guidance in Appendix B).
580 Proposed Appendix C to part 37, among other
things, provides related guidance on the design of
physically-settled swap contracts that should be
adopted by a SEF to minimize their susceptibility
to manipulation. See paragraph (b) of the proposed
578 17
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Among other things, a swap contract’s
terms and conditions should assure the
availability of adequate deliverable
supplies, such that the contract is not
readily susceptible to price
manipulation.581 To ensure that a swap
contract’s terms and conditions remain
appropriately designed, § 37.402 would
require a SEF to (i) monitor the swap’s
terms and conditions as they relate to
the underlying commodity market by
reviewing the convergence between the
swap’s price and the price of the
underlying commodity, and make a
good-faith effort to resolve conditions
that are interfering with convergence or
notify the Commission of such
conditions; and (ii) monitor the
availability of the supply of the
commodity specified by the delivery
requirements of the swap, and make a
good-faith effort to resolve conditions
that threaten the adequacy of supplies
or the delivery process or notify the
Commission of such conditions.582
The Commission notes that Core
Principles 3 and 4 place affirmative
obligations on SEFs to permit trading
only in swaps that are not readily
susceptible to manipulation and prevent
manipulation, price distortion, and
disruptions of the delivery or cashsettlement process, respectively. As
such, proposed § 37.402 places
affirmative obligations on a SEF to make
a good-faith effort to resolve conditions
that are interfering with convergence or
that threaten the adequacy of supplies
or the delivery process. The
Commission recognizes, however, that a
SEF may not always be able to resolve
these conditions; therefore, proposed
§ 37.402 allows the SEF to notify the
Commission of such conditions.583
The Commission further proposes
corresponding amendments to the
associated guidance to Core Principle 4
Appendix C to part 37—‘‘Guidance for physicallysettled swaps.’’ 17 CFR part 37 app. C.
581 Proposed Appendix C to part 37 specifies that
a SEF should estimate the deliverable supply for
which the swap is not readily susceptible to price
manipulation. To assure the availability of adequate
deliverable supplies, the swap contract terms and
conditions, in particular, should be designed based
upon an adequate assessment of the potential range
of deliverable supplies and should account for
variations in the patterns of production,
consumption, and supply over a period of at least
three years. See id. (paragraph (b)(iii)—‘‘Accounting
for variations in deliverable supplies’’).
582 The Commission also proposes to (i) amend
the guidance to Core Principle 4 in Appendix B to
define ‘‘price convergence’’ as the process whereby
the price of a physically-delivered swap converges
to the spot price of the underlying commodity as
the swap nears expiration; and (ii) make conforming
changes. 17 CFR part 37 app. B.
583 A SEF should provide electronic notification
to the Commission at submissions@cftc.gov and
DMO at DMOSubmissions@cftc.gov.
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in Appendix B.584 The Commission
proposes a non-substantive revision to
clarify that a SEF should monitor
physical-delivery swaps listed on its
facility. To conform to Core Principle 4,
the Commission also proposes to clarify
that a SEF should monitor for
conditions that may cause a swap to
become susceptible to manipulation,
price distortion, or disruptions; 585 such
conditions would include those that
influence the convergence between the
swap’s price and the price of the
underlying commodity. This proposed
language would conform to the
proposed guidance for physicallysettled swaps in the proposed Appendix
C to part 37, which states that a
physically-settled swap contract’s terms
and conditions should be designed to
avoid any impediments to the delivery
of the commodity so as to promote
convergence between the value of the
swap contract and the cash market value
of the commodity at the expiration of
the swap contract.586
The Commission also proposes a nonsubstantive change to eliminate the
demonstration-based requirement under
§ 37.402. As noted above, the
Commission proposes to set forth an
affirmative monitoring requirement for
SEFs, rather than a demonstration
requirement. The Commission notes
that demonstration of compliance could
otherwise be required upon Commission
request under § 37.5(b), which requires
a SEF to provide a written
demonstration that it is in compliance
with its obligations under the Act.587
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.402 and
the associated guidance to Core
Principle 4 in Appendix B.
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C. § 37.403—Additional Requirements
for Cash-Settled Swaps
For cash-settled swaps, § 37.403(a)
requires that a SEF monitor the pricing
of the reference price used to determine
cash flows or settlement of a swap.588
Where the reference price is formulated
or computed by the SEF, § 37.403(b)
requires a SEF to demonstrate that it
monitors the continued appropriateness
of its methodology for deriving that
price.589 Where the reference price
584 17 CFR part 37 app. B (guidance to Core
Principle 4—paragraph (a)(2)—‘‘Physical-delivery
swaps’’).
585 Id.
586 See 17 CFR part 37 app. C (paragraph (b)(iv)
of the proposed Appendix C to part 37—‘‘Contract
terms and conditions’’).
587 17 CFR 37.5(b).
588 17 CFR 37.403(a).
589 17 CFR 37.403(b).
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relies on a third-party index or
instrument, § 37.403(c) requires a SEF to
demonstrate that it monitors the
continued appropriateness of the index
or instrument.590 The Commission
provided additional guidance to Core
Principle 4 in Appendix B to specify
that a SEF should monitor pricing
abnormalities in the index or instrument
used to calculate the reference price to
avoid manipulation, price disruptions,
or market distortions.591 For selfformulated or self-computed reference
prices, the SEF should amend the
existing methodology or impose new
methodologies where such threats exist.
For pricing based on a third-party index
or instrument, a SEF should conduct
due diligence to ensure that the contract
is not susceptible to manipulation.592
Based on its experience, the
Commission acknowledges that the
requirement imposed by § 37.403(a) to
monitor the methodologies behind
third-party indexes or instruments is not
realistic due to the proprietary nature of
these indexes and instruments. The
Commission has observed that many
SEFs offer swaps for which pricing is
based on benchmark prices or
benchmark indices owned or
administered by third parties, such as
the Intercontinental Exchange, Inc.
(‘‘ICE’’),593 IHS Markit Ltd. (‘‘IHS
Markit’’),594 and the European Money
Markets Institute (‘‘EMMI’’).595 For
example, many SEFs offer IRS for
trading that rely on LIBOR or EURIBOR
as the underlying benchmark, which are
based upon submissions from panel
590 17
CFR 37.403(c).
591 17 CFR part 37 app. B (guidance to Core
Principle 4—paragraph (a)(3)—‘‘Cash-settled
swaps’’). See SEF Core Principles Final Rule at
33529 (stating that market participants may have
incentives to disrupt or manipulate reference prices
for cash-settled swaps and stating that SEFs must
monitor the pricing of the reference price in order
to comply with Core Principle 4’s requirement to
prevent manipulation, price distortion, and
disruptions of the cash settlement process).
592 Id.
593 ICE serves as the current administrator for ICE
Swap Rate (formerly known as ISDAFix), which
serves as a benchmark for swap rates and spreads
for IRS. ICE, About ICE Swap Rate, https://
www.theice.com/iba/ice-swap-rate. ICE also serves
as the current administrator for ICE LIBOR
(formerly known as BBA LIBOR), which is a
widely-adopted benchmark for short-term interest
rates that is used to specify the floating rate for
fixed-to-floating IRS. ICE, ICE Libor-Overview,
https://www.theice.com/iba/libor.
594 IHS Markit owns and operates several
tradeable CDS indices that are based on a basket of
single-name CDS. IHS Markit, Indices, https://
ihsmarkit.com/products/indices.html.
595 EMMI, a non-profit making association whose
members are national banking associations in the
EU-member states, serves as the current
administrator for Euribor and EONIA, which are
widely-adopted benchmarks for euro-denominated
IRS. EMMI, 2 Benchmarks, https://www.emmibenchmarks.eu.
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62015
banks. The Commission believes that
requiring a SEF to monitor the inputs
and calculations involved in ICE’s or
EMMI’s methodologies when
calculating their respective benchmarks
on an ongoing basis is impractical.596
The Commission understands that as a
general matter, certain aspects of these
benchmarks remain proprietary in
nature. Therefore, the Commission
acknowledges that SEFs do not
necessarily have full access to the
information to monitor trading to detect
disruptions or manipulations of indexes
or reference rates administered by other
industry participants. Further, the
Commission notes that these entities are
subject to their own monitoring and
oversight mechanisms.597
Based on these considerations, the
Commission proposes to eliminate the
requirement under § 37.403(a) that SEFs
monitor the ‘‘pricing’’ of the reference
price used to determine cash flows or
settlement.598 Where the reference price
relies on a third-party index or
instrument, a SEF would continue to be
required under proposed § 37.403(b)
(existing § 37.403(c)) to monitor the
‘‘appropriateness’’ of the index or
instrument; the Commission, however,
proposes to amend this requirement to
additionally require a SEF to take
appropriate action, including selecting
an alternate index or instrument for
deriving the reference price, where there
is a threat of manipulation, price
596 The Commission notes, however, that ICE and
EMMI offer general information on the
methodologies for calculating their respective
benchmarks. For example, ICE states that it
determines the ICE Swap Rate benchmark, which
represents the mid-price for the fixed leg of IRS,
based on tradeable quotes from regulated,
electronic, multilateral trading venues. See ICE,
Calculation of ICE Swap Rate from Tradeable
Quotes, available at https://www.theice.com/
publicdocs/ICE_Swap_Rate_Full_Calculation_
Methodology.pdf; see also EMMI, Euribor Code of
Conduct, available at https://www.emmibenchmarks.eu/assets/files/D2712J-2014-Euribor%
20Code%20of%20Conduct%2001Oct2013%20%20Revised%201%20June%202016-%
20final%20new.pdf.
597 ICE maintains an oversight committee for
LIBOR, which is responsible for reviewing the
methodology, scope, and definition of the
benchmark (including assessing its underlying
market and usage); overseeing any changes to the
benchmark; and overseeing and reviewing an
associated code of conduct. ICE, Governance &
Oversight, https://www.theice.com/iba/libor#
methodology. EMMI maintains a Steering
Committee, which is responsible for similar
functions with respect to Euribor. EMMI, Steering
Committee, https://www.emmi-benchmarks.eu/
euribor-org/steering-committee.html.
598 The Commission notes, however, that a SEF
would be required under proposed § 37.401(b) to
monitor trading in the index or instrument used as
a reference price.
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distortion, or market disruption.599 The
Commission believes that sufficient
information is generally available to
SEFs to comply with this proposed
requirement. Based on this proposed
requirement, the Commission expects
that a SEF would take action with
respect to its use of a third-party index
or instrument for a listed swap contract
that would inhibit the SEF’s ability to
prevent manipulation pursuant to Core
Principles 3 and 4. Where a SEF
formulates and computes the reference
price, the Commission proposes to
amend § 37.403(b) to require a SEF to
take appropriate action, including
amending the methodology, where there
is a threat of manipulation, price
distortion, or market disruption.600 In
contrast to the circumstances where a
SEF relies on a third-party index or
instrument, the SEF could monitor its
own methodology for deriving the
reference price.
The Commission believes that these
proposed amendments would provide
greater clarity and establish more
practical requirements for SEFs to
monitor the reference prices, including
the index or instrument used to
calculate them, in a manner that is
consistent with Core Principle 4.
Further, the Commission believes that
these proposed amendments are
consistent with the proposed guidance
in Appendix C to part 37 regarding the
design of cash-settled swap contracts.
Among other things, that guidance
specifies that the SEF should ensure
that the reference price used for its
contract is not readily susceptible to
manipulation by assessing its reliability
as an indicator of cash market values in
the underlying commercial market.601
The Commission also proposes a nonsubstantive change to eliminate the
demonstration-based requirements
under § 37.403. As noted above, the
Commission proposes to set forth an
affirmative monitoring requirement,
rather than a demonstration
requirement. The Commission notes
that demonstration of compliance could
otherwise be required upon Commission
request under § 37.5(b), which requires
a SEF to provide a written
demonstration that it is in compliance
with its obligations under the Act.602
599 The Commission proposes to renumber
existing subsection (c) to subsection (b) and amend
the language as described.
600 The Commission proposes to renumber
existing subsection (b) to subsection (a) and amend
the language as described.
601 See 17 CFR part 37 app. C (paragraph (a)(ii)
of the proposed Appendix C to part 37—‘‘Reference
price susceptibility to manipulation’’).
602 17 CFR 37.5(b).
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Given the changes to § 37.403
proposed above, the Commission
proposes to delete the existing
associated guidance in Core Principle 4
in Appendix B.603
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.403 and
the elimination of the associated
guidance to Core Principle 4 in
Appendix B.
D. § 37.404—Ability To Obtain
Information
Section 37.404(a) provides that a SEF
must demonstrate that it has access to
sufficient information to assess whether
trading in swaps listed on its market, in
the index or instrument used as a
reference price, or in the underlying
commodity for its listed swaps is being
used to affect prices on its market.604
Section 37.404(b) requires a SEF to have
rules that require its market participants
to keep records of their trading,
including records of their activity in the
index or instrument used as a reference
price, the underlying commodity, and
related derivatives markets; and make
those records available to the SEF, its
regulatory service provider if applicable,
and the Commission.605 The
Commission specified in the guidance
to Core Principle 4 in Appendix B that
a SEF may limit the application of these
requirements to market participants
who conduct ‘‘substantial trading’’ on
its facility.606
The Commission proposes several
amendments to the associated guidance
to Core Principle 4 in Appendix B. In
particular, the Commission proposes to
eliminate a SEF’s ability to limit the
application of proposed § 37.404(a) and
proposed § 37.404(b) to only those
market participants who conduct
‘‘substantial trading’’ on its facility. The
Commission notes that it has not
provided SEFs with any additional
guidance, e.g., volume-based metrics or
similar factors, as to what constitutes
‘‘substantial trading’’ by a market
participant. Eliminating this guidance
would not only remove an ambiguity as
to whom § 37.404 applies, but also
promote a more comprehensive and
effective monitoring requirement that
would require a SEF to have the ability
to obtain information from all of its
market participants, thereby better
fulfilling the objectives of Core Principle
603 The Commission proposes to eliminate
paragraph (a)(3).
604 17 CFR 37.404(a).
605 17 CFR 37.404(b).
606 17 CFR part 37 app. B (guidance to Core
Principle 4—paragraph (a)(4)—‘‘Ability to obtain
information’’).
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4.607 In addition, based on its
experience, the Commission believes
that market participants are keeping
records of their related trading, so
eliminating the ‘‘substantial’’
requirement should not impose
additional burdens. In addition to this
amendment, the Commission also
proposes several non-substantive
amendments to the guidance.608
The Commission also proposes a nonsubstantive change to eliminate the
demonstration-based requirement under
§ 37.404(a).609 As noted above, the
Commission proposes to set forth an
affirmative monitoring requirement,
rather than a demonstration
requirement. The Commission notes
that demonstration of compliance could
otherwise be required upon Commission
request under § 37.5(b), which requires
a SEF to provide a written
demonstration that it is in compliance
with its obligations under the Act.610
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.404 and
the associated guidance to Core
Principle 4 in Appendix B.
E. § 37.405—Risk Controls for Trading
Section 37.405 requires that a SEF
establish and maintain risk control
mechanisms to prevent and reduce the
potential risk of market disruptions,
including, but not limited to, market
restrictions that pause or halt trading in
market conditions prescribed by the
SEF.611 The associated guidance to Core
Principle 4 in Appendix B, among other
things, provides examples of the
different types of risk controls that a
SEF may adopt based on whether or not
they are appropriate to the
characteristics of the trading platform or
607 The Commission notes, however, that the
scope of this requirement would be based on the
proposed definition of ‘‘market participant’’ under
§ 37.2(b), which would limit § 37.404 to persons
who access the SEF directly or through a third-party
functionality, or otherwise direct an intermediary to
trade on their behalf. See supra Section IV.B.2.a.—
Applicability of § 37.404(b) to Market Participants.
608 The Commission proposes to streamline and
move the guidance that currently specifies that a
SEF can adopt information-sharing agreements with
other trading venues or a third-party regulatory
service provider where position and trading
information is not available directly from market
participants. The Commission proposes to move
this guidance to paragraph (a) of the guidance to
Core Principle 5 because the applicable
requirements for a SEF to adopt information-sharing
practices are addressed under proposed § 37.503, as
discussed below.
609 The Commission also proposes to eliminate
similar associated guidance to Core Principle 4 in
Appendix B.
610 17 CFR 37.5(b).
611 17 CFR 37.405.
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market offered by the SEF.612 Among
those types of controls, the guidance
specifies that a SEF may establish clear
error-trade and order cancellation
policies.
The Commission proposes two
amendments to § 37.405 to align the
existing requirement with the proposed
amendments to other Core Principle 4
regulations. First, the Commission
proposes to clarify that a SEF is required
to have risk control mechanisms to
prevent and reduce market disruptions,
as well as price distortions on their
facility. This proposed change is
consistent with Core Principle 4, which
requires a SEF to monitor trading to
prevent price distortions and
disruptions to the delivery or cash
settlement process.613 Second, the
Commission proposes to limit this
requirement to swaps trading activity
occurring on a SEF’s own facility, which
would be consistent with the proposed
changes to § 37.401(a).
The Commission also proposes
several amendments to the associated
guidance to Core Principle 4 in
Appendix B. First, the Commission
proposes to eliminate the reference to
intraday position limit risk controls,
which generally do not apply to a SEF
because the Commission has yet to
establish position limit rules for swaps.
Second, the Commission proposes to
clarify that a SEF’s risk controls should
be adapted to the swap contracts that it
lists for trading; this amendment does
not reflect a substantive change, but
rather would be consistent with the
proposed guidance in Appendix C to
part 37, which provides that a SEF may
adapt certain risk controls for swap
contracts based on whether they are
standardized or non-standardized.614
Third, the Commission proposes to
eliminate the language specifying that a
SEF may adopt an error trade policy; the
Commission notes that, as described
above, proposed § 37.203(e) would
require a SEF to adopt an error trade
policy for trading on its facility. The
Commission also proposes to make
several other non-substantive
conforming and clarifying amendments
to the guidance.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.405 and
the associated guidance to Core
Principle 4 in Appendix B.
612 17 CFR part 37 app. B (guidance to Core
Principle 4—paragraph (a)(5)—‘‘Risk controls for
trading’’).
613 7 U.S.C. 7b–3(f)(4)(b).
614 See supra Section VIII.A.1.—Appendix C—
Demonstration of Compliance that a Swap Contract
is Not Readily Susceptible to Manipulation.
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F. § 37.406—Trade Reconstruction
Section 37.406 requires that a SEF
have the ability to comprehensively and
accurately reconstruct all trading on its
facility, and that audit-trail data and
reconstructions be made available to the
Commission in a form, manner, and
time that is acceptable to the
Commission.615
Given the proposed consolidation
with § 37.401(d), as described above, the
Commission proposes to eliminate
§ 37.406.616 The Commission also notes
that the requirement to make
information available to the
Commission is already addressed under
Core Principle 5 regulations, discussed
further below.617
Request for Comment
The Commission requests comment
on all aspects of the proposed
elimination of § 37.406.
G. § 37.407—Regulatory Service
Provider; § 37.408—Additional Sources
for Compliance 618
The Commission is not proposing any
amendments to §§ 37.407–408.
X. Part 37—Subpart F: Core Principle 5
(Ability To Obtain Information)
Core Principle 5 requires a SEF to
establish and enforce rules that allow
the facility to obtain any ‘‘necessary
information’’ to perform any of the
functions described in CEA section 5h;
provide the information to the
Commission upon request; and have the
capacity to carry out international
information-sharing agreements as the
Commission may require.619 The
Commission further implemented Core
Principle 5 under §§ 37.501–504. Based
on the Commission’s understanding of
current SEF operational practices, the
Commission is proposing several
amendments, including non-substantive
changes, to these implementing
regulations, as described below.
A. § 37.501—Establish and Enforce
Rules
Section 37.501 specifies that a SEF’s
rules must allow it to obtain sufficient
information to fulfill its functions and
615 17
CFR 37.406.
discussed above, proposed § 37.401(d)
would require a SEF to have the ability to
comprehensively and accurately reconstruct all
trading activity on its facility for the purpose of
detecting instances or threats of manipulation, price
distortion, and disruptions.
617 See infra Section X.B.—§ 37.502—Provide
Information to the Commission.
618 The Commission proposes to renumber
§§ 37.407–408 to §§ 37.406–407, given the proposed
elimination of existing § 37.406.
619 7 U.S.C. 7b–3(f)(5). The Commission codified
Core Principle 5 under § 37.500. 17 CFR 37.500.
616 As
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62017
obligations under part 37, including the
capacity to carry out such international
information-sharing agreements as the
Commission may require.620 The
Commission proposes a non-substantive
amendment to eliminate the duplicative
language under § 37.501 regarding a
SEF’s capacity to carry out international
information-sharing agreements. The
Commission notes that this requirement
is already established under Core
Principle 5.
B. § 37.502—Provide Information to the
Commission
Existing § 37.502 requires a SEF to
adopt rules that allow it to collect
information on a routine basis, allow for
the collection of non-routine data from
its market participants, and allow for its
examination of books and records kept
by its market participants.621
The Commission proposes to
eliminate existing § 37.502.622 The
Commission notes that the language of
this requirement is duplicative of the
general requirement that SEFs have the
ability to obtain information from their
market participants, as already set forth
in Core Principle 5 and § 37.501.
Eliminating the requirement that a SEF
must have rules to allow it to examine
books and records is also consistent
with the Commission’s proposed
amendment to § 37.203(b), which would
replace a similar existing requirement
with a more general rule that would
allow a SEF to tailor its rules for
collecting books and records from
market participants.623
Request for Comment
The Commission requests comment
on all aspects of the proposed
elimination of existing § 37.502.
C. § 37.503—Information-Sharing 624
Existing § 37.504 requires a SEF to
share information with other regulatory
organizations, data repositories, and
third-party data reporting services as
required by the Commission or as
otherwise necessary and appropriate to
fulfill its self-regulatory and reporting
620 17
CFR 37.501.
CFR 37.502.
622 The Commission proposes to renumber
existing § 37.503 to § 37.502 and retitle the
provision to ‘‘Provide information to the
Commission’’ from ‘‘Collection of information’’
based on the proposed changes described below.
623 See supra Section VII.B.2.—§ 37.203(b)—
Authority to Collect Information (proposing an
amendment to require that a SEF have the authority
to collect information required to be kept by
persons subject to the SEF’s recordkeeping rules).
624 The Commission proposes to renumber
existing § 37.504 to § 37.503 and retitle the
provision to ‘‘Information-sharing’’ from ‘‘Provide
information to the Commission’’ based on the
proposed changes described below.
621 17
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responsibilities.625 Section 37.504 also
states that appropriate informationsharing agreements can be established
with the specified entities or the
Commission can act in conjunction with
the SEF to carry out such information
sharing.
The Commission proposes to establish
a more straightforward and streamlined
information-sharing requirement by
eliminating the specifically enumerated
list of entities with which a SEF must
share information and adopting
conforming amendments. Instead, a SEF
would be required to generally share
information, as required by the
Commission, or as appropriate to fulfill
its self-regulatory and reporting
responsibilities. Rather than limiting the
types of entities that a SEF may share
information with, however, a SEF
would have the flexibility to share
information with third parties that it
may utilize to carry out those
responsibilities, including affiliated
entities. This broader and more adaptive
approach to information-sharing
practices would better accommodate, for
example, a SEF’s ability to use different
types of regulatory service providers
pursuant to the proposed amendments
under § 37.204. The Commission
emphasizes, however, that SEFs would
not be required to share information
with competitor entities. In relevant
situations where information or data
may need to be shared across different
markets to help identify manipulation,
price distortions or other disruptions,
for example, the Commission
anticipates that it will continue working
in conjunction with SEFs to help
establish such information-sharing
arrangements.
The Commission also proposes a nonsubstantive revision by moving certain
provisions from the existing guidance to
Core Principle 4 to the guidance to Core
Principle 5 in Appendix B.626 This
proposed guidance would specify that if
position and trading information is
available through information-sharing
agreements with other trading venues or
a third-party regulatory service
provider, then the SEF should
cooperate, to the extent practicable, in
such information-sharing agreements.
D. § 37.504—Prohibited Use of Data
Collected for Regulatory Purposes 627
Section 37.7—‘‘Prohibited use of data
collected for regulatory purposes’’—
prohibits a SEF from using, for business
or marketing purposes, any proprietary
data or personal information it collects
or receives, from or on behalf of any
person, for the purpose of fulfilling its
regulatory obligations, unless the person
clearly consents to the SEF’s use of such
data or information in such manner.628
The purpose of this provision is to
protect customer privacy and prevent a
SEF from using information, obtained
for compliance purposes, to otherwise
advance its commercial interests.629
Section 37.7 also provides that a SEF,
where necessary for regulatory
purposes, may share such data or
information with one or more SEFs or
DCMs registered with the
Commission.630
The Commission proposes to create a
more cohesive rule with respect to
information-sharing practices under
Core Principle 5 by moving existing
§ 37.7 to a new proposed § 37.504 and
amending the current language of the
requirement. Consistent with the
existing prohibition, the Commission
proposes that a SEF that shares such
proprietary data or personal information
with a third party shall ensure that that
third party does not use the data or
information for business or marketing
purposes, unless the person from whom
such data or information was obtained
clearly consents to its use for business
or marketing purposes (including
consent to use by those third parties
with whom the SEF may share such
information). This proposed amendment
corresponds to the Commission’s other
proposed amendments that would
expand the scope of entities with whom
a SEF may share information, including
§ 37.503, which would provide a SEF
with greater flexibility in selecting a
third-party provider to fulfill its selfregulatory and reporting
responsibilities; and § 37.204, which
would allow the SEF to utilize a broader
scope of third-party entities, including
non-registered affiliates to provide
regulatory services, subject to
Commission approval.631
Request for Comment
627 The Commission proposes to retitle § 37.504 to
‘‘Prohibited use of data collected for regulatory
purposes’’ from ‘‘Information-sharing agreements’’
based on the proposed changes described below.
628 17 CFR 37.7.
629 SEF Core Principles Final Rule at 33492.
630 17 CFR 37.7.
631 In this regard, the Commission notes that
under its proposed amendments to § 37.204, a SEF
would be permitted to contract with any entity for
the provision of services to assist in complying with
the Act and Commission regulations, subject to
The Commission requests comment
on all aspects of proposed § 37.503 and
the associated guidance to Core
Principle 5 in Appendix B.
625 17
CFR 37.504.
Commission proposes to move this
guidance from paragraph (a)(4) to Core Principle 4
to paragraph (a) to Core Principle 5 in Appendix B.
626 The
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In the course of using such a provider,
a SEF may need to share proprietary
data or personal information with that
third party. To the extent that § 37.504
would continue to limit SEFs from
using this type of information for nonregulatory purposes, the Commission
believes that the objective of protecting
customer privacy and preventing the
use of data for commercial purposes
should also equally apply to third
parties that obtain access to such data or
information from a SEF for regulatory
purposes. The Commission believes that
the proposed amendments achieve this
objective.
Request for Comment
The Commission requests comments
on all aspects of proposed § 37.504.
XI. Part 37—Subpart G: Core Principle
6 (Position Limits or Accountability)
Core Principle 6 requires a SEF that
is a trading facility to adopt, as is
necessary and appropriate, position
limits or position accountability levels
for each swap contract to reduce the
potential threat of market manipulation
or congestion.632 For contracts that are
subject to a federal position limit under
CEA section 4a(a), the SEF must set its
position limits at a level that is no
higher than the limit established by the
Commission; and monitor positions
established on or through the SEF for
compliance with the Commission’s limit
and the limit, if any, set by the SEF.633
A. § 37.601—Additional Sources for
Compliance; Guidance to Core Principle
6 in Appendix B
Section 37.601 further implements
Core Principle 6 and specifies that until
such time that compliance is required
under part 151 of the Commission’s
regulations, a SEF may refer to the
associated guidance and/or acceptable
practices set forth in Appendix B to part
37.634 The guidance to Core Principle 6
in Appendix B provides a SEF with
reasonable discretion to comply with
Core Principle 6 and sets forth how a
SEF may demonstrate compliance for
trading that occurs on its own
market.635 The Commission notes that it
has proposed new language for § 37.601
and new corresponding guidance to
Core Principle 6 in Appendix B in a reproposal of a position limits
Commission approval. See supra Section VII.C.1.—
§ 37.204(a)—Use of Regulatory Service Provider
Permitted.
632 7 U.S.C. 7b–3(f)(6). The Commission codified
Core Principle 6 under § 37.600. 17 CFR 37.600.
633 Id.
634 17 CFR 37.601.
635 17 CFR part 37 app. B (guidance to Core
Principle 6—paragraph (a)—‘‘Guidance’’).
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rulemaking, pending further
Commission action.636
The Commission proposes to
eliminate the language of § 37.601 and
the existing corresponding guidance to
Core Principle 6, based on its intent to
address this issue in a separate
rulemaking. Until that time, the
Commission clarifies that SEFs have
reasonable discretion to determine how
to comply with Core Principle 6
pursuant to Core Principle 1.637 This
approach is consistent with the existing
approach under § 37.601 and the
associated guidance to Core Principle 6.
Request for Comment
The Commission requests comment
on all aspects of the proposed
elimination of § 37.601 and the
associated guidance to Core Principle 6
in Appendix B.
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XII. Part 37—Subpart H: Core Principle
7 (Financial Integrity of Transactions);
§ 39.12—Participant and Product
Eligibility
Core Principle 7 requires a SEF to
establish and enforce rules and
procedures for ensuring the financial
integrity of swaps entered on or through
the facilities of the SEF, including the
clearance and settlement of the swaps
pursuant to CEA section 2(h)(1).638 As
described further below, §§ 37.700–703
implement Core Principle 7 by
establishing requirements for SEFs to
facilitate the processing and routing of
swap transactions to a DCO for clearing.
Section 39.12(b)(7), which implements
Core Principle C for DCOs, sets forth
corresponding requirements for
registered DCOs that specify the time
frame for acceptance or rejection of
transactions submitted to the registered
DCO from DCMs and SEFs.639
As described further below, the
Commission is proposing several
amendments to the implementing
regulations and § 39.12(b)(7), including
amendments to certain ‘‘straightthrough processing’’ obligations that
apply to SEFs, DCMs, and DCOs.640
636 Position Limits for Derivatives, 81 FR 96704
(proposed Dec. 30, 2016).
637 7 U.S.C. 7b–3(f)(1).
638 The Commission codified Core Principle 7
under § 37.700. 17 CFR 37.700.
639 17 CFR 39.12(b)(7). Core Principle C for DCOs,
among other things, requires that each DCO
establish appropriate standards for determining the
eligibility of agreements, contracts, or transactions
submitted to the DCO for clearing. 7 U.S.C. 7a–
1(c)(2)(C)(i)(II). Section 39.12(b) implements Core
Principle C for DCOs by setting forth product
eligibility requirements. 17 CFR 39.12(b).
640 The Commission notes that § 39.12(b)(7) also
applies to the acceptance or rejection for clearing
by a DCO of (i) futures and options on futures
transactions and (ii) swaps submitted by a DCM.
Accordingly, the Commission’s proposed
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A. § 37.701—Required Clearing
Section 37.701 requires that
transactions executed on or through a
SEF that are subject to the clearing
requirement, or are voluntarily cleared
by the counterparties, must be cleared
through a registered DCO or an exempt
DCO.641
The Commission proposes to amend
§ 37.701 to require a SEF to establish a
direct and independent clearing
agreement with each registered DCO or
exempt DCO to which the SEF submits
swap transactions for clearing.642
During the part 37 implementation, the
Commission observed that some SEFs
would route swap transactions to
certain exempt DCOs for clearing
without having established a direct
clearing agreement with those DCOs.
Rather than enter a direct agreement
with the exempt DCO, the SEF would
establish the capacity to route
transactions through the use of a thirdparty service provider. Such routing
arrangements occurred pursuant to a
services agreement between the SEF and
the provider; the provider, in turn,
maintained a separate agreement with
the exempt DCO.
A SEF’s use of a third-party service
provider to route swap transactions to a
DCO for clearing may generally be
appropriate, but the Commission
believes that the indirect routing of
transactions for clearing must occur
pursuant to a direct and independent
clearing services agreement between the
SEF and each DCO utilized by the SEF.
The Commission believes that
maintaining a direct agreement between
a SEF and DCO, notwithstanding the
use of a third-party provider, is
consistent with § 37.702(b), which
requires each SEF to coordinate with a
DCO to develop rules and procedures to
facilitate prompt and efficient
processing of transactions in accordance
with the DCO’s obligations under
§ 39.12(b)(7)(i)(A).643 Such an agreement
would provide greater certainty to
amendments to § 39.12(b)(7) would also apply to
those transactions. See infra Section XII.B.2.b.(2)—
§ 39.12(b)(7)(ii)—AQATP Standard for Registered
DCOs.
641 17 CFR 37.701.
642 The Commission proposes to renumber the
existing requirement under § 37.701 as subsection
(a) based on a new requirement proposed under
subsection (b), described below.
643 Section 39.12(b)(7)(i)(A) requires each DCO to
coordinate with DCMs and SEFs to develop rules
and procedures to facilitate prompt, efficient, and
accurate processing of transactions to the DCO for
clearing. 17 CFR 39.12(b)(7)(i)(A). As discussed
below, § 39.12(b)(7)(i)(A), as amended, would apply
to both the processing and routing of transactions
to the DCO for clearing. See infra Section
XII.B.2.b.(1)—§ 37.702(b)(1) and
§ 39.12(b)(7)(i)(A)—‘‘Prompt, Efficient, and
Accurate’’ Standard.
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62019
market participants that the SEF has the
appropriate processes to facilitate swaps
clearing. The Commission also believes
that the terms established in a direct
clearing agreement between the SEF and
DCO would help the SEF and DCO
resolve any problems that arise at the
DCO that could diminish the SEF’s
ability to submit transactions for
clearing.
The Commission also proposes a nonsubstantive amendment to § 37.701 to
eliminate ‘‘or through’’ from the
language of the existing requirement.
The Commission notes that this
proposed amendment is a conforming
change to other part 37 regulations and
does not affect the scope of transactions
that are required to be cleared pursuant
to the clearing requirement in CEA
section 2(h)(1)(A).644
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.701.
B. § 37.702—General Financial Integrity
1. § 37.702(a)
Section 37.702(a) requires a SEF to
establish minimum financial standards
for its members, which include at a
minimum a requirement that each
member qualifies as an ECP pursuant to
CEA section 1a(18).645 The Commission
proposes a non-substantive amendment
to § 37.702(a) to replace the term
‘‘member’’ with ‘‘market participant.’’
The Commission notes that its proposed
definition of ‘‘market participant’’ under
§ 37.2(b) would capture the universe of
persons and entities that participate on
SEFs and would be subject to minimum
financial requirements, including a
SEF’s members.646
2. § 37.702(b) and § 39.12(b)(7)—Time
Frame for Clearing
Existing § 37.702(b) and § 39.12(b)(7)
require SEFs and registered DCOs,
respectively, to coordinate with one
another to facilitate the clearing of swap
transactions executed on or through the
SEF.647 The two provisions are intended
to ensure that SEFs and registered DCOs
coordinate and work together to
644 The Commission notes that Core Principle 7
refers to swaps ‘‘entered on or through’’ the SEF,
but notes that the existing requirement under
§ 37.701 specifically applies to ‘‘executed’’
transactions, which are submitted for clearing.
645 17 CFR 37.702(a).
646 See supra Section IV.B.2.—§ 37.2(b)—
Definition of ‘‘Market Participant.’’ The
Commission notes that CEA section 2(e) limits
swaps trading to ECPs, as defined by section 1a(18)
of the Act. 7 U.S.C. 2(e).
647 The Commission notes that part 39 only
applies to registered DCOs and does not apply to
exempt DCOs. Accordingly, the Commission notes
that § 37.702(b) only refers to registered DCOs.
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facilitate the ‘‘straight-through
processing’’ of transactions from
execution through clearing,648 which
the Divisions have described as the
‘‘near[-]instantaneous acceptance or
rejection of each trade. . . .’’ 649 In
order for a DCO to clear a SEF swap
transaction, existing § 37.702(b)(1)
requires a SEF to ensure that it has the
capacity to route transactions to the
DCO in a manner acceptable to the
registered DCO for purposes of
clearing.650 Existing § 37.702(b)(2)
requires a SEF to coordinate with each
registered DCO to which it submits
transactions for clearing to develop
rules and procedures to facilitate
‘‘prompt and efficient’’ transaction
processing in accordance with the
requirements of § 39.12(b)(7).651 Section
39.12(b)(7)(i)(A) requires each registered
DCO to coordinate with a relevant SEF
or DCM to develop rules and procedures
to facilitate ‘‘prompt, efficient, and
accurate’’ processing of all transactions,
including swaps submitted to the
registered DCO for clearing by the SEF
or DCM (emphasis added).652
Sections 39.12(b)(7)(ii)–(iii) each
further require a registered DCO to
establish standards to accept or reject
transactions for clearing as quickly as
would be technologically practicable as
if fully automated systems were used
(the ‘‘AQATP’’ standard).653 Section
39.12(b)(7)(ii) applies this standard to
registered DCOs for transactions,
648 Customer Clearing Documentation, Timing of
Acceptance for Clearing, and Clearing Member Risk
Management, 77 FR 21278, 21283 (Apr. 9, 2012)
(‘‘Timing of Acceptance for Clearing Final Rule’’).
649 2013 Staff STP Guidance at 2. See also infra
notes 658–659 and accompanying discussion. The
Commission has previously stated that the
‘‘acceptance or rejection for clearing in close to real
time is crucial for both effective risk management
and for the efficient operation of trading venues.’’
Timing of Acceptance for Clearing Final Rule at
21285. The Commission notes that § 39.12(b)(7)
applies to a DCO with respect to (i) futures and
options on futures transactions and (ii) swaps
submitted by a DCM for clearing. To the extent that
the Commission is addressing the proposed
amendments to § 39.12(b)(7), as discussed further
below, in conjunction with proposed amendments
to § 37.702(b)(2), the discussion focuses on swaps
routed by a SEF to a DCO for clearing. See also infra
note 673 (noting that at this time the Commission
is not proposing corresponding amendments to
§ 38.601(b), which establishes analogous processing
and routing requirements for DCMs). As discussed
below, however, the proposed amendments to
§ 39.12(b)(7) would also apply to those transactions,
including swaps, futures, and options on futures,
submitted by a DCM to a DCO for clearing. See infra
Section XII.B.2.b.(2)—§ 39.12(b)(7)(ii)—AQATP
Standard for Registered DCOs.
650 17 CFR 37.702(b)(1).
651 17 CFR 37.702(b)(2).
652 17 CFR 39.12(b)(7)(i)(A). The Commission
notes that ‘‘transactions’’ refers to swaps submitted
by a SEF or DCM, as well as futures and options
on futures submitted by a DCM.
653 17 CFR 39.12(b)(7).
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including swaps, that are ‘‘executed
competitively on or subject to the rules’’
of a SEF or DCM and requires the
registered DCO to accept or reject a
transaction for clearing pursuant to the
AQATP standard ‘‘after execution’’ of
the transaction.654 For swaps ‘‘not
executed on or subject to the rules’’ of
a SEF or DCM or ‘‘executed noncompetitively on or subject to the rules’’
of a SEF or DCM, § 39.12(b)(7)(iii)
requires a registered DCO to accept or
reject a swap for clearing pursuant to
the AQATP standard ‘‘after submission’’
of the swap to the DCO.655 In adopting
the AQATP standard, the Commission
noted that it intended for the
requirement to track the evolving
industry standard, based on
technological developments.656
The Divisions subsequently issued the
2013 Staff STP Guidance to further
clarify the application of ‘‘straightthrough processing’’ obligations for
swaps that apply to SEFs, DCMs, and
DCOs under § 37.702(b), § 38.601(b),657
and § 39.12(b)(7), respectively.658 The
Divisions stated that the standard for
straight-through processing, i.e., the
‘‘near instantaneous acceptance or
rejection’’ of a transaction by a DCO, is
critical to providing certainty of
execution and clearing, which in turn
would reduce costs and reduce risk.659
To achieve that standard, the guidance
expressed the view that SEFs, DCMs,
and registered DCOs must facilitate
swap transaction processing through
several requirements. With respect to
SEFs, the guidance expressed the view
that a SEF must ensure that a clearing
FCM has been identified in advance for
each party on an order-by-order basis;
and facilitate the mandatory preexecution screening of orders by each
clearing FCM for compliance with riskbased limits, i.e., ‘‘pre-execution credit
screening,’’ in accordance with a
clearing FCM’s obligations under
§ 1.73.660 The guidance also expressed
CFR 39.12(b)(7)(ii).
CFR 39.12(b)(7)(iii).
656 Timing of Acceptance for Clearing Final Rule
at 21285–86.
657 Section 38.601(b) applies to DCMs and
establishes processing and routing requirements
that are analogous to § 37.702(b) for SEFs. 17 CFR
38.601.
658 2013 Staff STP Guidance at 2. The 2013 Staff
STP Guidance also specified straight-through
processing requirements for FCMs under § 1.74. Id.
at 2–3. See infra note 660.
659 2013 Staff STP Guidance at 2.
660 2013 Staff STP Guidance at 3. Section 1.74
applies similar straight-through processing
requirements to FCMs, including the requirement
that a FCM to coordinate with any DCO to which
it is a clearing member to establish systems that
enable the FCM, or the DCO acting on its behalf,
to accept or reject each trade submitted to the DCO
for clearing as quickly as would be technologically
the view that a DCO must meet a
specific time frame, i.e., ten seconds, to
satisfy its obligation under the AQATP
standard.661
a. ‘‘Prompt and Efficient’’ Standard and
AQATP Standard
Based on data received by DCR, the
2013 Staff STP Guidance expressed the
view that compliance with the AQATP
standard under § 39.12(b)(7)(ii) means
that a registered DCO must accept or
reject such trades for clearing within ten
seconds after submission to the DCO.662
Given that existing § 37.702(b)(2) and
§ 38.601(b) require SEFs and DCMs,
respectively, to coordinate with DCOs in
processing transactions for clearing, the
2013 Staff STP Guidance accordingly
expressed the view that a SEF or DCM
must route swaps to a DCO in
compliance with the AQATP
standard.663
The 2013 Staff STP Guidance also
expressed the view that the AQATP
standard applies to swap transactions
that are routed to a DCO through a SEF’s
or DCM’s use of a post-execution, thirdparty manual affirmation hub
(‘‘affirmation hub’’).664 The Divisions
further explained in a follow-up letter to
the 2013 Staff STP Guidance (the ‘‘2015
Supplementary Staff Letter’’) that a SEF
or DCM may send executed trade terms
to such a hub to be manually affirmed
by the counterparties prior to routing
the transaction to the DCO for
clearing.665 According to market
participants, this process may take
minutes or hours, or occasionally may
occur overnight.666 The Divisions
acknowledged that such affirmation
hubs can promote prompt and efficient
processing by helping counterparties
identify and correct potential errors in
a transaction’s terms prior to routing to
a DCO for clearing.667 The Divisions
also stated their belief, however, that the
Commission intended the AQATP
standard to account for the need to
654 17
655 17
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practicable if fully automated systems were used.
17 CFR 1.74.
661 2013 Staff STP Guidance at 5.
662 Id.
663 Id. at 4.
664 Id.
665 Straight Through Processing and Affirmation
of SEF Cleared Swaps, CFTC Letter No. 15–67 (Dec.
21, 2015) (‘‘2015 Supplementary Staff Letter’’).
666 Id. at 2.
667 The Divisions noted that if an erroneous swap
is cleared immediately after execution, the
counterparties would have to address the errors
after clearing, which may be difficult and costly.
Additionally, counterparties may have to bear
significant margin costs until an error is corrected
because the swap may have been cleared at the
wrong DCO; the swap terms may contain the wrong
counterparty; or the swap may contain incorrect
economic terms. Id.
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refine and reduce errors to facilitate
prompt and efficient processing.668
The 2015 Supplementary Staff Letter
expressed the view that the AQATP
standard for transactions routed to an
affirmation hub would be satisfied if the
transactions were routed to and received
by the relevant DCO no more than ten
minutes after execution.669 In
establishing this standard, the Divisions
noted the interaction between a DCO’s
requirements under § 39.12(b)(7) with a
SEF’s or a DCM’s requirements under
§ 37.702(b) and § 38.601(b),
respectively.670 Accordingly, based on
the interaction between these respective
requirements, the staff letter expressed
the view that a SEF or DCM is also
obligated under the AQATP standard—
at least to the extent that the SEF uses
a third-party affirmation hub acting as
its agent—to ensure that the DCO
receives the transaction no later than ten
minutes after execution.671 The
Divisions stated, however, that they
would continue to review this standard
and take further action as necessary,
based in part on industry
developments.672
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b. Proposed Approach to StraightThrough Processing
The Commission notes that the
Divisions provided views regarding
several aspects of straight-through
processing in the 2013 Staff STP
Guidance and the 2015 Supplementary
Staff Letter. The Commission also
understands that certain aspects of the
guidance and staff letter may be unclear
when read in conjunction with existing
regulations. Therefore, the Commission
seeks to provide clarity under the
proposed regulatory framework with
respect to the straight-through
processing requirements for SEFs and
DCOs through the proposed
clarifications and amendments
described below.673
668 Id. at 3. The Commission previously stated
that the use of an affirmation hub for routing a swap
to a DCO for clearing would be permissible,
provided that such routing complies with
§ 37.702(b) and the trade is processed in accordance
with § 39.12, among other related Commission
requirements. SEF Core Principles Final Rule at
33535.
669 2015 Supplementary Staff Letter at 3.
670 Id. at 1–2.
671 Id. at 3.
672 Id. The Commission also previously stated
that it would monitor the implementation of the
AQATP standard and propose amendments in the
future. Timing of Acceptance for Clearing Final
Rule at 21286.
673 Notwithstanding the fact that § 39.12(b)(7), the
2013 Staff STP Guidance, and the 2015
Supplementary Letter also apply to DCMs as
described above, the scope of this proposed rule
does not include a similar proposed amendment to
§ 38.601(b) for DCMs that submit (i) futures and
options on futures; and (ii) swaps to a DCO for
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(1) § 37.702(b)(1) and
§ 39.12(b)(7)(i)(A)—‘‘Prompt, Efficient,
and Accurate’’ Standard
The Commission proposes several
amendments to streamline and align the
straight-through processing
requirements between SEFs and
DCOs.674 First, the Commission
proposes to eliminate the duplicative
requirement under existing
§ 37.702(b)(1) that requires SEFs to have
the capacity to route transactions to the
DCO for purposes of clearing.
Accordingly, the Commission proposes
to renumber existing § 37.702(b)(2) to a
new proposed § 37.702(b)(1) and revise
the existing ‘‘prompt and efficient’’
standard for SEFs to ‘‘prompt, efficient,
and accurate’’ to conform to the
requirement for DCOs (emphasis
added). The Commission notes that this
proposed amendment would establish
the same requirement for both SEFs and
DCOs, respectively, to coordinate with
one another to facilitate the processing
of swaps for clearing. To clarify the
functions that are subject to straightthrough processing requirements, the
Commission also proposes to specify
under proposed § 37.702(b)(1) that this
standard applies to the ‘‘routing’’ of
swaps by a SEF to a DCO for clearing.675
Further, the Commission proposes a
non-substantive amendment to specify
that a SEF’s obligation to coordinate
with DCOs should be in accordance
with the DCOs’ obligations under
§ 39.12(b)(7)(i)(A).676
clearing. The Commission may propose a
conforming amendment in a future proposed
rulemaking that applies to DCMs. As discussed
herein, however, a DCO’s obligations under the
proposed amendments to § 39.12(b)(7) would apply
equally to futures and options on futures and swaps
executed on a SEF or DCM, or executed pursuant
to the rules of a DCM. See supra note 640.
674 To the extent that the Commission is
addressing the proposed amendments to
§ 39.12(b)(7)(i)(A) in conjunction with the proposed
amendments to § 37.702(b)(1), the discussion
focuses on swaps routed by a SEF to a DCO for
clearing. See also supra note 673 (noting that the
Commission is not proposing corresponding
amendments to § 38.601(b), which establishes
analogous processing and routing requirements for
DCMs, at this time). The proposed amendments to
§ 39.12(b)(7)(i)(A), however, would also apply to
those transactions, including swaps, futures, and
options on futures submitted by a DCM to a DCO
for clearing.
675 The Commission acknowledges that the term
‘‘processing’’ in the existing requirement may
encompass the routing of swaps from a SEF to a
DCO, but proposes to amend the language to
include ‘‘routing’’ for greater clarity and the
avoidance of doubt.
676 The current language under § 37.702(b)(2)
requires SEFs to work with each DCO in accordance
with the requirements of § 39.12(b)(7). The
Commission’s proposal would amend the
requirement to specify § 39.12(b)(7)(i)(A), which
imposes a corresponding obligation on DCOs to
work with SEFs to develop rules to facilitate the
‘‘prompt, efficient, and accurate processing’’ of
transactions.
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The Commission also notes that some
uncertainty exists about the interaction
between the ‘‘prompt, efficient, and
accurate’’ standard 677 and the AQATP
standard for registered DCOs, based in
part on the 2013 Staff STP Guidance
and 2015 Supplementary Staff Letter.
Accordingly, the Commission proposes
that the ‘‘prompt, efficient, and
accurate’’ standard applies to (i) each
SEF, under proposed § 37.702(b)(1),
with respect to the processing and
routing of transactions to a DCO; and (ii)
each registered DCO, under
§ 39.12(b)(7)(i)(A), with respect to any
coordination needed to assist a SEF
with implementing any procedures or
systems to facilitate the processing and
routing of swaps to the DCO. For the
avoidance of doubt, the Commission
proposes that the AQATP standard does
not apply to the processing and routing
of transactions. As discussed further
below, the Commission proposes that
the AQATP standard set forth under
§§ 39.12(b)(7)(ii)–(iii) specifically
applies to a registered DCO’s acceptance
or rejection of a transaction from a SEF
or DCM, i.e., when the DCO receives the
transaction.678 The Commission
believes that this proposed approach
establishes a requirement for a SEF that
addresses its functions—to process and
route swaps to the DCO—that is
appropriately distinct from a DCO’s
functions—to accept or reject a swap
from clearing upon submission of the
swap to the DCO, among other things.
For further clarity, the Commission
specifies that the SEF’s requirement to
process and route swaps in a prompt,
efficient, and accurate manner also
includes the SEF’s transmission and
delivery of the swap to the DCO;
accordingly, the ‘‘submission’’ of a swap
by the SEF to the DCO is deemed to
have occurred upon the DCO’s receipt of
the swap.
In particular, the Commission
proposes that the ‘‘prompt, efficient,
and accurate’’ standard also applies to
the processing and routing of swaps
from a SEF to a DCO via affirmation
hubs.679 The Commission acknowledges
677 As noted above, the Commission is proposing
to amend the existing standard for SEFs under
§ 37.702(b)(2) (renumbered as § 37.702(b)(1)) to
‘‘prompt, efficient, and accurate.’’
678 The Commission notes that it is proposing
amendments to streamline § 39.12(b)(7)(ii)–(iii), as
discussed below. See infra Section XII.B.2.b.(2)—
§ 39.12(b)(7)(ii)—AQATP Standard for Registered
DCOs.
679 The Commission notes that the 2015
Supplementary Staff Letter expresses the view that
the AQATP standard applies to a SEF’s use of
affirmation hubs to process and route trades to a
DCO. 2015 Supplementary Staff Letter at 3. As
discussed further below, however, the Commission
proposes that the AQATP standard applies to a
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the beneficial role of these mechanisms
and intends to facilitate their use to
reduce error rates and related costs prior
to routing a swap to the DCO. Instead
of the ten-minute time frame set forth in
the 2015 Supplementary Staff Letter,
however, the Commission proposes that
the ‘‘prompt, efficient, and accurate’’
standard would allow swaps subject to
affirmation via third-party hubs to be
processed and routed to the DCO in a
manner that accounts for existing
market practices and technology, as well
as market conditions at the time of
execution.
Based on the Divisions’ experience
with the ten-minute time frame, the
Commission believes that a qualitative
interpretation of ‘‘prompt, efficient, and
accurate’’ is more appropriate than
imposing a specific time standard upon
SEFs for processing and routing
transactions to the DCO. The
Commission has observed that many
SEFs, particularly those that offer voicebased or voice-assisted trading systems
or platforms, have not been able to meet
the time frame when using manual
affirmation hubs. Further, the
Commission believes that maintaining a
specific time standard would be
inconsistent with the proposed
expansion of the trade execution
requirement and the availability of
flexible execution methods under the
proposed framework. In particular, the
expansion of the trade execution
requirement will lead to the trading of
a broader array of swaps on SEFs, many
of which are likely more complex in
nature and require more time for
affirmation to occur. The inability to
comply with a specific time frame could
hinder the anticipated growth of trading
in additional products on SEFs and
impede the ability to utilize flexible
means of execution. Further, a specific
time frame may also limit the use—and
therefore the benefits—of affirmation
hubs. Therefore, the Commission
believes that a rigid time frame for
processing and routing trades from a
SEF to a DCO is inappropriate under the
proposed regulatory framework.
The ‘‘prompt, efficient, and accurate’’
standard may result in varying lengths
of time for transactions to be processed
and routed to a DCO, including some
longer instances, e.g., a time period that
exceeds ten minutes. The Commission,
however, expects that market and
technological developments will enable
processing and routing through
registered DCO after submission of the trade to the
DCO for clearing. Proposed § 37.702(b)(1) and
§ 39.12(b)(7)(i)(A), as amended, would require SEFs
and DCOs to respectively coordinate and work
together to effect the ‘‘prompt, efficient, and
accurate’’ standard.
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affirmation hubs to occur in
increasingly shorter time intervals.
Further, the Commission notes that
under the qualitative standard,
transactions that can be reasonably
affirmed on a fully automatic basis after
execution should be affirmed in that
manner.680 In such cases, the
Commission believes that ‘‘prompt,
efficient, and accurate’’ processing and
routing would occur in a much shorter
time frame, e.g., less than ten minutes.
Where affirmation hubs are not
utilized, the Commission believes that
the ‘‘prompt, efficient, and accurate’’
standard would also result in a trade
being processed and routed from a SEF
to a DCO in a much shorter time frame.
As noted above, that exact time frame
would depend on swap market practices
and technology, as well as market
conditions at the time of execution. The
Commission expects that the industry
will continue to reduce time frames for
transaction processing and routing to a
DCO. The Commission emphasizes that
it will continue to monitor time frames
and industry developments with respect
to transaction processing to ensure that
SEFs and DCOs facilitate prompt,
efficient, and accurate transaction
processing and routing.
(2) § 39.12(b)(7)(ii)—AQATP Standard
for Registered DCOs
In addition to specifying that the
‘‘prompt, efficient, and accurate’’
standard applies to SEFs with respect to
processing and routing transactions, the
Commission proposes to clarify that the
AQATP standard applies to a DCO’s
acceptance or rejection of a transaction
for clearing upon submission to the
DCO, i.e., when the DCO receives the
transaction. The Commission also
proposes to delete existing
§ 39.12(b)(7)(iii) as unnecessary.681 The
Commission notes that this approach is
generally consistent with the 2013 Staff
STP Guidance with respect to swaps,
but this proposal specifies that the
AQATP standard applies exclusively to
the DCO and is triggered upon
submission of the agreement, contract,
or transaction 682 to the DCO from a
680 The Commission notes that this statement is
consistent with the views expressed by the
Divisions in the 2015 Supplementary Staff Letter.
Id. at 3.
681 As discussed below, the Commission notes
that it is proposing amendments to streamline
§§ 39.12(b)(7)(ii)–(iii) into a single provision.
682 The Commission notes that both CEA section
1a(15), which defines a DCO, and § 39.12(b)(1),
which establishes product eligibility for DCOs, refer
to ‘‘agreements, contracts, or transactions.’’
Similarly, CEA section 1a(47), which defines a
‘‘swap,’’ also refers to an ‘‘agreement, contract, or
transaction.’’ To conform to these provisions, the
Commission proposes non-substantive amendments
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SEF, a DCM, or counterparties that
submit swaps directly to the DCO for
clearing. Therefore, a DCO’s ability to
comply with the AQATP standard for
accepting or rejecting a trade is distinct
from the length of time it takes an entity
such as a SEF or DCM to process and
route a trade to the DCO.683 As
discussed below, the DCO’s obligation
to comply with the AQATP standard is
also independent from the method of
execution or venue by which
counterparties execute an agreement,
contract, or transaction, given that the
DCO’s obligation to accept or reject that
executed agreement, contract, or
transaction only begins from the point
after which it has been submitted to the
DCO, i.e., when the DCO receives the
transaction. If a SEF, DCM, or
counterparty to a bilaterally-executed
agreement, contract, or transaction
delays the submission of a cleared swap
to a DCO for clearing, then it would not
impact the DCO’s obligation to accept or
reject on an AQATP basis after it has
received the transaction.
In conjunction with clarifying that the
AQATP standard applies to registered
DCOs, the Commission proposes to
streamline and consolidate
§§ 39.12(b)(7)(ii)–(iii) to establish one
AQATP standard for registered DCOs
under a new proposed § 39.12(b)(7)(ii)
for all agreements, contracts, and
transactions, regardless of whether they
(i) are executed competitively or noncompetitively; (ii) are executed on or
pursuant to the rules of a SEF or DCM;
or (iii) are swaps, futures contracts, or
options on futures contracts.684 The
Commission also proposes that this
AQATP standard would apply to all
such agreements, contracts, and
transactions after submission to the
DCO, rather than after execution, as
currently required for competitively
executed transactions on or subject to
to §§ 39.12(b)(7)(i)–(ii) to apply to all ‘‘agreements,
contracts, and transactions.’’ The Commission notes
that this conforming change does not alter the
substantive scope of a DCO’s obligations under
proposed § 39.12(b)(7). Core Principle 7 and its
implementing regulations, however, refer to
‘‘swaps’’ and ‘‘transactions’’ interchangeably
without intending to impose a substantive
distinction on a SEF’s obligations. For example,
§ 37.700 refers to ‘‘swaps’’ while §§ 37.701–702
refer to ‘‘transactions,’’ but the Commission’s use of
‘‘transaction’’ is intended to refer generally to
transactions of swaps on the SEF and not intended
to differentiate among agreements, contracts, or
transactions that constitute swaps (emphasis
added).
683 Under proposed § 37.702(b)(1), a SEF’s
obligation to submit swaps for clearing to the DCO
includes the SEF’s obligation to process and route
swaps and is subject to the prompt, efficient, and
accurate standard.
684 Based on this consolidation, the Commission
proposes to eliminate the existing language of
§ 39.12(b)(7)(iii).
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the rules of a DCM or SEF under
existing § 39.12(b)(7)(ii) (emphasis
added). The Commission believes that a
DCO should be able to accept or reject
a trade for clearing in a similar AQATP
standard time frame after receiving the
transaction, regardless of the manner of
execution—competitive or noncompetitive—or whether the trade has
been processed and routed by a SEF or
DCM, a third-party affirmation hub, or
the counterparties themselves on a
direct basis. As applied to swaps, a DCO
would be subject to the same AQATP
standard, regardless of whether the
swap is subject to the trade execution
requirement or otherwise voluntarily
cleared.
The AQATP standard reflects the
Commission’s belief that acceptance or
rejection for clearing in close to real
time is crucial both for effective risk
management and for the efficient
operation of trading venues.685 While
the Commission did not prescribe a
rigid time frame for acceptance or
rejection for clearing when adopting
existing §§ 39.12(b)(7)(ii)–(iii), the
Commission did note that the
performance standard would require
action in a matter of milliseconds or
seconds, or at most, a few minutes, not
hours or days.686 The Commission notes
that Commission staff continues to
monitor reports from DCOs about their
ability to accept or reject trades for
clearing in a timely matter. To date, the
Commission has not been made aware
of significant delays or difficulties
meeting the ten-second standard
articulated in the 2013 Staff STP
Guidance. Accordingly, as DCOs have
been able to accept or reject trades
within ten seconds after submission by
the SEF for the past five years, the
Commission proposes that this standard
continue for registered DCOs under the
AQATP standard under proposed
§ 39.12(b)(7)(ii).
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685 See
Timing of Acceptance for Clearing Final
Rule at 21285. In recognizing that some trading
venues may not be fully automated, the
Commission stated that the use of manual steps
would be permitted, as long as the process could
operate within the same timeframes as the
automated systems. Id. The Commission also noted
that the timeframe for acceptance by clearing FCMs
(outlined under § 1.74) and DCOs is stricter than the
timeframes for submission by SDs and MSPs. Id.
The Commission noted that ‘‘where execution is
bilateral and clearing is voluntary, the delay
between execution and submission to clearing is, of
necessity, within the discretion of the parties to
some degree. The Commission believes, however,
that prudent risk management dictates that once a
trade has been submitted to a clearing member or
a DCO, the clearing member or DCO must accept
or reject it as quickly as possible.’’ Id.
686 See id. For example, IRS were executed and
cleared with an average time of 1.9 seconds on CME
platforms in early 2012. Id.
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(3) §§ 37.702(b)(2)–(3)—Pre-Execution
Credit Screening
With respect to the pre-execution
credit screening of orders for
compliance with risk-based limits, the
2013 Staff STP Guidance expressed the
view that (i) a clearing FCM must be
identified in advance for each
counterparty on an order-by-order basis
for trades intended for clearing; and (ii)
a SEF must facilitate pre-execution
screening by each clearing FCM in
accordance with § 1.73 on an order-byorder basis.687 To facilitate such
screening in practice, SEFs have
provided their respective clearing FCMs
with a ‘‘pre-trade credit screening’’
functionality that allows them to screen
orders executed on the facility.688 The
Divisions have viewed pre-trade credit
screening functionalities as beneficial to
facilitate ‘‘prompt and efficient’’
transaction processing in accordance
with straight-through processing
requirements.689
With respect to pre-execution
screening by each clearing FCM, the
2013 Staff STP Guidance viewed
§§ 1.73(a)(2)(i)–(ii) as requiring a
clearing FCM to conduct pre-execution
screening of orders for execution on a
SEF or DCM for compliance with riskbased limits.690 The 2013 Staff STP
687 2013
Staff STP Guidance at 3.
have been able to facilitate the use of
their pre-trade credit screening functionalities by
clearing FCMs for swap block trades pursuant to
time-limited no-action relief provided by
Commission staff, which allows market participants
to execute swap block trades on the SEF that are
intended to be cleared. See infra Section XXII.A.—
§ 43.2—Definition—Block Trade; § 37.203(a)—
Elimination of Block Trade Exception to PreArranged Trading. As discussed below, the
Commission is proposing to amend the definition
of ‘‘block trade’’ under § 43.2 to continue to allow
clearing FCMs to comply with § 1.73 by using preexecution credit screenings on the SEF.
689 2013 Staff STP Guidance at 2–3. With respect
to establishing pre-execution credit screenings, the
2013 Staff STP Guidance expressed the view that
SEFs and FCMs should work together to effect the
risk-based limits to ensure straight-through
processing of swaps. Id.
690 2013 Staff STP Guidance at 1–2. Section
1.73(a)(1) requires each clearing FCM to establish
risk-based limits for each proprietary account and
each customer account that are based on position
size, order size, margin requirements, or similar
factors. 17 CFR 1.73(a)(1). Similarly, § 1.73(a)(2)(i)
states that when a clearing FCM provides electronic
market access or accepts orders for automated
execution, the FCM must use automated means to
screen orders for compliance with such risk-based
limits. 17 CFR 1.73(a)(2)(i). Section 1.73(a)(2)(ii)
states that when a clearing FCM accepts orders for
non-automated execution, the FCM must establish
and maintain systems of risk controls reasonably
designed to ensure compliance with the limits. 17
CFR 1.73(a)(2)(ii). Section 1.73(a)(2)(iii) states that
when a clearing FCM accepts transactions that were
executed bilaterally and then submitted for
clearing, the FCM must establish and maintain
systems of risk controls reasonably designed to
ensure compliance with the limits. 17 CFR
688 SEFs
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62023
Guidance further expressed the view
that § 1.73 provides FCMs with the
ability to reject orders before execution;
as a result, orders that have satisfied
clearing FCMs’ pre-execution limits are
deemed accepted for clearing and
thereby subject to a guarantee by the
clearing FCM upon execution.691
Accordingly, the 2013 Staff STP
Guidance expressed the view that a
clearing FCM may not reject a trade that
has passed its pre-execution credit
screening filter because this would
violate the AQATP standard, under
which trades should be accepted or
rejected for clearing as soon as
technologically practicable as if fully
automated systems were used.692
With respect to the requirement that
a clearing FCM must be identified in
advance for trades intended for clearing,
the 2013 Staff STP Guidance noted that
the Commission has already required
parties to have a clearing arrangement in
place with a clearing FCM in advance of
execution and that in cases where more
than one DCO offered clearing services,
the parties would also need to specify
in advance where the trade should be
sent for clearing.693 Accordingly, the
2013 Staff STP Guidance expressed the
view that no trade intended for clearing
may be executed on or subject to the
rules of a SEF unless a clearing FCM
was identified in advance for each party
on an order-by-order basis.694
In conjunction with the Commission’s
proposal to clarify and amend straightthrough processing requirements, the
Commission proposes to adopt these
two obligations—that each market
participant identify a clearing member
in advance and that a SEF facilitate preexecution credit screening—under
§§ 37.702(b)(2)–(3), respectively. The
Commission believes that the proposed
requirements are consistent with the
proposed approach to straight-through
processing as described above. In
1.73(a)(2)(iii). The Commission notes that paragraph
(a)(2)(i)–(ii) apply to ‘‘orders,’’ while paragraph
(a)(2)(iii) applies to ‘‘transactions.’’ In addition,
paragraph (a)(2)(iii) is limited to transactions
executed ‘‘bilaterally.’’ In contrast, the Commission
stated in the final rule adopting § 1.73 that
paragraph (a)(2)(i) refers to ‘‘automated trading
systems,’’ such as CME’s Globex, while paragraph
(a)(2)(ii) includes ‘‘non-automated markets such as
open outcry exchanges or voice brokers.’’ See
Timing of Acceptance for Clearing Final Rule at
21288. As the Commission affirmatively included
voice brokers in connection with paragraph
(a)(2)(ii), transactions executed through voice
brokers do not fall under paragraph (a)(2)(iii).
Accordingly, § 1.73(a)(2)(iii) only applies where two
parties transact directly with one another, outside
of a SEF or DCM.
691 2013 Staff STP Guidance at 3.
692 Id.
693 See Timing of Acceptance for Clearing Final
Rule at 21284.
694 2013 Staff STP Guidance at 3.
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particular, the use of pre-execution
credit screening functionalities help
SEFs and DCOs to both meet their
respective straight-through processing
requirements by reducing the number of
transactions that are rejected from
clearing by a DCO. The Commission
notes that pre-execution credit
screening has become a fundamental
component of the swaps clearing
infrastructure.695
Request for Comment
amozie on DSK3GDR082PROD with PROPOSALS3
The Commission requests comment
on all aspects of proposed § 37.702 and
§§ 39.12(b)(7)(i)–(ii). In particular, the
Commission requests comment on the
following questions:
(71) The proposed ‘‘prompt, efficient,
and accurate’’ standard, as applied to
trades submitted to a DCO for clearing
via third-party affirmation hubs would
take into consideration evolving swap
market practices and technology, as well
as current market conditions at the time
of execution. Is the proposed approach
appropriate? Why or why not? Does the
approach provide sufficient guidance
regarding the standard?
(72) Is the distinction sufficiently
clear between (i) the submission and
related processing and routing of a swap
by a SEF to a DCO under the ‘‘prompt,
efficient, and accurate’’ standard and (ii)
the DCO’s decision to accept or not
accept a swap under the AQATP
standard? Does the approach provide
sufficient clarity regarding the distinct,
but interrelated, roles of SEFs and
DCOs? Why or why not?
(73) The 2013 Staff STP Guidance and
2015 Supplementary Staff Letter apply
to ‘‘intended to be cleared swaps,’’
including swaps subject to the clearing
requirement and swaps that are
voluntarily cleared by the
counterparties. Should these
requirements apply to voluntarilycleared swaps?
(74) Proposed §§ 39.12(b)(7)(ii) would
eliminate the distinction when applying
the AQATP standard between (i) trades
that are executed competitively and (ii)
trades that are not executed
competitively or are executed away
from a SEF or DCM. Is the proposed
approach appropriate? Why or why not?
695 As noted above, the 2013 Staff STP Guidance
expressed the view that a clearing FCM may not
reject a trade that has passed its pre-execution
credit screening filter because such a rejection
would violate the AQATP requirement. 2013 Staff
STP Guidance at 3. The Commission expects that
this practice which is beneficial to market
participants by providing trade certainty in as
minimal a time delay as possible, will continue.
The screening of transactions by a clearing FCM
does not, however, prevent the DCO from rejecting
a swap for clearing.
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(75) Proposed § 39.12(b)(7)(ii) would
apply the AQATP standard after
submission to the DCO, rather than after
execution. Is the proposed approach
appropriate? Why or why not?
(76) Proposed § 39.12(b)(7)(ii) would
apply the AQATP standard after
submission to the DCO, rather than after
execution, for all swaps, futures, and
options on futures submitted for
clearing. Proposed § 39.12(b)(7)(ii)
would apply to all agreements,
contracts, and transactions submitted to
the DCO for clearing. Is the proposed
approach appropriate? Why or why not?
(77) Should a DCO have the flexibility
to have additional time to address
instances in which a clearing member
has insufficient credit on deposit for the
DCO to accept an agreement, contract,
or transaction for clearing? If so, should
the Commission require the DCO to
have rules and procedures for the DCO’s
process to address those instances?
3. Applicability of § 37.702(b) to SEFs
That Do Not Facilitate Clearing
The Commission proposes to amend
the introductory language under
proposed § 37.702(b) to specify that its
requirements apply only to those
transactions routed through a SEF to a
registered DCO for clearing rather than,
as currently required, to any transaction
cleared by a DCO. While not meant to
reflect a substantive change, the
Commission believes that this
amendment would clarify that the
requirements of § 37.702(b) do not apply
to a SEF that does not facilitate the
clearing of applicable listed swaps that
are not subject to the clearing
requirement. The requirements would
apply, however, if the SEF offers to
facilitate the clearing of such swaps.696
Therefore, to the extent counterparties
choose to voluntary clear such
transactions through a SEF that offers to
facilitate clearing for such swaps,
696 The Commission notes that certain SEFs, such
as those that facilitate trading in FX non-deliverable
forward products, do not hold themselves out as
offering services to facilitate clearing with a DCO.
As a result, the straight-through processing
requirements, including the ‘‘prompt, efficient, and
accurate’’ standard and pre-execution credit
screening requirements, would not apply to such
SEFs, even if the counterparties subsequently
voluntarily clear a swap away from the SEF. The
Commission notes that a SEF could offer to
facilitate the clearing of certain listed swaps, to
which § 37.702(b)’s requirements would apply,
while not offering to facilitate the clearing of other
of its listed swaps, to which § 37.702(b)’s
requirements would not apply. The Commission
notes, however, that the requirements of
§ 39.12(b)(7)(ii) apply to all agreements, contracts,
and transactions submitted to a DCO for clearing,
regardless of whether a particular swap is subject
to the clearing requirement pursuant to section
2(h)(1) of the CEA.
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§ 37.702(b) would then apply to the
SEF.
C. § 37.703—Monitoring for Financial
Soundness
Section 37.703(a) requires a SEF to
monitor its members to ensure that they
continue to qualify as an ECP pursuant
to CEA section 1a(18).697 The
Commission proposes a non-substantive
amendment to proposed § 37.703 to
replace the term ‘‘member’’ with
‘‘market participant.’’ The Commission
notes that its proposed definition of
‘‘market participant’’ under § 37.2(b)
would capture the universe of persons
and entities that participate on SEFs and
would be subject to minimum financial
requirements, including a SEF’s
members.698
XIII. Part 37—Subpart I: Core Principle
8 (Emergency Authority)
Core Principle 8 requires a SEF to
adopt rules to provide for the exercise
of emergency authority, in consultation
or cooperation with the Commission, as
is necessary and appropriate, including
the authority to liquidate or transfer
open positions in any swap or to
suspend or curtail trading in a swap.699
A. § 37.801—Additional Sources for
Compliance
Section 37.801 further implements
Core Principle 8 by referring SEFs to
associated guidance and/or acceptable
practices set forth in Appendix B to
comply with § 37.800.700 The guidance
to Core Principle 8 specifies, among
other things, the types of emergency
actions that a SEF should take in
particular to address perceived market
threats, and states that the SEF should
promptly notify the Commission of its
exercise of emergency action.
The Commission proposes to amend
the guidance to Core Principle 8 by
eliminating references to certain
emergency actions that the Commission
understands a SEF, as a matter of
general market practice, would not be
able to adopt, including imposing
special margin requirements and
transferring customer contracts and the
margin. Since SEFs do not own the
contracts, they do not have the ability to
impose margin or transfer contracts.
Additionally, the Commission proposes
697 17
CFR 37.703.
supra Section IV.B.2.—§ 37.2(b)—
Definition of ‘‘Market Participant.’’ The
Commission notes that CEA section 2(e) limits
swaps trading to ECPs, as defined by section 1a(18)
of the Act. 7 U.S.C. 2(e).
699 7 U.S.C. 7b–3(f)(8). The Commission codified
Core Principle 8 under § 37.800. 17 CFR 37.800.
700 17 CFR 37.801.
698 See
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several non-substantive amendments to
the guidance.701
Request for Comment
The Commission requests comment
on all aspects of the proposed associated
guidance to Core Principle 8 in
Appendix B.
XIV. Part 37—Subpart J: Core Principle
9 (Timely Publication of Trading
Information)
The Commission is not proposing any
amendments to the regulations under
Core Principle 9.
XV. Part 37—Subpart K: Core Principle
10 (Recordkeeping and Reporting)
Core Principle 10 requires a SEF,
among other things, to maintain records
of all activities related to the business of
the facility, including a complete audit
trail, in a form and manner acceptable
to the Commission for a period of five
years.702 Section 37.1001 implements
this requirement by requiring a SEF to
maintain an audit trail for all swaps
executed on or subject to the rules of the
SEF, among other types of records. The
Commission proposes a non-substantive
amendment to § 37.1001 to eliminate
‘‘or subject to the rules of’’ from the
existing requirement. This proposed
amendment confirms to conforms to the
proposed amendment to the ‘‘block
trade’’ definition under § 43.2,
discussed further below.703
XVI. Part 37—Subpart L: Core Principle
11 (Antitrust Considerations)
The Commission is not proposing any
amendments to the regulations under
Core Principle 11.
XVII. Part 37—Subpart M: Core
Principle 12 (Conflicts of Interest)
The Commission has not adopted any
regulations under Core Principle 12 and
is not proposing any regulations at this
time.
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XVIII. Part 37—Subpart N: Core
Principle 13 (Financial Resources)
Core Principle 13 requires a SEF to
have adequate financial, operational,
and managerial resources to discharge
each of its responsibilities.704 To
achieve financial resource adequacy, a
SEF must maintain financial resources
sufficient to cover its operating costs for
a period of at least one year, calculated
701 For example, the Commission proposes to
eliminate the reference to § 40.9, as this section is
currently reserved by the Commission.
702 7 U.S.C. 7b–3(f)(10). The Commission codified
Core Principle 10 under § 37.1000. 17 CFR 37.1000.
703 See infra Section XXII.—Part 43—§ 43.2—
Definition of ‘‘Block Trade.’’
704 7 U.S.C. 7b–3(f)(13). The Commission codified
Core Principle 13 under § 37.1300. 17 CFR 37.1300.
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on a rolling basis.705 The Commission
implemented Core Principle 13 by
adopting §§ 37.1301–1307 to specify (i)
the eligible types of financial resources
that may be counted toward compliance
(§ 37.1302); (ii) the computation of
projected operating costs (existing
§ 37.1303); (iii) valuation requirements
(existing § 37.1304); (iv) a liquidity
requirement for those financial
resources that is equal to six months of
a SEF’s operating costs (existing
§ 37.1305); and (v) reporting obligations
to the Commission (§ 37.1306).
The Commission implemented these
regulations to ensure a SEF’s financial
strength so that it could discharge its
responsibilities, ensure market
continuity, and withstand unpredictable
market events.706 During the part 37
implementation, the Commission has
continued to receive feedback from
several SEFs that the existing
requirements impose impractical
financial and operating burdens.707
Among other things, these SEFs have
contended that the amount of financial
resources that a SEF is required to
maintain has proven to be unnecessary
and confines resources that could
otherwise be allocated toward
operational growth and further
innovation. To address some of these
concerns, Commission staff issued two
guidance documents regarding the
calculation of operating costs.708
Based on its experience with
overseeing the financial resources
requirements, the Commission proposes
several amendments to the Core
Principle 13 regulations that would
achieve a better balance between
ensuring SEF financial stability,
promoting SEF growth and innovation,
and reducing unnecessary costs. The
Commission’s proposed amendments,
which include the addition of
acceptable practices to Core Principle 13
in Appendix B, are based in part on
existing Commission staff guidance,
feedback received from SEFs, and
Commission experience gained from
ongoing oversight. As discussed in
detail further below, the Commission’s
proposed changes consist of (i)
clarification of the scope of operating
costs that a SEF must cover with
705 Id.
706 When the Commission adopted § 37.1301(a), it
recognized that a ‘‘SEF’s financial strength is vital
to ensure that the SEF can discharge its core
principle responsibilities. . . .’’ SEF Core
Principles Final Rule at 33538–39.
707 See WMBAA, Re: Project KISS at 5 (Sept. 29,
2017) (‘‘2017 WMBAA Letter’’).
708 CFTC Letter No. 17–25; CFTC Letter No. 15–
26, Division of Market Oversight Guidance on
Calculating Projected Operating Costs by Swap
Execution Facilities (Apr. 23, 2015) (‘‘CFTC Letter
No. 15–26’’).
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adequate financial resources; (ii)
acceptable practices, based on existing
Commission staff guidance, that address
the discretion that a SEF has when
calculating projected operating costs
pursuant to proposed § 37.1304; (iii)
amendments to the existing six-month
liquidity requirement for financial
resources held by a SEF; and (iv)
streamlined requirements with respect
to financial reports filed with the
Commission. The proposed changes also
would include non-substantive
amendments to clarify certain existing
requirements, including the
renumbering of several provisions to
present the requirements in a more
cohesive manner.
A. § 37.1301—General Requirements
1. § 37.1301(a)
Existing § 37.1301(a) requires a SEF to
maintain financial resources that are
sufficient to enable it to perform its
functions in compliance with the SEF
core principles set forth in section 5h of
the Act (emphasis added).709 Existing
§ 37.1301(c) relates to this requirement
and specifies that a SEF’s financial
resources are sufficient if their value is
‘‘at least equal to’’ the SEF’s operating
costs for a one-year period, on a rolling
basis.710
Certain SEFs have stated that existing
§ 37.1301(a), when read in conjunction
with § existing 37.1301(c), can be
construed to state that operational costs
incurred for functions that are not
germane to discharging SEF core
principle responsibilities must be
included in a financial resources
calculation. According to those SEFs,
requiring those costs to be included
would require a SEF to allocate
additional resources to comply with the
requirement, which would hinder its
ability to allocate that capital to
operational growth and innovation,
thereby creating unnecessary
burdens.711
The Commission proposes to
consolidate the requirement under
existing § 37.1301(c) into a new
proposed § 37.1301(a) and adopt several
amendments. First, the Commission
proposes to amend the types of
operating costs that must be included in
a SEF’s financial resources
determination. As proposed, a SEF
would be required to maintain adequate
financial resources to cover the
709 17
CFR 37.1301(a).
CFR 37.1301(c).
711 See 2017 WMBAA Letter at 6 (stating that the
financial resource requirements should focus on
fixed costs required for compliance, rather than
variable costs and staff-related costs that are not
essential).
710 17
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operating costs that a SEF needs to
‘‘comply’’ with the SEF core principles
and any applicable Commission
regulations, rather than ‘‘perform its
functions in compliance with’’ the core
principles. For example, under the
current requirement, a SEF must
maintain financial resources to continue
to afford all of its existing activities (for
example, activities such as product
research or business development), even
if such activities are not mandated by
any core principle or regulatory
requirement. Under the proposed
amendment, a SEF would not need to
include costs that are not necessary to
comply with the SEF core principles
and any applicable Commission
regulations when calculating its
operating costs.
The Commission believes that the
proposed regulation represents a better
and more balanced regulatory approach
to implementing the Core Principle 13
requirements. Some SEF operational
costs may not be necessary for
discharging core principle and
regulatory responsibilities, and
therefore, should not be included when
calculating a SEF’s financial resources.
Rather than require a SEF to allocate
capital to account for such operating
costs, the proposed amendment permits
SEFs to allocate their capital to other
areas, thereby furthering the goal of
promoting SEF growth and
innovation.712 Therefore, proposed
§ 37.1301(a) would achieve a better
balance between ensuring that a SEF is
financially stable, while also providing
the SEF with greater discretion to
allocate its limited resources.713
712 The Commission understands that businesses,
particularly nascent SEFs or SEFs developing new
product lines, may incur relatively greater expenses
in growing new business, compared to established
SEFs or existing product lines. The Commission
notes that under the proposed acceptable practices
to Core Principle 13 in Appendix B, costs related
to marketing and business development could be
excluded from a SEF’s projected operating cost
calculations. See infra Section XVIII.D.1.—
Acceptable Practices to Core Principle 13 in
Appendix B.
713 The Commission believes that the proposed
financial resources obligations in the aggregate
would better ensure market stability and the
financial viability of SEFs. While proposed
§ 37.1301(a), along with the associated acceptable
practices to Core Principle 13, may reduce the total
amount of financial resources that a SEF must hold
under § 37.1301(a), the Commission believes that
such a change should not affect market integrity or
the financial viability of SEFs. SEFs may include
illiquid financial assets, as opposed to cash or cash
equivalents, towards satisfying this requirement.
The Commission, however, has also recognized that
based on its experience, illiquid resources are less
effective for ensuring an entity’s viability,
especially in times of market volatility where it may
be difficult to timely sell illiquid assets or avoid a
significant haircut on such assets. Consequently,
the Commission believes that the amount of liquid
assets that a SEF must hold, which the Commission
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Further, the proposed amendment
would remove a potential barrier for
new SEF entrants who may otherwise
have been deterred by the relatively
higher capital costs posed by a broad
reading of the existing requirement.
The Commission also proposes
several non-substantive changes to align
proposed § 37.1301(a) more closely to
Core Principle 13 requirements. To
reflect the ongoing nature of the Core
Principle 13 requirements, the
Commission proposes to specify that a
SEF must maintain adequate financial
resources on an ‘‘ongoing basis.’’ For
consistency purposes with Core
Principle 13, the Commission also
proposes to replace the word
‘‘sufficient’’ with ‘‘adequate’’ and adopt
additional language to specify that a
SEF’s financial resources will be
considered ‘‘adequate’’ if their value
‘‘exceeds,’’ rather than is ‘‘at least equal
to,’’ one year’s worth of operating
costs,714 calculated on a rolling basis
pursuant to the requirements for
calculating such costs under proposed
§ 37.1304.715
Further, as noted above, the
Commission proposes to adopt
additional language to clarify that a
SEF’s financial resources must be
adequate to comply with the SEF core
principles and any ‘‘applicable
Commission regulations.’’ This
amendment is intended to clarify that a
SEF’s resource adequacy obligation
under proposed § 37.1301(a) also
applies to any resources needed for
complying with any additional
regulatory requirements that the
Commission has promulgated.716 The
addresses under proposed § 37.1303, more
effectively protects market integrity and the
financial viability of SEFs. As discussed below,
proposed § 37.1303 would explicitly require SEFs
to maintain sufficient liquidity to cover their
projected wind-down costs, with a minimum
liquidity level in an amount no less than three
months of projected operating costs where winddown costs would be less than three months of
projected operating costs. See infra Section
XVIII.C.—§ 37.1303—Liquidity of Financial
Resources.
714 The Commission notes that it is also proposing
a non-substantive amendment to refer to ‘‘projected
operating costs’’ instead of ‘‘operating costs’’ to
conform to existing § 37.1304 and § 37.1307, both
of which refer to ‘‘projected operating costs.’’ The
Commission notes that during informal discussions
with SEFs, Commission staff and SEFs have
generally referred to SEFs’ ‘‘projected’’ operating
costs.
715 As discussed below, proposed § 37.1304
(which the Commission proposes to renumber from
existing § 37.1303) would continue to provide SEFs
with reasonable discretion to calculate their
projected operating costs to determine their
financial resources requirement under § 37.1301(a)
and their liquidity requirement under proposed
§ 37.1303.
716 The Commission notes that under Core
Principle 1, a SEF must comply with any rule or
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Commission notes that SEFs are already
complying with this clarification in
practice.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1301(a).
In particular, the Commission requests
comment on the following question:
(78) To what extent does a
requirement for SEFs to maintain
financial resources to cover operational
costs needed only for core principle and
regulatory compliance reduce the
financial resources that a SEF needs to
maintain, as opposed to the current
requirement? Would such a reduction, if
any, impair the stability of either the
SEF or the marketplace or the
marketplace’s confidence in the SEF
market structure? Would this proposed
change encourage innovation or new
entrants into the marketplace?
2. § 37.1301(b)
Section 37.1301(b) requires a SEF that
also operates as a DCO to also comply
with the financial resource requirements
for DCOs under § 39.11.717 The
Commission proposes to amend
§ 37.1301(b) to permit SEFs that also
operate as DCOs to file a single financial
report under § 39.11 that covers both the
SEF and DCO.718 This proposed
approach would streamline and
simplify the SEF financial report filing
process set forth under § 37.1306 and
would also be consistent with the
requirement for DCMs under
§ 38.1101(a)(3), which permits DCMs
that operate as a DCO to file a single
financial report.719
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1301(b).
regulation promulgated by the Commission
pursuant to section 8a(5) of the Act. 17 CFR 37.100.
For a SEF to discharge its responsibilities pursuant
to Core Principle 13, which include complying with
the SEF core principles, it is required to ensure that
its financial resources are adequate to comply with
those rules or regulations.
717 17 CFR 37.1301(b).
718 See Derivatives Clearing Organization General
Provisions and Core Principles, 76 FR 69334 (Nov.
8, 2011). Section 39.11 establishes requirements
that a DCO will have to meet in order to comply
with Core Principle B (Financial Resources) for
DCOs. Core Principle B requires a DCO to possess
financial resources that, at a minimum, exceed the
total amount that would enable the DCO to meet its
financial obligations to its clearing members,
notwithstanding a default by a clearing member
creating the largest financial exposure for the DCO
in extreme but plausible conditions; and enable the
DCO to cover its operating costs for a period of one
year, as calculated on a rolling basis. 7 U.S.C. 7a–
1(c)(2)(B)(ii).
719 17 CFR 38.1101(a)(3).
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3. § 37.1301(c)
Given the proposed consolidation
with § 37.1301(a), as described above,
the Commission proposes to eliminate
§ 37.1301(c).
B. § 37.1302—Types of Financial
Resources
Section 37.1302 sets forth the types of
financial resources available to SEFs to
satisfy the general financial resources
requirement.720 These resources include
the SEF’s own capital, meaning its
assets minus liabilities calculated in
accordance with U.S. generally accepted
accounting principles; and any other
financial resource deemed acceptable by
the Commission.721 The Commission
proposes a non-substantive amendment
to the current language by referring to
generally accepted accounting
principles ‘‘in the United States’’ to
conform to the proposed amendments to
§ 37.1306 described further below.722
C. § 37.1303—Liquidity of Financial
Resources 723
Existing § 37.1305—‘‘Liquidity of
financial resources’’—currently requires
a SEF to maintain unencumbered, liquid
financial assets, i.e., cash and/or highly
liquid securities, that are equal to at
least six months of a SEF’s operating
costs.724 If any portion of a SEF’s
financial resources is not sufficiently
liquid, then a SEF is permitted to take
into account a committed line of credit
or similar facility to meet this
requirement.725 In adopting this rule,
the Commission explained that the
liquidity requirement is intended to
ensure that a SEF could continue to
operate and wind down its operations in
an orderly fashion, if necessary.726 The
Commission also determined that a sixmonth period would be an accurate
assessment of how long it would take
for a SEF to wind down in an orderly
manner, absent support for alternative
time frames.727
The Commission proposes to amend
the minimum amount of liquid financial
resources that a SEF must include from
six months of operating costs to the
720 17
CFR 37.1302.
721 Id.
722 See
infra Section XVIII.F.1.—§ 37.1306(a).
Commission proposes to renumber
existing § 37.1305 to § 37.1303 and amend the
requirement as described.
724 17 CFR 37.1305.
725 Id.
726 The Commission stated that ‘‘the purpose of
the liquidity requirement is so that all SEFs have
liquid financial assets to allow them to continue to
operate and to wind down in an orderly fashion’’
and that the Commission ‘‘view[ed] a six month
period as appropriate for a wind-down period
. . . .’’ SEF Core Principles Final Rule at 33540.
727 Id.
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723 The
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greater of (i) three months of a SEF’s
projected operating costs or (ii) the
projected costs for a SEF to wind down
its business, as determined by the
SEF.728 The Commission acknowledges
that in the SEF Core Principles Final
Rule, it rejected a three-month
requirement based on a lack of cited
support for a shorter time frame.729
Based on its own past oversight of SEFs
and DCMs and feedback from registered
SEFs since the adoption of part 37,
however, the Commission recognizes
that the existing six-month requirement
is not necessary. Rather, the
Commission believes that the proposed
requirement, which sets the minimum
amount of unencumbered, liquid
financial assets that a SEF must
maintain at three months of projected
operating costs, would be sufficient to
fulfill the goal of ensuring that a SEF
can continue to operate and, if
necessary, wind down its SEF
operations in an orderly fashion.
Since the adoption of part 37, many
SEFs have continued to maintain that a
six-month minimum requirement is not
necessary and that some of their liquid
assets would be better applied toward
growth initiatives.730 Consistent with
that feedback, the Commission has
observed over time that the wind downs
or ownership changes of several
registered trading platforms, including
SEFs and DCMs, have occurred within
a much shorter time frame.731 Based on
this experience, the Commission
acknowledges that a SEF may be better
positioned to determine the amount of
liquid financial resources needed to
continue its operations and to conduct
an orderly wind down. Under the
proposed change, SEFs would be able to
use the additional resources to invest in
other areas of their operations.
Accordingly, compared to the existing
static six-month requirement, the
Commission believes that a liquid
resources requirement of the ‘‘greater
of’’ either (i) three months of projected
728 The Commission notes that it is proposing to
specify ‘‘projected’’ operating costs for consistency
with the cost calculation requirement under
§ 37.1304, discussed below. See infra Section
XVIII.D.—§ 37.1304—Computation of Costs to Meet
Financial Resources Requirement.
729 SEF Core Principles Final Rule at 33540.
730 See 2017 WMBAA Letter at 5 (citing argument
that a shorter liquidity requirement would allow for
a SEF to allocate capital for innovation).
731 For example, the Commission notes that the
DCM Green Exchange LLC had its designation
vacated and ceased operations. Similarly, the DCM
Kansas City Board of Trade was acquired by CME
Group and had its designation vacated; it ultimately
ceased operations. Likewise, Javelin SEF, LLC was
acquired by Bats Global Markets, Inc., which in turn
was subsequently acquired by CBOE SEF, LLC. In
each case, the Commission observed a relatively
efficient process.
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62027
operating costs or (ii) projected winddown costs would better ensure an
orderly wind down for SEFs and ensure
a more efficient allocation of resources
for SEFs that require a wind-down
period of less than six months. Further,
by explicitly requiring a SEF to
maintain sufficient liquidity to conduct
an orderly wind down of its business,
this approach would also better protect
against the risk of failure in the unlikely
event that a SEF would require a winddown period of longer than six months.
The Commission also proposes a nonsubstantive amendment to clarify that if
a SEF has a deficiency in satisfying this
requirement, then it may overcome that
deficiency by obtaining a committed
line of credit or similar facility in an
amount at least equal to that deficiency.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1303. In
particular, the Commission requests
responses to the questions below.
(79) Is the Commission’s proposed
requirement for a SEF to have liquid
assets equal to the greater of either three
months of projected operating costs or
projected wind-down costs an
appropriate approach? If not, then what
should the Commission adopt as a more
appropriate liquidity requirement and
why? Would a SEF’s wind-down period
generally be longer or shorter than three
months?
(80) Would the change to the liquidity
requirement under proposed § 37.1303
impair the stability of either the SEF or
the marketplace? Would proposed
§ 37.1303 encourage innovation or new
entrants into the marketplace?
D. § 37.1304—Computation of Costs To
Meet Financial Resources
Requirement 732
Existing § 37.1303—‘‘Computation of
projected operating costs to meet
financial resource requirement’’—
currently requires a SEF to make a
reasonable calculation of its projected
operating costs for each fiscal quarter
over a twelve-month period to
determine the amount of financial
resources needed to comply with the
financial resource requirement.733
Existing § 37.1303 further provides that
a SEF has reasonable discretion to
determine the methodology that it uses
to compute its projected operating costs,
although the Commission may review
732 The Commission also proposes to renumber
existing § 37.1303 to § 37.1304 and amend the
requirement as described.
733 17 CFR 37.1303.
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the SEF’s methodology and require the
SEF to make changes as appropriate.734
The Commission proposes to amend
the existing requirement to specify that
a SEF must also make a reasonable
calculation of projected wind-down
costs, but would have reasonable
discretion in adopting the methodology
for calculating such costs. This
proposed addition is consistent with the
reasonable discretion already provided
for calculating projected operating costs
and corresponds to § 37.1303, which
incorporates the calculation of a SEF’s
wind-down costs into the liquidity
determination. The Commission also
proposes two non-substantive
amendments that would add a reference
to § 37.1303, given that a SEF must
calculate projected operating costs to
determine how to comply with the
liquidity requirement; and eliminate the
twelve-month requirement, given that
proposed § 37.1301(a) already
establishes that the financial resource
requirement applies on a one-year,
rolling basis.
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1. Acceptable Practices to Core Principle
13 in Appendix B
To help SEFs comply with Core
Principle 13, which requires a SEF to
calculate its operating costs as part of a
financial resources determination, the
Commission is proposing acceptable
practices to Core Principle 13 in
Appendix B associated with § 37.1304.
The proposed acceptable practices
expound upon the reasonable discretion
that SEFs have for computing projected
operating costs in determining their
financial resource requirements. Among
other things, these acceptable practices
would further explain which operating
costs are not necessary to comply with
the SEF core principles and the
Commission’s regulations. The
Commission notes that these acceptable
practices generally incorporate existing
guidance provided by Commission
staff.735
The proposed acceptable practices
state that calculations of projected
operating costs, i.e., those that are
necessary for the SEF to comply with
the SEF core principles and any
applicable Commission regulations,
should be based on a SEF’s current
business model and anticipated
business volume.736 In particular, if the
734 Id.
735 The proposed acceptable practices to Core
Principle 13 in Appendix B are based in part upon
existing DMO staff guidance. See CFTC Letter No.
17–25 and CFTC Letter No. 15–26.
736 In determining a SEF’s projected operating
costs under § 37.1301(a) or § 37.1303, a calculation
based upon a hypothetical business model that has
lower associated costs or lower business volume,
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SEF offers more than one bona fide
execution method, then a SEF would be
allowed to include the costs of only one
of those methods in calculating
projected operating costs.737 A bona fide
method refers to a method actually used
by SEF participants and not established
by a SEF on a pro forma basis merely
for the purpose of complying with—or
evading—the financial resources
requirement.
This approach would still require
SEFs to maintain sufficient financial
resources to ensure their financial
viability, but also provide greater
flexibility to SEFs to compute operating
costs, consistent with the reasonable
discretion provided under proposed
§ 37.1304. Although neither the CEA nor
the Commission’s regulations require a
SEF to have more than one execution
method, this flexibility could encourage
SEFs to innovate and experiment in
offering a variety of trading systems or
platforms compared to the current
requirements. Accordingly, this
flexibility would mitigate possible
disincentives for a SEF to limit the
number and types of execution methods
that it might otherwise develop and
offer, were it required to account for the
associated operating costs for all offered
execution methods in a calculation. In
excluding any of these expenses,
however, a SEF would need to
document and justify those exclusions
pursuant to proposed requirements
under § 37.1306, discussed further
below.738
The proposed acceptable practices
would also specify that a SEF may
exclude certain expenses in making a
‘‘reasonable’’ calculation of projected
operating costs. These expenses include,
in part, marketing and development
costs; variable commissions paid to SEF
trading specialists, the payment of
which is contingent on whether the SEF
collects associated revenue from
transactions on its systems or
platforms; 739 and costs for other SEF
personnel who are not necessary to
enable a SEF to comply with the core
principles, based on its current business
and is intended to underestimate or minimize the
level of required financial resources, would not be
appropriate. As stated in the proposed acceptable
practices, however, a SEF may account for any
projected modification to its business model, e.g.,
the addition or subtraction of business lines or
operations or other changes, in its calculations and
therefore any projected increase or decrease in
revenue or operating costs from those changes over
the next 12 months.
737 For example, if a SEF offers both an order
book and RFQ system, then the SEF may include
the costs associated with one of those methods and
exclude the costs associated with the other method.
738 See infra Section XVIII.F.3.—§ 37.1306(c).
739 See CFTC Letter No. 17–25.
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model and business volume.740 Further,
a SEF may exclude any non-cash costs,
including depreciation and
amortization. The Commission notes
that excluding these expenses would be
consistent with the proposed financial
resource requirement and proposed
liquidity requirement because they do
not reflect costs necessary for a SEF to
comply with the SEF core principles or
Commission regulations.
In addition to allowing a SEF to
exclude certain projected operating
costs, the proposed acceptable practices
further specify that a SEF may pro-rate,
but not exclude, certain expenses in
calculating projected operating costs.
The Commission recognizes that some
costs may be only partly attributable to
a SEF’s ability to comply with the SEF
core principles and the Commission’s
regulations; therefore, only those
attributed costs would need to be
included in a SEF’s projected operating
costs. Accordingly, a SEF may pro-rate
expenses that are shared with affiliates,
e.g., the costs of administrative staff or
seconded employees that a SEF shares
with affiliates. Further, a SEF may also
pro-rate expenses that are attributable in
part to operational aspects that are not
required to comply with the SEF core
principles, e.g., costs of a SEF’s office
rental space, to the extent that it is also
used to house marketing personnel. In
pro-rating any such expenses, however,
a SEF would need to document and
justify those pro-rated expenses
pursuant to proposed requirements
under § 37.1306, discussed further
below.741
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1304 and
the associated acceptable practices to
Core Principle 13 in Appendix B. In
particular, the Commission requests
comment on the following question:
(81) The proposed acceptable
practices would permit a SEF to include
only the costs related to one of the bona
fide execution methods that it offers.
Should a SEF instead be required to
include in its projected operating costs
the expenses related to all of its
execution methods? Why or why not?
740 For example, if a SEF requires a certain
amount of SEF trading specialists to operate a
voice-based or voice-assisted trading system or
platform, but hires additional personnel to enhance
its operations to benefit market participants, then
the SEF would only need to include the minimum
number of trading specialists needed to operate the
trading system or platform based on its current
business volume and take into account any
projected increase or decrease in business volume
in its projected operating cost calculations.
741 See infra Section XVIII.F.3.—§ 37.1306(c).
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E. § 37.1305—Valuation of Financial
Resources 742
Section 37.1304—‘‘Valuation of
financial resources’’—currently requires
a SEF, at least once each fiscal quarter,
to compute the current market value of
each financial resource used to meet its
financial resources requirement under
§ 37.1301.743 The requirement is
designed to address the need to update
valuations when there may have been
material fluctuations in market value
that could impact a SEF’s ability to
satisfy its financial resource
requirement.744 When valuing a
financial resource, the SEF must reduce
the value, as appropriate, to reflect any
market or credit risk specific to that
particular resource, i.e., apply a
haircut.745
The Commission proposes a nonsubstantive amendment to add an
applicable reference to § 37.1303. The
Commission notes that in addition to
calculating the current market value of
each financial resource used to satisfy
its financial resource requirement,
compliance with the liquidity
requirement would require a SEF to
utilize the current market value of the
applicable financial resources.
F. § 37.1306—Reporting to the
Commission
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1. § 37.1306(a)
Section 37.1306 establishes a SEF’s
financial reporting requirements to the
Commission. Section 37.1306(a)(1)
currently requires that at the end of each
fiscal quarter or upon Commission
request, a SEF must report to the
Commission (i) the amount of financial
resources necessary to meet the
financial resources requirement of
§ 37.1301; and (ii) the value of each
financial resource available to meet
those requirements as calculated under
§ 37.1304.746 Section 37.1306(a)(2)
additionally requires a SEF to provide
the Commission with a financial
statement, including a balance sheet,
income statement, and statement of cash
flows of the SEF or its parent
company.747 In lieu of submitting its
own financial statements, a SEF may
submit the financial statements of its
parent company.748
742 The Commission proposes to renumber
§ 37.1304 to § 37.1305 and amend the requirement
as described.
743 17 CFR 37.1304.
744 SEF Core Principles Final Rule at 33539.
745 A ‘‘haircut’’ is a deduction taken from the
value of an asset to reserve for potential future
adverse price movement in such asset. Id. at 33539
n.772.
746 17 CFR 37.1306(a)(1).
747 17 CFR 37.1306(a)(2).
748 Id.
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The Commission proposes several
amendments to § 37.1306(a)(2). First,
the Commission proposes to require a
SEF to prepare its financial statements
in accordance with generally accepted
accounting principles in the United
States (‘‘GAAP’’). For a SEF that is not
domiciled in the U.S. and is not
otherwise required to prepare its
financial statements in accordance with
GAAP, the Commission would allow
that SEF to prepare its statements in
accordance with either the International
Financial Reporting Standards issued by
the International Accounting Standards
Board, or a comparable international
standard as the Commission may accept
in its discretion. The Commission notes
that the quality and transparency of SEF
financial reports submitted under the
existing requirement have varied and
believes that the GAAP-based
requirement would promote consistency
and better ensure a minimum reporting
standard across financial submissions.
The Commission also proposes to
require a SEF to provide its own
financial statements, rather than allow a
SEF the option of submitting the
statements of its parent company. The
Commission notes that it may lack
jurisdiction over a SEF’s parent
company or its affiliates; in such
instances, the Commission could not
consider the parent company’s financial
resources in determining whether the
SEF itself possesses adequate financial
resources. Therefore, the Commission
believes that a separate SEF financial
statement would more clearly
demonstrate evidence of the SEF’s
compliance with Core Principle 13.
In addition to the proposed
amendments to § 37.1306(a)(2), the
Commission proposes non-substantive
revisions to § 37.1306(a)(1) to add
appropriate references to § 37.1303 to
§ 37.1305, as discussed above. In
addition to specifying the amount of
financial resources necessary to comply
with § 37.1301, a SEF’s quarterly report
must include the amount of financial
resources necessary to comply with the
liquidity requirement. Further, the
amounts specified in the report must be
based on the current market value of
each financial resource and computed
as reasonable calculations of the SEF’s
projected operating costs and winddown costs.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1306(a).
In particular, the Commission requests
comment on the questions below:
(82) Should the Commission require a
SEF’s financial reports to be audited?
Would requiring an audited annual
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financial report improve Commission
oversight? What costs would be
associated with an audit requirement?
(83) Instead of submitting four
financial reports as currently required,
should the Commission require a semiannual report and an audited annual
report?
(84) Would providing the Commission
with the discretionary authority to
request that SEFs provide audited
financial statements, as necessary or
appropriate, help the Commission meet
its oversight responsibilities?
(85) Financial statements currently
submitted by SEFs do not need to
comply with GAAP. What are the costs
and benefits of requiring GAAPcompliant financial submissions?
2. § 37.1306(b)
Section 37.1306(b) currently requires
a SEF to make its financial resource
calculations on the last business day of
its fiscal quarter.749 The Commission
proposes a non-substantive amendment
to § 37.1306(b) that would add the word
‘‘applicable’’ before ‘‘fiscal quarter’’ in
the existing rule text.
3. § 37.1306(c)
Section 37.1306(c) sets forth
documentation requirements for a SEF’s
financial reporting obligations. Section
37.1306(c)(1) requires a SEF to provide
the Commission with sufficient
documentation explaining the
methodology used to calculate its
financial resource requirements under
§ 37.1301.750 Section 37.1306(c)(2)
requires a SEF to provide sufficient
documentation explaining the basis for
its valuation and liquidity
determinations.751 To provide such
documentation, § 37.1306(c)(3) requires
SEFs to provide copies of certain
agreements that evidence or otherwise
support its conclusions.752
Based on the proposed amendments
to the Core Principle 13 regulations
described above, the Commission
proposes conforming amendments to
§ 37.1306(c) to require a SEF to specify
the methodology used to compute its
financial resource and liquidity
requirements. The documentation to be
provided must be sufficient for the
Commission to determine that the SEF
has made reasonable calculations of
projected operating costs and winddown costs under § 37.1304. As
749 17
CFR 37.1306(b).
CFR 37.1306(c)(1)
751 17 CFR 37.1306(c)(2).
752 17 CFR 37.1306(c)(3).
750 17
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proposed, §§ 37.1306(c)(2)(i)–(iv) 753
would require that the SEF, at a
minimum (i) list all of its expenses,
without exclusion; (ii) identify all of
those expenses that the SEF excluded or
pro-rated in its projected operating cost
calculations and explain the basis for
excluding or pro-rating any expenses;
(iii) include documentation related to
any committed line of credit or similar
facility used to meet the liquidity
requirement; 754 and (v) identify
estimates of all of the costs and the
projected amount of time required for
any wind down of operations, including
the basis for those estimates.
The proposed requirement does not
necessarily create new obligations, but
rather clarifies a SEF’s existing
obligations based upon existing
guidance provided by Commission
staff.755 Further, the proposed
requirement is specifically intended to
ensure that a SEF has sufficient
financial resources, particularly in light
of the discretion provided to SEFs to
compute their projected operating costs
and wind-down costs. Therefore, the
Commission believes that maintaining
the general obligation for each SEF to
identify all of its expenses in its
financial report, including those that
correspond to activities that are not
needed for compliance or otherwise are
excluded or pro-rated from projected
operating costs, is appropriate on an
ongoing basis.
The Commission further believes that
proposed §§ 37.1306(c)(2)(i)–(iv) would
address the current lack of adequate
documentation or insufficient
identification of excluded or pro-rated
expenses by some SEFs in submitting
their projected operating costs based on
Commission staff guidance. Absent the
guidance, the Commission notes that the
existing rule has created burdens for
Commission staff when determining
whether a SEF complies with Core
Principle 13. In its experience thus far,
the Commission recognizes that
753 The Commission proposes to consolidate
paragraphs (c)(1)–(3) into paragraphs (c)(1)–(2) and
adopt the proposed requirements as described.
754 The Commission notes that it is also proposing
a non-substantive change to eliminate the current
language in paragraph (c)(3) regarding copies of
insurance coverage or other arrangement evidencing
or otherwise supporting the SEF’s conclusions. The
Commission notes that subsection (c) still requires
a SEF to provide sufficient documentation
explaining the methodology used to compute its
financial resource requirements; therefore, if
insurance coverage or other arrangements are
necessary to explain a SEF’s methodology, then the
SEF must submit such documentation. The
Commission also notes, however, that such
documentation may not be required in all cases;
proposed paragraph (c)(2) provides minimum
requirements.
755 See CFTC Letter No. 17–25 at 4.
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Commission staff has devoted
additional effort to obtain the
appropriate documentation from SEFs.
Therefore, the Commission believes that
adding greater specificity to the existing
requirement would mitigate the time
and resources required to determine a
SEF’s compliance with the financial
resource requirements.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1306(c).
4. § 37.1306(d)
Section 37.1306(d) requires a SEF to
file its financial report no later than
forty calendar days after the end of each
of the SEF’s first three fiscal quarters
and no later than sixty calendar days
after the end of the SEF’s fourth fiscal
quarter, or at such later time as the
Commission may permit.756
The Commission proposes to extend
the due date for each SEF’s fourth fiscal
quarter report from sixty to ninety days
following the end of the quarter. This
new proposed due date conforms with
the due date for the SEF annual
compliance report under proposed
§ 37.1501(e)(2).757 The Commission
recognizes that preparing multiple yearend reports, which includes a fourthquarter financial report and an annual
compliance report, for concurrent
submission imposes resource
constraints on a SEF.758 Therefore, the
Commission believes that such potential
constraints justify an additional thirty
days to prepare and concurrently file
the SEF’s fourth quarter financial report
along with its annual compliance report.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1306(d).
5. § 37.1306(e)
The Commission proposes to add a
new requirement under § 37.1306(e) for
each SEF to provide notice to the
Commission of its non-compliance with
the financial resource requirements no
later than forty-eight hours after the SEF
knows or reasonably should have
known of its non-compliance.759 Each
756 17
CFR 37.1306(d).
infra Section XX.A.5.—§ 37.1501(e)—
Submission of Annual Compliance Report and
Related Matters.
758 The Commission also notes that it is proposing
to require a SEF to submit an updated Technology
Questionnaire under § 37.1401(g) at the same time
on an annual basis. See infra Section XIX.B.—
§ 37.1401(g)—Program of Risk Analysis and
Oversight Technology Questionnaire.
759 For example, if a SEF knows or reasonably
should know that its assets will no longer cover its
projected operating costs for the next twelve
months, as calculated on a rolling basis, then the
757 See
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SEF has an ongoing obligation to
comply with the requirements under
Core Principle 13. The proposed
requirement would clarify that the SEF
cannot wait until filing its quarterly
financial reports to notify the
Commission that it no longer satisfies
the Core Principle 13 financial resources
requirements. In some instances, the
Commission has not been informed of a
SEF’s non-compliance with the
financial resource requirements until
the filing of a quarterly financial report.
The Commission believes, however, that
prompt notification of non-compliance
is necessary for the Commission to
conduct proper market oversight and
ensure market stability on an ongoing
basis.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1306(e).
G. § 37.1307—Delegation of Authority
Section 37.1307(a) currently delegates
authority to the Director of DMO, or
other staff as the Director may designate,
to perform certain functions that are
reserved to the Commission under the
Core Principle 13 regulations, including
reviewing the methodology used to
compute projected operating costs.760
The Commission proposes to amend
§ 37.1307(a)(2) to clarify that the
Commission may additionally delegate
the authority to review and make
changes to the methodology used by a
SEF to determine the market value of its
financial resources under § 37.1305 and
the methodology that SEFs use to
determine their wind-down costs under
§ 37.1304. Further, the Commission
would delegate the ability to request the
additional documentation related to the
calculation methodologies used under
§ 37.1306(c) and the notification of noncompliance under § 37.1306(e). The
proposed amendments also include
several additional non-substantive
amendments based on the proposed
amendments to Core Principle 13
regulations, as described above.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1307.
XIX. Part 37—Subpart O: Core
Principle 14 (System Safeguards)
Core Principle 14 requires that SEFs
(i) establish and maintain a program of
risk analysis and oversight to identify
and minimize sources of operational
risk, through the development of
SEF should notify the Commission within fortyeight hours.
760 17 CFR 37.1307(a).
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appropriate controls and procedures,
and automated systems that are reliable,
secure, and have adequate scalable
capacity; (ii) establish and maintain
emergency procedures, backup
facilities, and a plan for disaster
recovery that allow for the timely
recovery and resumption of operations
and the fulfillment of the SEFs’
responsibilities and obligations; and (iii)
periodically conduct tests to verify that
backup resources are sufficient to
ensure continued order processing and
trade matching, price reporting, market
surveillance, and maintenance of a
comprehensive and accurate audit
trail.761 The Commission promulgated
rules under § 37.1401 to further
implement those requirements.762
The Commission is not proposing any
amendments to existing §§ 37.1401(a)–
(b), (e)–(f), (g)–(i), or (k)–(m), other than
non-substantive changes to paragraph
references that are based on the changes
described below.
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A. § 37.1401(c)
Section 37.1401(c) requires each SEF
to maintain a business continuitydisaster recovery plan and resources,
emergency procedures, and backup
facilities sufficient to enable timely
recovery, resumption of its operations,
and resumption of its ongoing
fulfillment of its responsibilities and
obligations as a SEF following any
disruption of its operations.763 A SEF’s
business continuity-disaster recovery
plan and resources generally should
enable resumption of trading and
clearing of swaps executed on or
pursuant to the rules of the SEF during
the next business day following the
disruption.
As noted above, the Commission
proposes to move the existing
requirement under § 37.205(b)(4)—‘‘Safe
storage capability’’—that a SEF must
protect audit trail data from
unauthorized alteration, accidental
erasure, or other loss to a more
appropriate provision under proposed
§ 37.1401(c).764 The Commission also
proposes additional non-substantive
amendments to § 37.1401(c). First, the
Commission proposes to eliminate the
sentence that references ‘‘critical
financial markets’’ and § 40.9, which do
not exist.765 Second, the Commission
761 7 U.S.C. 7b–3(f)(14). The Commission codified
Core Principle 14 under § 37.1400. 17 CFR 37.1400.
762 17 CFR 37.1401.
763 17 CFR 37.1401(c).
764 See supra Section VII.D.2.a.—§ 37.205(b)(1)—
Original Source Documents; § 37.205(b)(2)—
Transaction History Database; § 37.205(b)(3)—
Electronic Analysis Capability.
765 The Commission further proposes to eliminate
the reference to ‘‘critical financial market’’ under
§ 37.1401(d).
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proposes to replace the reference to
‘‘designated clearing organization’’ with
‘‘derivatives clearing organization,’’
which is the appropriate term under the
Commission’s regulations. Finally, the
Commission proposes to eliminate the
reference to swaps executed ‘‘pursuant
to the rules of’’ a SEF, which conforms
to the proposed amendment to the
‘‘block trade’’ definition under § 43.2,
discussed further below.766
B. § 37.1401(g)—Program of Risk
Analysis and Oversight Technology
Questionnaire
Existing Exhibit V to Form SEF in
Appendix A requires an applicant for
SEF registration to file an Operational
Capability Technology Questionnaire
(‘‘Questionnaire’’) in order to
demonstrate compliance with Core
Principle 14 and § 37.1401.767 The
current version of the Questionnaire
requests documents and information
pertaining to the following eight areas of
an applicant’s program of risk analysis
and oversight: (i) Organizational
structure, system descriptions, facility
locations, and geographic distribution of
staff and equipment; (ii) risk analysis
and oversight; (iii) system operations;
(iv) systems development methodology;
(v) information security; (vi) physical
security and environmental controls;
(vii) capacity planning and testing; and
(viii) business continuity and disaster
recovery. The current version of the
Questionnaire is located on the
Commission’s website.768
The Commission proposes a new
provision under § 37.1401(g) to require
each SEF to annually prepare and
submit an up-to-date Questionnaire to
Commission staff not later than 90
calendar days after the SEF’s fiscal yearend.769 The Commission notes that
where information previously submitted
766 See infra Section XXII.—Part 43—§ 43.2—
Definition of ‘‘Block Trade.’’
767 17 CFR part 37 app. A.
768 SEF Operational Capability Technology
Questionnaire, available at https://www.cftc.gov/
sites/default/files/idc/groups/public/@
industryoversight/documents/file/seftechnology
questionnaire.pdf.
769 The Commission notes that based on the
proposed amendments to Form SEF in Appendix A
discussed above, Exhibit V would be re-designated
as Exhibit Q of Form SEF. The up-to-date
questionnaire would be called the ‘‘Program of Risk
Analysis and Oversight Technology Questionnaire’’
and would be located in Appendix A to part 37. See
supra note 169 and accompanying discussion.
Based on the proposed addition of subsection (g),
the Commission proposes to renumber the existing
provisions under subsections (g)–(i) to subsections
(h)–(j), respectively. Based on the renumbering of
these provisions, the Commission also proposes
conforming non-substantive amendments to update
applicable cross-references to these provisions in
proposed paragraphs (a)(3), (h)(5), (i)(1)–(i)(7), and
subsection (m).
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on the Questionnaire remains current,
the annual update may note that fact,
rather than fully describe the same
information again.
The updated version of the
Questionnaire requests documents and
information in the following nine areas
to assist the Commission in assessing a
SEF’s compliance with the Act and
Commission regulations: (i)
Organizational structure, system
descriptions, facility locations, and
geographic distribution of staff and
equipment, including organizational
charts and diagrams; (ii) enterprise risk
management program and governance,
including information regarding the
Board of Directors, audits, and thirdparty providers; (iii) information
security, including storage of records,
access controls, and cybersecurity threat
intelligence capabilities; (iv) business
continuity and disaster recovery plan
and resources, including testing and
recovery time objectives; (v) capacity
planning and testing; (vi) system
operations, including configuration
management and event management;
(vii) systems development methodology,
including quality assurance; (viii)
physical security and environmental
controls; and (ix) testing, including
vulnerability, penetration, and controls
testing. While the majority of the
updated Questionnaire is unchanged
from the current version, the
Commission is making certain
amendments, including the addition of
enterprise technology risk assessments,
board of director and committee
information, third-party service
provider information, and cybersecurity
threat intelligence capabilities to keep
up-to-date with the rapidly changing
field of system safeguards and
cybersecurity.
The proposed annual update is
designed to reduce overall compliancerelated burdens and enhance internal
operational efficiency for SEFs. First,
the Commission would use the
Questionnaire as the basis for Systems
Safeguards Examination (‘‘SSE’’)
document requests. The Commission
believes that maintaining an updated
Questionnaire would limit SSE
document requests and the effort
required to respond to these requests—
a SEF would be able to provide updated
information and documents for sections
of the Questionnaire that have changed
since the last annual filing.770 Second,
770 To the extent that still-current information and
documents were provided in the most recent update
to the Questionnaire, a SEF responding to an SSE
document request would be able to reference that
fact, rather than resubmit such information and
documents.
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the Commission would use the
Questionnaire to conduct required
system safeguards oversight and
maintain a current profile of the SEF’s
automated systems.771 Annual updates
would reduce the need for separate
requests and the burden of responding
to these requests. Third, annual updates
would assist a SEF’s obligation to
provide timely advance notice of all
material (i) planned changes to
automated systems that may impact the
reliability, security, or adequate scalable
capacity of such systems; and (ii)
planned changes to the SEF’s program
of risk analysis and oversight.772 Fourth,
annual updates, which a SEF would
submit concurrently with its annual
compliance report, could provide
information and documents that are
potentially useful in preparing that
report.773
responsibilities, a CCO is required to
ensure that the SEF complies with the
CEA and applicable rules and
regulations, as well as establish and
administer required policies and
procedures.775 Core Principle 15 also
requires the CCO to prepare and file an
annual compliance report (‘‘ACR’’) to
the Commission.776 The Commission
further promulgated requirements under
§ 37.1501 to implement these
requirements.777 Based on its
experience during part 37
implementation, the Commission
proposes several amendments to
§ 37.1501, in particular to streamline
requirements related to the composition
of the ACR and provide more useful
information to the Commission.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1401(g).
Core Principle 15 requires a CCO to
report directly to the SEF’s ‘‘board [of
directors]’’ or the SEF’s ‘‘senior
officer’’ 778 and consult either the board
or the senior officer to resolve conflicts
of interest.779 Section 37.1501(a) defines
‘‘board of directors,’’ 780 but does not
define ‘‘senior officer.’’ 781 In the SEF
Core Principles Final Rule, the
Commission noted that it would not
adopt a definition of ‘‘senior officer,’’
but noted that the statutory term would
only include the most senior executive
officer of the legal entity registered as a
SEF.782
The Commission proposes to define a
‘‘senior officer’’ under § 37.1501(a) as
the chief executive officer or other
equivalent officer of the SEF. Across the
various organizational structures that
SEFs have established, the Commission
has observed that a senior officer often
may be the appropriate individual to
whom a CCO would report regarding
SEF activities. Therefore, this proposed
definition would clarify the permissible
reporting lines for the CCO and would
provide specificity to the Commission’s
proposed amendments to the Core
Principle 15 regulations, as described
below. Among other things, the
proposed requirements would enable
C. § 37.1401(j)
Section 37.1401(j) specifies that for
registered entities deemed by the
Commission to be ‘‘critical financial
markets,’’ § 40.9 sets forth requirements
for maintaining and dispersing disaster
recovery resources in a manner
sufficient to meet a same-day recovery
time objective in the event of a widescale disruption. The Commission
proposes to eliminate this provision,
given that the Commission has not
defined ‘‘critical financial markets’’ and
such requirements do not exist under
§ 40.9.
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XX. Part 37—Subpart P: Core Principle
15 (Designation of Chief Compliance
Officer)
Core Principle 15 requires each SEF to
designate a CCO and sets forth its
corresponding duties.774 Among other
771 The Commission notes that proposed
subsection (h) (renumbered from existing
subsection (g)) requires a SEF to provide to the
Commission system safeguards-related books and
records, including (i) current copies of its business
continuity-disaster recovery plans and other
emergency procedures; (ii) all assessments of its
operational risks or system safeguards-related
controls; (iii) all reports concerning system
safeguards testing and assessment required by this
chapter; and (iv) all other books and records
requested by Commission staff in connection with
Commission oversight of system safeguards or
maintenance of a current profile of the SEF’s
automated systems. Id.
772 17 CFR 37.1401(f)(1)–(2).
773 The Commission is proposing under
§ 37.1306(d) and § 37.1501(e)(2), respectively, to
require a SEF to submit its fourth quarter financial
report and annual compliance report no later than
ninety days after the SEF’s fiscal year end.
774 7 U.S.C. 7b–3(f)(15). The Commission codified
Core Principle 15 under § 37.1500. 17 CFR 37.1500.
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A. § 37.1501—Chief Compliance Officer
1. § 37.1501(a)—Definitions
775 7
U.S.C. 7b–3(f)(15)(B)(iv)–(v).
U.S.C. 7b–3(f)(15)(D).
777 17 CFR 37.1501.
778 7 U.S.C. 7b–3(f)(15)(B)(i). The Commission
also notes that the CEA does not define ‘‘senior
officer.’’
779 7 U.S.C. 7b–3(f)(15)(B)(iii).
780 Section 37.1501(a) defines ‘‘board of
directors’’ as the board of directors of a SEF, or for
those SEFs whose organizational structure does not
include a board of directors, a body performing a
function similar to a board of directors. 17 CFR
37.1501(a).
781 17 CFR 37.1501(a).
782 SEF Core Principles Final Rule at 33544.
776 7
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the senior officer to have greater
oversight responsibilities over the CCO
consistent with Core Principle 15.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1501(a).
In particular, the Commission requests
comment on the questions below.
(86) Is the Commission’s proposed
definition of ‘‘senior officer’’ sufficiently
clear and complete? If not, then please
provide an explanation of those aspects
of the definition that you believe are
insufficiently clear or inadequately
addressed.
(87) Are there any officers that may
meet the definition of ‘‘senior officer,’’
but pose a potential conflict of interest?
If so, identify such officers and the types
of conflicts that may arise.
(88) Should the Commission add any
other definitions to proposed
§ 37.1501(a)?
2. § 37.1501(b)—Chief Compliance
Officer 783
Sections 37.1501(b)–(c) set forth
certain baseline requirements for the
SEF CCO position. Section 37.1501(b)—
‘‘Designation and qualifications of chief
compliance officer’’— requires a SEF to
designate an individual to serve as the
CCO; requires the CCO to have the
authority and resources to help fulfill
the SEF’s statutory and regulatory
duties, including supervisory authority
over compliance staff; and establishes
minimum qualifications for the
designated CCO.784 Section
37.1501(c)—‘‘Appointment,
supervision, and removal of chief
compliance officer’’—establishes the
respective authorities of the SEF board
of directors and senior officer to
designate, supervise, and remove the
CCO; and requires the CCO to meet with
the SEF’s board and regulatory oversight
committee (‘‘ROC’’) on an annual and
quarterly basis, respectively, and
provide them with information as
requested.785
The Commission proposes to amend,
clarify, and eliminate various existing
requirements under §§ 37.1501(b)–(c)
and consolidate the remaining
provisions into § 37.1501(b), as
described below. The Commission
proposes to eliminate duplicative rules
to Core Principle 15, including
requirements that a SEF designate a
783 The Commission proposes to retitle
§ 37.1501(b) to ‘‘Chief compliance officer’’ from
‘‘Designation and qualifications of chief compliance
officer’’ based on the proposed changes described
below.
784 17 CFR 37.1501(b).
785 17 CFR 37.1501(c).
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CCO 786 and the CCO report directly to
the board or the senior officer.787 With
respect to the CCO’s obligations to a
ROC, Core Principle 15 does not require
a SEF to establish a ROC and the
Commission has not finalized a rule that
establishes requirements for a ROC;
therefore, the Commission proposes to
eliminate the existing ROC-related
requirements from part 37.788
Consistent with Core Principle 15,
which requires the CCO to report to the
SEF’s board or senior officer, the
Commission also proposes amendments
to the consolidated requirement under
§ 37.1501(b) to allow the SEF’s senior
officer to have the same oversight
responsibilities over the CCO as the
board. First, the Commission proposes
to allow a CCO to consult with the
board of directors or senior officer of the
SEF as the CCO develops the SEF’s
policies and procedures.789 Second, the
Commission also proposes to allow a
CCO to meet with the senior officer of
the SEF, in addition to the board of
directors, on an annual basis.790 Third,
the Commission further proposes to
allow the CCO to provide self-regulatory
program information to the SEF’s senior
officer, in addition to the board of
directors.791
The Commission further proposes to
eliminate the limitations on authority to
remove a CCO, which currently restricts
that removal authority to a majority of
the board, or in the absence of a board,
a senior officer.792 Instead, the
Commission proposes a more simplified
requirement under proposed
§ 37.1501(b) to establish that (i) the
board or the senior officer may appoint
or remove the CCO; 793 and (ii) the SEF
786 The Commission proposes to eliminate this
requirement under existing paragraph (b)(1), which
the Commission proposes to retitle to ‘‘Authority of
chief compliance officer’’ from ‘‘Chief compliance
officer required.’’
787 The Commission proposes to eliminate this
requirement under existing paragraph (c)(2).
788 These requirements include a mandatory
quarterly meeting with the ROC under existing
subparagraph (c)(1)(iii); and the requirement that
the CCO provide self-regulatory program
information to the ROC under existing
subparagraph (c)(1)(iv). Conflicts of Interest
Proposed Rule at 36741–42.
789 The Commission proposes the amendment
under proposed subparagraph (b)(1)(i).
790 The Commission proposes to renumber
existing subparagraph (c)(1)(iii) to paragraph (b)(5),
based on the proposed consolidation of existing
subsections (b)–(c), and amend the requirement as
described.
791 The Commission proposes to renumber
existing subparagraph (c)(1)(iv) to paragraph (b)(6),
based on the proposed consolidation of existing
subsections (b)–(c), and amend the requirement as
described.
792 The Commission proposes to eliminate this
requirement under existing paragraph (c)(3).
793 The Commission proposes to consolidate and
amend the requirements under existing
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must notify the Commission within two
business days of the appointment or
removal (on an interim or permanent
basis) of the CCO.794 Based on its
experience, the Commission recognizes
that in many instances, the senior
officer may be better positioned than the
board to provide day-to-day oversight of
the SEF and the CCO, as well as to
determine whether to remove a CCO.
Therefore, consistent with Core
Principle 15, the Commission believes
that a SEF’s senior officer should have
the same CCO oversight authority as the
SEF’s board of directors. This proposed
amendment is consistent with Core
Principle 15, which does not mandate a
voting percentage to approve or remove
the CCO. The Commission also believes
that these proposed amendments would
not only allow a SEF to more
appropriately designate, appoint,
supervise, and remove a CCO based on
the SEF’s particular corporate structure,
size, and complexity, but also continue
to ensure a level of independence for its
CCO that is appropriate to comply with
Core Principle 15.
Based on the proposed consolidation
of existing §§ 37.1501(b)–(c), the
Commission also proposes several nonsubstantive amendments to the
remaining provisions under proposed
§ 37.1501(b), including the renumbering
of certain existing provisions.795
a. Acceptable Practices to Core Principle
15 in Appendix B
The Commission proposes a new
acceptable practice to Core Principle 15
in Appendix B associated with
§ 37.1501(b)(2)(i), which requires a CCO
to have the background and skills
subparagraph (c)(1)(i) in part, which addresses the
appointment of a CCO by the board or senior
officer, with existing subparagraph (c)(3)(i), which
currently addresses the removal of a CCO. Based on
the proposed consolidation of existing subsections
(b)–(c), the Commission proposes to renumber this
consolidated provision to paragraph (b)(3) and
retitle the consolidated provision to ‘‘Appointment
and removal of chief compliance officer.’’
794 The Commission notes that notification to the
Commission of the appointment and removal of a
CCO is currently required under existing
subparagraph (c)(1)(i) and existing subparagraph
(c)(3)(ii), respectively. Based on the proposed
consolidation of existing subsections (b)–(c), the
Commission proposes to consolidate and amend
these notification requirements, and renumber the
consolidated requirement to subparagraph (b)(3)(i).
795 The Commission proposes to renumber the
requirements under existing paragraph (b)(2)—
‘‘Qualifications of chief compliance officer’’—to
proposed subparagraphs (b)(2)(i)–(ii). The
Commission also proposes to retitle existing
subparagraph (c)(1)(ii), which specifies that the
board or the senior officer must approve the CCO’s
compensation, to ‘‘Compensation of the chief
compliance officer.’’ Based on the proposed
consolidation of existing subsections (b)–(c), the
Commission is proposing to renumber this
requirement to paragraph (b)(4).
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appropriate to the position.796 The
proposed acceptable practice would
provide a non-exclusive list of factors
that a SEF may consider when
evaluating an individual’s qualifications
to be a CCO and state that a SEF may
make a determination based on the
totality of a person’s qualifications. The
Commission believes that a nonexclusive list provides the clarity that
SEFs have sought as to a CCO’s requisite
qualifications, but still allows a board
and senior officer reasonable flexibility
in appointing a CCO.
The proposed acceptable practice also
states that a SEF should be especially
vigilant regarding potential conflicts of
interest when appointing a CCO. The
Commission notes that the preamble to
the SEF Core Principles Final Rule
stated ‘‘a conflict of interest may
compromise a CCO’s ability to
effectively fulfill his or her
responsibilities as a CCO . . . .’’ 797
The Commission continues to believe
that conflicts of interest could affect a
CCO’s ability to effectively fulfill his or
her responsibilities. Accordingly, a SEF
should be especially vigilant in this
regard when appointing a CCO. The
Commission also continues to believe
that a SEF should have policies and
procedures in place to handle instances
where its CCO has conflicts of interest.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1501(b)
and the associated acceptable practices
to Core Principle 15 in Appendix B.
3. § 37.1501(c)—Duties of Chief
Compliance Officer 798
Section 37.1501(d)—‘‘Duties of chief
compliance officer’’—currently requires
a CCO, at a minimum, to (i) oversee and
review the SEF’s compliance with the
Act and Commission regulations; 799 (ii)
resolve any conflicts of interest that may
arise, including in certain enumerated
circumstances; 800 (iii) establish and
administer written policies and
procedures reasonably designed to
prevent violations of the Act and
796 The Commission proposes to add this
provision in paragraph (b)(1) of the acceptable
practices to Core Principle 15 in Appendix B. 17
CFR part 37 app. B.
797 SEF Core Principles Final Rule at 33543–44.
798 The Commission proposes to renumber
existing subsection (d) to subsection (c).
799 17 CFR 37.1501(d)(1).
800 17 CFR 37.1501(d)(2). A CCO is specifically
required to address conflicts between (i) business
considerations and compliance requirements; (ii)
business considerations and the requirement that
the SEF provide fair, open, and impartial access
under § 37.202; and (iii) a SEF’s management and
board members. 17 CFR 37.1501(d)(2)(i)–(iii).
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Commission regulations; 801 (iv) take
reasonable steps to ensure compliance
with the Act and Commission
regulations; 802 (v) establish procedures
for the remediation of noncompliance
issues identified by the CCO through
certain specified protocols; 803 (vi)
establish and follow appropriate
procedures for the handling,
management response, remediation,
retesting, and closing of noncompliance
issues; 804 (vii) establish and administer
a compliance manual and a written code
of ethics; 805 (viii) supervise a SEF’s selfregulatory program; 806 and (ix)
supervise the effectiveness and
sufficiency of any regulatory services
provided to the SEF in accordance with
§ 37.204.807
The Commission proposes to adopt
several substantive and non-substantive
amendments to clarify and streamline
these duties. The Commission proposes
to consolidate certain existing
provisions and specify that the CCO
may identify noncompliance matters
through ‘‘any means,’’ in addition to the
currently prescribed means; and clarify
that the procedures followed to address
noncompliance issues must be
‘‘reasonably designed’’ by the CCO to
handle, respond, remediate, retest, and
resolve noncompliance issues identified
by the CCO.808 These proposed
amendments acknowledge that a CCO
may not be able to design procedures
that detect all possible noncompliance
issues and reflect that a CCO may utilize
a variety of resources to identify
noncompliance issues beyond a limited
set of means.
The Commission also proposes to
amend a CCO’s duty to resolve conflicts
of interest.809 First, the Commission
proposes to limit a CCO’s duty to
address only ‘‘material’’ conflicts of
interest. This proposed amendment
801 17
CFR 37.1501(d)(3).
CFR 37.1501(d)(4).
803 17 CFR 37.1501(d)(5).
804 17 CFR 37.1501(d)(6).
805 17 CFR 37.1501(d)(7).
806 17 CFR 37.1501(d)(8).
807 17 CFR 37.1501(d)(9).
808 Existing paragraph (d)(5) requires a CCO to
establish procedures for remediation of
noncompliance issues identified through a
compliance office review, look-back, internal or
external audit finding, self-reported error, or
validated complaint. Existing paragraph (d)(6)
requires a CCO to establish and follow appropriate
procedures for the handling, management response,
remediation, retesting, and closing of noncompliance issues. The Commission proposes to
consolidate and amend these requirements and
renumber the consolidated requirement to
paragraph (c)(5).
809 The Commission proposes to renumber
existing paragraph (d)(2), which addresses the
CCO’s duty to resolve conflicts of interest, to
paragraph (c)(2) and amend the requirement as
described.
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802 17
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reflects the Commission’s view that the
current requirement is overly broad and
impractical because a CCO cannot
reasonably be expected to resolve every
potential conflict of interest that may
arise. Consistent with this view, the
Commission also proposes to refine the
scope of the CCO’s duty to taking only
‘‘reasonable steps’’ to resolve ‘‘material’’
conflicts of interest that may arise.810
The Commission further proposes to
eliminate the existing enumerated
conflicts of interest to avoid any
inference that they are an exhaustive list
of conflicts that a CCO must address.811
The Commission believes that these
proposed amendments do not weaken a
CCO’s statutory duty to address
conflicts of interest, but rather reflect
the CCO’s practical ability to detect and
resolve conflicts. Moreover, the
proposed amendments reflect the
Commission’s belief that a CCO should
have discretion to determine the
conflicts that are material to his or her
SEF’s ability to comply with the Act and
the Commission’s regulations. The
Commission believes that these
proposed changes are consistent with
Core Principle 15.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1501(c).
4. § 37.1501(d)—Preparation of Annual
Compliance Report 812
Existing § 37.1501(e)—‘‘Preparation of
annual compliance report’’—currently
requires the CCO to annually prepare
and sign an ACR that, at a minimum (i)
describes the SEF’s written policies and
procedures, including the code of ethics
and conflicts of interest policies; 813 (ii)
reviews the SEF’s compliance with the
Act and Commission regulations in
conjunction with the SEF’s policies and
procedures; 814 (iii) provides a selfassessment of the effectiveness of the
SEF’s policies and procedures,
including areas of improvement and
related recommendations for the SEF’s
compliance program or resources; 815
(iv) lists material changes to the policies
and procedures; 816 (v) describes the
810 The Commission also proposes to eliminate ‘‘a
body performing a function similar to the board of
directors’’ under proposed paragraph (c)(2) (existing
paragraph (d)(2)), as this phrase is already included
in the definition of ‘‘board of directors’’ under
§ 37.1501(a).
811 These provisions are currently set forth under
existing subparagraphs (d)(2)(i)–(iii). See supra note
800.
812 The Commission proposes to renumber
existing subsection (e) to subsection (d).
813 17 CFR 37.1501(e)(1).
814 17 CFR 37.1501(e)(2)(i).
815 17 CFR 37.1501(e)(2)(ii)–(iii).
816 17 CFR 37.1501(e)(3).
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SEF’s financial, managerial, and
operational resources, including
compliance program staffing and
resources, a catalogue of investigations
and disciplinary actions, and a review
of the disciplinary committee’s
performance; 817 (vi) describes any
material compliance matters identified
through certain enumerated
mechanisms, e.g., compliance office
review or lookback, and explains how
they were resolved; 818 and (vii) certifies
that, to the best of the CCO’s knowledge
and reasonable belief and under penalty
of law, the ACR report is accurate and
complete.819
During part 37 implementation, the
Commission has gained experience and
received feedback with respect to the
ACR requirements. The Commission
notes that some of the required ACR
content has provided the Commission
with minimal meaningful insight into a
SEF’s compliance program. For
example, some of the content is
duplicative of information obtained by
the Commission from other reporting
channels, such as the system-related
information that a SEF must file
pursuant to Core Principle 14 820 and
rule certifications filed pursuant to part
40 of the Commission’s regulations.821
Various SEF CCOs have also provided
feedback that certain ACR content
requires substantial time to prepare and
includes some information that does not
change frequently.822 They have
requested that the Commission simplify
these requirements and provide
additional time to file the reports. The
Commission also notes, however, that
many SEFs have not provided sufficient
details that describe and assess whether
their respective policies and procedures
817 17
CFR 37.1501(e)(4).
CFR 37.1501(e)(5).
819 17 CFR 37.1501(e)(6).
820 The Commission notes that proposed
subsection (h) (existing subsection (g)) requires a
SEF to produce system safeguards-related books
and records that include current copies of its
business continuity-disaster recovery plans and
emergency procedures, assessments of its
operational risks and controls, and reports
concerning system safeguards testing and
assessments.
821 Among other information required to be
submitted to the Commission pursuant to part 40,
a SEF is required to provide the Commission with
amendments to its rulebook and compliance
manual.
822 See CFTC Letter No. 17–61, No-Action Relief
for Swap Execution Facilities from Compliance
with the Timing Requirements of Commission
Regulation 37.1501(f)(2) Relating to Chief
Compliance Officer Annual Compliance Reports
and Commission Regulation 37.1306(d) Relating to
Fourth Quarter Financial Reports at 2–3 (Nov. 20,
2017) (‘‘NAL No. 17–61’’) (citing testimonials from
SEFs that the preparation of an ACR requires an
extensive information gathering process, including
a review and documentation of information
gathered on an entity-wide basis).
818 17
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(e.g., rulebooks, compliance manuals,
conflict of interest policies, code of
ethics, governance documentation, and
third-party service agreements) comply
with the Act and Commission
regulations.
Based upon its experience in
reviewing ACRs, the Commission is
proposing certain amendments that
would eliminate duplicative or
unnecessary information requirements
and streamline existing requirements.
These amendments would reduce
unnecessary regulatory burdens and
compliance costs associated with
certain aspects of ACRs. The
Commission is also proposing certain
amendments to enhance the usefulness
of ACRs by enabling the Commission to
assess the effectiveness of a SEF’s
compliance and self-regulatory
programs. The proposed revisions
represent a simplified approach that
continues to effectuate Core Principle
15.
The Commission proposes to refine
the scope of some of the required ACR
content that it believes is otherwise
duplicative, unnecessary, or
burdensome. Under the proposed
approach, a SEF would no longer need
to include in its ACR either a review of
all the Commission regulations
applicable to a SEF or an identification
of the written policies and procedures
designed to ensure compliance with the
Act and Commission regulations.823 The
Commission believes that instead
requiring an ACR to include a
description and self-assessment of the
effectiveness of the SEF’s written
policies and procedures to ‘‘reasonably
ensure’’ compliance with the Act and
applicable Commission regulations is
more closely aligned with the
corresponding provisions of Core
Principle 15 and would still allow the
Commission to properly assess the
SEF’s compliance and self-regulatory
programs.824 Similarly, the Commission
823 The Commission proposes to eliminate these
requirements in existing subparagraph (e)(2)(i) and
the introductory language of existing paragraph
(e)(2).
824 As proposed, a SEF would continue to be
required to describe the SEF’s written policies and
procedures, consistent with Core Principle 15. In
addition to the required description, the
Commission proposes to consolidate and amend
existing subparagraph (e)(2)(ii), which requires a
SEF to provide a self-assessment as to the
effectiveness of its policies and procedures in the
ACR, with existing paragraph (e)(1), and renumber
the consolidated requirement to paragraph (d)(1).
Further, the Commission proposes to consolidate
and amend existing subparagraph (e)(2)(iii), which
requires an ACR to discuss areas for improvement
and recommend potential or prospective changes or
improvements to a SEF’s compliance program and
resources, with existing paragraph (e)(3) and
renumber the consolidated requirement to
paragraph (d)(2). The Commission expects that the
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also proposes to eliminate a required
discussion of the SEF’s compliance
staffing and structure; a catalogue of
investigations and disciplinary actions
taken over the last year; and a review of
disciplinary committee and panel
performance.825 An ACR would
continue to be required to describe a
SEF’s financial, managerial, and
operational resources set aside for
compliance, which the Commission
believes is sufficient information to
assess a SEF’s self-regulatory
program.826 By refining the scope of
information required to be included in
the ACR, the Commission anticipates
that a SEF will be to devote its resources
in providing more detailed, and
ultimately better quality, information
that will better help assess its
compliance.
To facilitate the Commission’s ability
to assess a SEF’s written policies and
procedures regarding compliance
matters, the Commission also proposes
to require a SEF to discuss only material
noncompliance matters and explain the
corresponding actions taken to resolve
such matters.827 The Commission
believes that requiring SEFs to focus on
describing material non-compliance
matters, rather than describing all
compliance matters in similar depth,
will streamline this requirement and
provide more useful information to the
Commission. Further, the Commission
proposes to eliminate the enumerated
mechanisms for identifying noncompliance issues, which conforms to
the ability of a CCO to establish
procedures to address non-compliance
issues through ‘‘any means,’’ as
described above.828
Consistent with these proposed
amendments, the Commission also
proposes to limit a SEF CCO’s
certification of an ACR’s accuracy and
completeness to ‘‘all material respects’’
of the report.829 The Commission
recognizes that CCOs have been hesitant
to certify that an entire ACR is accurate
CCO will provide more nuanced and in-depth
discussions through these consolidated provisions,
rather than merely providing generalized responses.
825 The Commission proposes to eliminate these
requirements under existing paragraph (e)(4).
826 The Commission proposes to renumber the
remaining requirements under existing paragraph
(e)(4) to paragraph (d)(3) and adopt minor nonsubstantive amendments.
827 The Commission proposes to renumber this
requirement under existing paragraph (e)(5) to
paragraph (d)(4) and adopt the amendments as
described above and other non-substantive
amendments.
828 The Commission proposes to eliminate these
enumerated mechanisms under existing paragraph
(e)(5).
829 The Commission proposes to renumber
existing paragraph (e)(6) to paragraph (d)(5) and
amend the requirement as described.
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62035
and complete under the penalty of the
law, without regard to whether a
potential inaccuracy or omission would
be a material error or not. Therefore, the
Commission believes this proposed
change will provide an appropriate
balance between the SEF CCOs’
concerns of potential liability with the
material accuracy of an ACR submitted
to the Commission.
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1501(d).
In particular, the Commission requests
comment to the questions below.
(89) Are the proposed revisions to the
required content for ACRs appropriate?
If not, then how should the Commission
modify the required content?
(90) Are there any unintended
consequences to removing the specific
requirements regarding a description of
a SEF’s self-regulatory program’s
staffing and structure, a catalogue of
investigations and disciplinary actions
taken since the last ACR, and a review
of the performance of the disciplinary
committees and panels?
(91) Is it appropriate to limit the
discussion of non-compliance matters to
only those that are material in nature?
If not, then why?
5. § 37.1501(e)—Submission of Annual
Compliance Report and Related
Matters 830
Existing § 37.1501(f)(1) currently
requires a CCO to provide an ACR to the
board or, in the absence of a board, the
senior officer for review.831 The board of
directors and senior officer may not
require the CCO to change the ACR.832
The SEF’s board minutes or a similar
written record must reflect the
submission of the ACR to the board of
directors or senior officer and any
subsequent discussion of the report.833
Additionally, the SEF must
concurrently file the ACR and the fourth
quarter financial statements with the
Commission within 60 calendar days of
the end of the SEF’s fiscal year end.834
The CCO must certify and promptly file
an amended ACR with the Commission
upon the discovery of any material error
or omission in the report.835 A SEF may
830 The Commission proposes to renumber
existing subsection (f) to subsection (e). The
Commission also proposes to retitle subsection (e)
to ‘‘Submission of annual compliance report and
related matters’’ from ‘‘Submission of annual
compliance report’’ based on the proposed changes
described below.
831 17 CFR 37.1501(f)(1).
832 Id.
833 Id.
834 17 CFR 37.1501(f)(2).
835 17 CFR 37.1501(f)(3).
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request an extension to file the ACR
with the Commission based on
substantial, undue hardship in filing the
ACR on time.836
The Commission proposes several
amendments to simplify the ACR
submission procedures. First, the
Commission proposes to provide SEFs
with an additional thirty days to file the
ACR with the Commission, but no later
than ninety calendar days after a SEF’s
fiscal year end.837 This proposed
extension is consistent with the basis
provided by Commission staff in
granting current no-action relief to SEFs
that provides an additional thirty days
to prepare and file an ACR.838 In
particular, the Commission recognizes
that in addition to the ACR, a CCO has
other reporting obligations, such as the
fourth quarter financial report required
to be submitted under Core Principle 13
and other year-end reports; SEFs have
indicated that these multiple reporting
obligations present resource constraints
on SEFs and their CCOs.839 In addition
to an extended deadline, the
Commission proposes to replace the
‘‘substantial and undue hardship’’
standard required for filing ACR
extensions with a ‘‘reasonable and
valid’’ standard.840 Further, the
Commission proposes to eliminate the
requirement that each SEF must
document the submission of the ACR to
the SEF’s board of directors or senior
officer in board minutes or some other
similar written record; 841 the
Commission notes that the Core
Principle 15 recordkeeping requirement
under proposed § 37.1501(f), as
discussed further below, would
incorporate this requirement.842 The
Commission also proposes to require a
CCO to submit an amended ACR to the
SEF’s board of directors or, in the
absence of a board of directors, the
senior officer of the SEF, for review
prior to submitting the amended ACR to
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836 17
CFR 37.1501(f)(4).
837 The Commission proposes to renumber
existing paragraph (f)(2) to paragraph (e)(2) and
amend the requirement as described. The
Commission also proposes to add a title to this
paragraph—‘‘Submission of annual compliance
report to the Commission.’’
838 NAL No. 17–61 at 4.
839 Id. at 2–3.
840 The Commission proposes to renumber
existing paragraph (f)(4) to paragraph (e)(4) and
amend the provision as described. The Commission
also proposes to add a title—‘‘Request for
extension.’’
841 The Commission proposes to eliminate this
requirement under existing paragraph (f)(1).
842 The Commission notes that existing
§ 37.1501(g) sets forth recordkeeping requirements
for SEFs related to the CCO’s duties. As discussed
below, the Commission is proposing to amend those
requirements. See infra Section XX.A.6.—
§ 37.1501(f)—Recordkeeping.
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the Commission; this approach is the
same as the requirements that exist for
submitting an initial ACR.843
In addition to the proposed
amendments described above related to
submitting the ACR, the Commission
proposes certain non-substantive
amendments to the remaining
provisions under proposed
§ 37.1501(e).844
Request for Comment
The Commission requests comment
on all aspects of proposed § 37.1501(e).
6. § 37.1501(f)—Recordkeeping 845
Existing Section 37.1501(g)(1)
currently requires a SEF to maintain a
copy of written policies and procedures
adopted in furtherance of compliance
with the Act and the Commissions
regulations; 846 copies of all materials
created in furtherance of the CCO’s
duties under existing §§ 37.1501(d)(8)–
(9); 847 copies of all materials in
connection with the review and
submission of the ACR; 848 and any
records relevant to the ACR.849 Existing
§ 37.1501(g)(2) requires the SEF to
maintain these records in accordance
with § 1.31 and part 45 of the
Commission’s regulations.850
The Commission proposes streamline
the recordkeeping requirements that
pertain to the CCO’s duties and the
preparation and submission of the ACR.
Accordingly, the Commission proposes
a revised general requirement under
proposed § 37.1501(f) that would
require the SEF to keep all records
demonstrating compliance with the
duties of the CCO and the preparation
and submission of the ACR consistent
with the recordkeeping requirements
under §§ 37.1000–1001.
843 The Commission proposes to renumber
existing paragraph (f)(3) to paragraph (e)(3) and add
a title—‘‘Amendments to annual compliance
report.’’ The Commission proposes to adopt this
requirement under subparagraph (e)(3)(i). The
Commission notes that under proposed
subparagraph (e)(3)(ii), an amended ACR would be
subject to the amended certification requirement,
i.e., a CCO must certify that the ACR is accurate and
complete in all material respects.
844 The Commission proposes to renumber
existing paragraph (f)(1) to paragraph (e)(1), adopt
non-substantive amendments to the existing
language, and add a title—‘‘Furnishing the annual
compliance report prior to submission to the
Commission.’’
845 The Commission proposes to renumber
existing subsection (g) to subsection (f).
846 17 CFR 37.1501(g)(1)(i).
847 17 CFR 37.1501(g)(1)(ii).
848 17 CFR 37.1501(g)(1)(iii).
849 17 CFR 37.1501(g)(1)(iv).
850 17 CFR 37.1501(g)(2).
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7. § 37.1501(g)—Delegation of
Authority 851
Section 37.1501(h)—‘‘Delegation of
authority’’—currently delegates the
authority to grant or deny a SEF’s
request for an extension of time to file
its ACR to the Director of DMO.852 In
addition to renumbering the provision
based on the amendments described
above, the Commission proposes to
adopt non-substantive amendments that
conform to the proposed amendments to
the Core Principle 15 regulations
discussed above.
XXI. Part 36—Trade Execution
Requirement
The Commission is proposing
regulations under part 36 to address the
broadened scope of swaps that will
become subject to the trade execution
requirement based on the proposed
interpretation of ‘‘makes the swap
available to trade’’ in CEA section
2(h)(8). In addition to an implementing
regulation, the Commission proposes
several exemptions from the
requirement for certain types of swap
transactions, as discussed below.
Further, the Commission proposes to
require that SEFs and DCMs file a
standardized form with the Commission
that details the swaps that they
respectively list for trading that are
subject to the requirement. The
Commission also proposes a new
provision to compel the Commission to
establish a centralized registry on its
website that reflects (i) the SEFs and
DCMs that list swaps subject to the
requirement; and (ii) the particular
swaps listed on each of those entities.
To transition trading of additional
swaps onto SEFs or DCMs pursuant to
the requirement, the Commission
additionally proposes a revised
compliance schedule.
A. § 36.1—Trade Execution
Requirement
1. § 36.1(a)—Trade Execution
Requirement
The Commission proposes § 36.1(a) to
codify the statutory language of the
trade execution requirement, which
requires counterparties to execute a
swap that is subject to the clearing
requirement on a DCM, a SEF or an
exempt SEF unless no such entity
‘‘makes the swap available to trade’’ or
the swap is subject to a clearing
exception in CEA section 2(h)(7).853 The
851 The Commission proposes to renumber
existing subsection (h) to subsection (g) based on
the changes described above.
852 17 CFR 37.1501(h).
853 7 U.S.C. 2(h)(8)(B). The Commission interprets
‘‘swap execution facility’’ in CEA section 2(h)(8)(B)
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Commission believes that the statutory
phrase ‘‘makes the swap available to
trade’’ specifies the listing of a swap by
a DCM, a SEF, or an exempt SEF on its
facility for trading.854 Accordingly,
§ 36.1(a) would specify that
counterparties must execute a
transaction subject to the clearing
requirement on a DCM, a SEF, or an
Exempt SEF that lists the swap for
trading.855
The Commission also proposes to
exempt certain types of swap
transactions from the trade execution
requirement pursuant to its exemptive
authority in CEA section 4(c). For the
purposes of promoting responsible
economic or financial innovation and
fair competition, CEA section 4(c)(1)
provides the Commission with the
authority to exempt any agreement,
contract, or transaction from any CEA
provision, subject to specified factors.856
CEA section 4(c)(2) prohibits the
Commission from providing an
exemption from any requirements in
CEA section 4(c)(1), unless the
Commission determines that (i) the
requirement should not be applied to
the agreement, contract, or transaction
for which the exemption is sought; (ii)
the exemption would be consistent with
the public interest and the purposes of
the Act; (iii) the agreement, contract, or
transaction at issue will be entered into
solely between appropriate persons; 857
and (iv) the agreement, contract, or
transaction at issue will not have a
material adverse effect on the ability of
the Commission or exchange to
to include a swap execution facility that is exempt
from registration pursuant to CEA section 5h(g). See
supra note 10. See also supra Section IV.I.4.a.—
§ 36.1(a)—Trade Execution Requirement.
854 See supra Section IV.I.4.a.—§ 36.1(a)—Trade
Execution Requirement. As discussed below, the
Commission is proposing an exemption from the
requirement for swap transactions involving swaps
that are listed for trading only by an Exempt SEF.
See infra Section XXI.A.2.—§ 36.1(b)—Exemption
For Certain Swaps Listed Only By Exempt SEFs.
855 See supra Section IV.I.4.a.—§ 36.1(a)—Trade
Execution Requirement.
856 7 U.S.C. 6(c)(1). CEA section 4(c)(1) is
intended to allow the Commission to ‘‘provid[e]
certainty and stability to existing and emerging
markets so that financial innovation and market
development can proceed in an effective and
competitive manner.’’ House Conf. Report No. 102–
978, 102d Cong. 2d Sess. at 81 (Oct. 2, 1992),
reprinted in 1992 U.S.C.C.A.N. 3179, 3213.
857 7 U.S.C. 6(c)(3). CEA section 4(c)(3) includes
a number of specified categories of persons within
‘‘appropriate persons’’ that are deemed as
appropriate to enter into swaps exempted pursuant
to CEA section 4(c). This includes persons the
Commission determines to be appropriate in light
of their financial profile or other qualifications, or
the applicability of appropriate regulatory
protections. For purposes of considering the CEA
section 4(c) exemptions within this proposal, the
Commission believes that ECPs would qualify as
‘‘appropriate persons.’’
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discharge its regulatory or selfregulatory duties under the Act.858
As discussed below, the Commission
specifically proposes exemptions from
the trade execution requirement for the
following transactions that would
otherwise be subject to that
requirement: (i) Swap transactions
involving swaps that are listed for
trading only by an Exempt SEF; (ii)
swap transactions for which the clearing
exceptions in CEA section 2(h)(7) or the
clearing exceptions or exemptions
under part 50 apply; (iii) swap
transactions that are executed as a
component of a package transaction that
includes a component that is a new
issuance bond; and (iv) swap
transactions between ‘‘eligible affiliate
counterparties’’ (‘‘inter-affiliate
counterparties’’) that elect to clear such
transactions, notwithstanding their
ability to elect the relevant clearing
exemption under § 50.52.
2. § 36.1(b)—Exemption For Certain
Swaps Listed Only By Exempt SEFs
The Commission proposes § 36.1(b) to
establish an exemption from the trade
execution requirement that may be
elected by counterparties to a swap that
is subject to the trade execution
requirement, but is listed for trading
only by Exempt SEFs.859 The
Commission believes that exempting
these types of transactions from the
trade execution requirement would be
consistent with the objectives of CEA
section 4(c).
As noted above, CEA section
2(h)(8)(A) provides that counterparties
to transactions involving a swap subject
to the clearing requirement must
execute the transaction on a DCM
designated under CEA section 5, a SEF
registered under CEA section 5h or a
SEF that is exempt from registration
under CEA 5h(g).860 CEA section
2(h)(8)(B), however, specifies that this
requirement does not apply if no DCM
or swap execution facility makes the
858 7 U.S.C. 6(c)(2). Notwithstanding the adoption
of exemptions from the Act, the Commission
emphasizes that their use is subject to the
Commission’s antifraud and anti-manipulation
enforcement authority. In this connection,
§ 50.10(a) prohibits any person from knowingly or
recklessly evading or participating in, or
facilitating, an evasion of CEA section 2(h) or any
Commission rule or regulation adopted thereunder.
17 CFR 50.10(a). Further, § 50.10(c) prohibits any
person from abusing any exemption or exception to
CEA section 2(h), including any associated
exemption or exception provided by rule,
regulation, or order. 17 CFR 50.10(c).
859 The Commission notes, however, that once a
swap subject to the clearing requirement is listed by
a SEF or a DCM, then counterparties may not use
this exemption and would be required to comply
with the trade execution requirement.
860 7 U.S.C. 2(h)(8)(A).
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swap available to trade (emphasis
added).861 The Commission interprets
the phrase ‘‘swap execution facility’’ in
CEA section 2(h)(8)(B) to include both
registered SEFs and SEFs that are
exempt from registration pursuant to
section 5h(g), given the references in
section 2(h)(8)(A) and the applicability
of section 5h to both types of entities.862
Therefore, under the Commission’s
proposed interpretation of ‘‘makes the
swap available to trade,’’ either a
registered SEF or an Exempt SEF that
lists a swap subject to the clearing
requirement for trading can make the
swap ‘‘available to trade,’’ thereby
triggering the trade execution
requirement for that swap.
While the Commission interprets CEA
section 2(h)(8) to mean that the listing
of a swap by an Exempt SEF would
trigger the trade execution requirement,
the Commission believes that it would
be appropriate to exempt such listings
from the requirement, given that the
Commission does not oversee the listing
of swaps by Exempt SEFs. To list new
contracts SEFs submit their products for
Commission review pursuant to the part
40 filing requirements.863 The
Commission reviews a new swap
contract to ensure that it is consistent
with the CEA and applicable
Commission regulations, including the
requirement that the contract not be
susceptible to manipulation. Upon
listing, a SEF, under Commission
oversight, remains responsible for
ensuring that the contract continues to
comport with the CEA and applicable
Commission regulations. In contrast, the
Commission does not have oversight
authority with respect to the listing of
new contracts by Exempt SEFs.
The Commission believes that
exempting swaps subject to the clearing
requirement that are listed exclusively
by Exempt SEFs should have little
practical impact on the number of
products that become subject to the
trade execution requirement. Given the
internationally competitive nature of the
swaps industry, the Commission
believes that SEFs and DCMs will likely
list many of the same swaps listed by
Exempt SEFs. The Commission also
emphasizes that once the trade
execution requirement is triggered for a
particular swap by a SEF or DCM that
lists the swap, the requirement may be
satisfied by executing the swap on not
only a SEF or DCM, but also on an
Exempt SEF as well.
861 7
U.S.C. 2(h)(8)(B).
supra note 10.
863 17 CFR 40.2–3.
862 See
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a. Discussion of CEA Section 4(c)
Enumerated Factors
For the reasons stated above, the
Commission believes that exempting a
swap subject to the clearing requirement
that is listed for trading only on an
Exempt SEF from triggering the trade
execution requirement would be
consistent with the objectives of CEA
section 4(c).
Given that the number of swaps that
are subject to the clearing requirement
and only listed by Exempt SEFs is likely
small, the Commission believes that the
proposed exemption is appropriate and
would be consistent with the public
interest and purposes of the CEA. The
Commission believes that the proposed
regulation would not have a material
adverse effect on the ability of the
Commission or any SEF or DCM to
discharge its regulatory or selfregulatory duties under the Act. The
Commission notes that under the
proposed exemption, swap agreements,
contracts, and transactions would still
be entered into solely between ECPs,864
who the Commission believes, for
purposes of this proposal, to be
appropriate persons.
Request for Comment
The Commission requests comment
on all aspects of proposed § 36.1(b),
including whether the proposed
exemptive relief is consistent with the
public interest and the other
requirements of CEA section 4(c). In
particular, the Commission requests
comment on the following question:
(92) Pursuant to its authority in CEA
section 4(c), should the Commission
exempt swaps that are subject to the
clearing requirement and listed for
trading only by an Exempt SEF from the
trade execution requirement, until such
swaps are listed by a SEF or DCM?
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3. § 36.1(c)—Exemption for Swap
Transactions Excepted or Exempted
From the Clearing Requirement Under
Part 50
The Commission proposes § 36.1(c) to
establish an exemption to the trade
execution requirement for swap
transactions for which an exception or
exemption has been elected pursuant to
part 50. The proposed exemption would
apply to any transaction for which (i) a
clearing exception under § 50.50 or a
clearing exemption under § 50.51 or
§ 50.52 has been elected; or (ii) a future
exemption that has been adopted by the
864 As noted above, pursuant to CEA section 2(e),
it is unlawful for any U.S. person other than an
ECP, as defined in CEA section 1a(18), to enter into
a swap unless the swap is entered into on, or
subject to the rules of, a DCM. 7 U.S.C. 2(e).
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Commission under part 50 would apply.
The Commission has determined that
exempting these types of transactions
from the trade execution requirement
would be consistent with the objectives
of CEA section 4(c).
The Act and the Commission’s
regulations specify that certain
transactions that are not subject to the
clearing requirement are not subject to
the trade execution requirement. CEA
section 2(h)(8) clearly establishes that
transactions that are not subject to the
clearing requirement pursuant to a
clearing exception in CEA section
2(h)(7) are not subject to the trade
execution requirement.865 CEA section
2(h)(7), i.e., the end-user exception,
provides a clearing exception to a swap
transaction if one of the counterparties
(i) is not a financial entity; (ii) is using
the swap to hedge or mitigate
commercial risk; and (iii) notifies the
Commission about how it generally
meets its financial obligations
associated with entering into uncleared
swaps.866 The Commission adopted
requirements under § 50.50 to
implement this exception.867
In contrast to swaps that are eligible
for the end-user exception, however,
swaps that are not subject to the clearing
requirement based on other statutory
authority are currently not expressly
exempted from the trade execution
requirement. Pursuant to its exemptive
authority in CEA section 4(c), the
Commission has provided additional
exemptions from the clearing
requirement for swaps between certain
types of entities, as well as for certain
types of swap transactions. Section
50.51 allows certain cooperatives—
those that otherwise consist entirely of
entities that would qualify for the enduser exception—to elect a clearing
exemption for swaps executed with a
member of an exempt cooperative.868
Section 50.52 allows inter-affiliate
counterparties who have ‘‘eligible
affiliate counterparty status’’ to elect a
clearing exemption for swaps that are
entered into between the affiliated
parties.869 The Commission notes that it
865 7
U.S.C. 2(h)(8)(B).
U.S.C. 2(h)(7).
867 7 U.S.C. 2(h)(7). Among other things, § 50.50
establishes when a swap transaction is considered
to hedge or mitigate commercial risk; specifies how
to satisfy the reporting requirement; and exempts
small financial institutions from the definition of
‘‘financial entity.’’ 17 CFR 50.50.
868 17 CFR 50.51. The exemption applies to swaps
that are executed in connection with originating a
loan or loans for the member of the cooperative, or
hedging or mitigating commercial risk related to
member loans or arising from swaps related to
originating loans for members. 17 CFR 50.51(b)(1)–
(2).
869 17 CFR 50.52. Counterparties have ‘‘eligible
affiliate counterparty status’’ if one counterparty,
has also proposed, pursuant to CEA
section 4(c), to exempt transactions by
eligible bank holding companies,
savings and loan holding companies,
and community development financial
institutions from the clearing
requirement.870
The Commission believes that
applying the trade execution
requirement to swaps that are eligible
for a clearing exception or clearing
exemption potentially mitigates the
benefits that are associated with that
exception or exemption. For example, a
counterparty that determines not to
clear a swap pursuant to a clearing
exemption, but otherwise remains
subject to the trade execution
requirement, would be limited in where
it may trade or execute that swap and
may incur additional costs related to
SEF onboarding. Therefore, in order to
fully preserve the benefits of a clearing
exception or clearing exemption, the
Commission believes swaps that are
excepted or exempted from the clearing
requirement should not be subject to the
trade execution requirement.
a. Discussion of CEA Section 4(c)
Enumerated Factors
For the reasons stated above, the
Commission believes that exempting a
swap transaction, for which a clearing
exception or clearing exemption have
been elected pursuant to part 50, from
the trade execution requirement would
be consistent with the objectives of CEA
section 4(c).
Given that the scope of this proposed
exemption is limited and applies to
transactions that are already excepted or
exempted from the clearing
requirement, the Commission believes
that the proposed regulation would not
have a material adverse effect on the
ability of the Commission or any SEF or
DCM to discharge its regulatory or selfregulatory responsibilities under the
CEA and the Commission’s regulations.
The Commission believes that under the
proposed exemption, swap transactions
would still be entered into solely
between ECPs, who the Commission
believes, for purposes of this proposal,
to be appropriate persons.871
866 7
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directly or indirectly, holds a majority ownership
interest in the other counterparty; or a third party,
directly or indirectly, holds a majority ownership
interest in both counterparties. 17 CFR
50.52(a)(1)(i)–(ii). To elect the exemption, such
counterparties must also meet additional
conditions, including reporting requirements. 17
CFR 50.52(b)–(c).
870 Amendments to Clearing Exemption for Swaps
Entered Into by Certain Bank Holding Companies,
Savings and Loan Holding Companies, and
Community Development Financial Institutions, 83
FR 44001 (proposed Aug. 29, 2018).
871 See supra note 857 (discussing the scope of
‘‘appropriate persons’’).
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Request for Comment
The Commission requests comment
on all aspects of proposed § 36.1(c),
including whether the proposed
exemptive relief is consistent with the
public interest and the other
requirements of CEA section 4(c). In
particular, the Commission requests
comment on the following question:
(93) Pursuant to its authority in CEA
section 4(c), should the Commission
exempt swap transactions that are
subject to a clearing exception or
clearing exemption under part 50 from
the trade execution requirement?
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4. § 36.1(d)—Exemption for Swaps
Executed With Bond Issuance
The Commission proposes § 36.1(d) to
establish an exemption to the trade
execution requirement for swap
transactions that are components of a
‘‘New Issuance Bond’’ package
transaction. The Commission believes
that exempting these types of
transactions from the trade execution
requirement would be consistent with
the objectives of CEA section 4(c). This
proposed approach is consistent with
the time-limited no-action relief
provided by Commission staff for this
category of package transactions.872
New Issuance Bond package
transactions include at least one
individual swap component that is
subject to the trade execution
requirement and at least one individual
component that is a bond 873 issued and
sold in the primary market.874 An
underwriter (on behalf of an issuer)
arranges the issuance of a bond
packaged with a fixed-to-floating IRS
that features the issuer as a
counterparty. The terms of the IRS,
which include tenor and payment
terms, typically match the terms of the
bond issuance. By issuing a bond with
a fixed-to-floating IRS, issuers are able
to effectively turn fixed-rate liabilities
into variable rate liabilities, or vice
872 See supra note 334 (describing the no-action
relief from the trade execution requirement
provided by Commission staff for categories of
package transactions).
873 The Commission notes that this proposed
exemption would not apply to swap components of
package transactions that include sovereign debt,
such as U.S. Treasury bonds, notes, and bills.
874 The Commission understands that a bond
issued and sold in the primary market that may
constitute part of a package transaction is a
‘‘security,’’ as defined in section 2(a)(1) of the
Securities Act of 1933 or section 3(a)(10) of the
Securities Exchange Act of 1934. To the extent that
counterparties may be facilitating package
transactions that involve a security, or any
component agreement, contract, or transaction over
which the Commission does not have exclusive
jurisdiction, the Commission does not opine on
whether such activity complies with other
applicable law and regulations.
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versa.875 To correspond the terms
between these two components and
facilitate the bond issuance in an
efficient and cost-effective manner, the
IRS component is customized and
negotiated in a manner that closely
corresponds to the bond issuance
process.
Given the role of the issuer in the
package transaction—both as issuer of
the bond and a counterparty to the
swap—and the process under which the
swap is negotiated,876 this type of
package transaction has not been
conducive to execution on a SEF trading
system or platform. The Commission
notes that the no-action relief that has
been provided by Commission staff for
these swaps components reflects the
ongoing lack of an available execution
method on an appropriate venue.877
Based on the integral role of the bond
issuance in facilitating the component
swap execution, the Commission
believes that the IRS component is not
suitable for execution on a SEF, even
where a SEF may offer flexible means of
execution.
Therefore, consistent with current noaction relief provided by Commission
staff, the Commission proposes to
exempt swap components of a New
Bond Issuance package transaction from
the trade execution requirement. The
proposed exemption would establish
that a ‘‘package transaction’’ consists of
two or more component transactions
executed between two or more
counterparties, where (i) execution of
each component transaction is
contingent upon the execution of all
other components transactions; and (ii)
the component transactions are priced
or quoted together as one economic
transaction with simultaneous or near
simultaneous execution of all
components. The Commission
recognizes the inherent challenges in
trading or executing these swap
components on a SEF or DCM and,
therefore, recognizes the benefits of
continuing to allow market participants
to maintain established market practices
875 For example, a bond issuer seeks to pay
variable rates on its bonds, but prospective
investors may seek a fixed rate of return. By
arranging a New Issuance Bond package
transaction, the bond issuer can issue a fixed-rate
bond and simultaneously enter into an offsetting
IRS. The IRS enables the issuer to receive a fixed
rate that matches the fixed rate on its bond to be
issued, while paying the variable rate that it
originally sought. Ultimately, this arrangement may
allow the bond issuer to issue the fixed-rate bond
at a lower cost.
876 The Commission notes that these types of
package transactions differ from other package
transactions that involve the purchase or sale of a
security in the secondary market, given that they
involve the issuance of a new security.
877 NAL No. 17–55 at 2–3.
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with respect to this type of package
transaction.
a. Discussion of CEA Section 4(c)
Enumerated Factors
The Commission believes that
exempting swap components of New
Issuance Bond package transactions
from the trade execution requirement
would be consistent with the objectives
of CEA section 4(c).
The Commission recognizes the
importance of new bond issuances in
helping market participants to raise
capital and fund origination loans for
businesses and homeowners.
Accordingly, the Commission
recognizes that allowing the swap
components of New Bond Issuance
package transaction to be executed away
from a SEF or DCM—consistent with
current market practice—is integral to
facilitating the bond issuance. Further,
the Commission recognizes that the
proposed exemption is limited in
nature, i.e., the swap transaction
remains subject to all other applicable
Commission rules and regulations.
The Commission believes, therefore,
that the proposed exemption from the
trade execution requirement for swap
components of New Issuance Bond
package transactions is appropriate and
would be consistent with the public
interest and purposes of the CEA. The
Commission further believes that the
proposed regulation would not have a
material adverse effect on the ability of
the Commission or any SEF or DCM to
discharge its regulatory or selfregulatory duties under the CEA. The
Commission notes that under the
proposed exemption, swap transactions
would still be entered into solely
between ECPs, who the Commission
believes, for purposes of this proposal,
to be appropriate persons.
Request for Comment
The Commission requests comment
on all aspects of the proposed
exemption of swap components of New
Issuance Bond package transactions
from the trade execution requirement
under proposed § 36.1(d), including
whether the proposed exemptive relief
is consistent with the public interest
and the other requirements of CEA
section 4(c). The Commission
specifically requests comment on the
following questions:
(94) Pursuant to its authority in CEA
section 4(c), should the Commission
exempt the swap components of a New
Issuance Bond package transaction from
the trade execution requirement?
(95) Is the proposed definition of
‘‘package transaction’’ in proposed
§ 36.1(d)(1) appropriate?
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(96) Are there additional package
transactions that should be exempt from
the trade execution requirement? If so,
then please describe in detail why such
package transactions should be exempt
from the trade execution requirement,
especially in light of the flexible means
of execution the Commission is
proposing to allow for all swaps listed
by a SEF.
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5. § 36.1(e)—Exemption for Swaps
Executed Between Affiliates That Elect
To Clear
The Commission proposes § 36.1(e) to
establish an exemption from the trade
execution requirement that may be
elected by inter-affiliate counterparties
to a swap that is submitted for clearing.
Counterparties would be eligible to elect
the exemption by meeting the
conditions set forth under § 50.52(a) for
‘‘eligible affiliate counterparty’’
status.878 The Commission notes that
this proposed exemption would apply
to transactions that inter-affiliate
counterparties elect to clear,
notwithstanding their ability to elect the
clearing exemption.
Based on time-limited no-action relief
granted by Commission staff, interaffiliate counterparties that do not elect
the § 50.52 clearing exemption are
executing swaps away from a SEF or
DCM that are otherwise subject to the
trade execution requirement.879 The
relief has been granted to address the
difficulty cited by market participants in
executing inter-affiliate swap
transactions through the required
878 See supra note 869 (describing requirements
for meeting ‘‘eligible affiliate counterparty’’ status).
879 CFTC Letter No. 17–67, Re: Extension of NoAction Relief from Commodity Exchange Act
Section 2(h)(8) for Swaps Executed Between Certain
Affiliated Entities that Are Not Exempt from
Clearing Under Commission Regulation 50.52 (Dec.
14, 2017) (‘‘NAL No. 17–67’’); CFTC Letter No. 16–
80, Re: Extension of No-Action Relief from
Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities that
Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Nov. 28, 2016); CFTC Letter No.
15–62, Re: Extension of No-Action Relief from
Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities that
Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Nov. 17, 2015); CFTC Letter No.
14–136, Re: Extension of No-Action Relief from
Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities that
Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Nov. 7, 2014); CFTC Letter No.
14–26, Time-Limited No-Action Relief from the
Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities Not
Electing Commission Regulation § 50.52 (Mar. 6,
2014). As discussed above, the Commission
previously stated that transactions subject to the
inter-affiliate exemption from clearing would also
be exempt from the trade execution requirement.
See supra Section XXI.A.3.—§ 36.1(c)—Exemption
for Swap Transactions Excepted or Exempted from
the Clearing Requirement under Part 50.
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methods of execution prescribed for
swaps subject to the trade execution
requirement under § 37.9, i.e., Order
Book and RFQ System. In particular,
executing these transactions via
competitive means of execution would
be difficult because inter-affiliate swaps
are generally not intended to be
executed on an arm’s-length basis or
based on fully competitive pricing.880
Rather, such swaps are used as tools to
manage risk between affiliates and are
carried out through internal accounting
processes.881 Market participants have
asserted that forcing these transactions
to be executed through a SEF would
impose unnecessary costs and
inefficiencies without any related
benefits.882 The Commission believes
that requiring these types of transactions
to be executed on a SEF would likely
confer less benefit to the overall swaps
markets and inhibit inter-affiliate
counterparties from efficiently
executing these types of transactions for
operational purposes.
a. Discussion of CEA Section 4(c)
Enumerated Factors
The Commission believes that
exempting a swap executed between
inter-affiliate counterparties that is
submitted for clearing from the trade
execution requirement would be
consistent with the objectives of CEA
section 4(c).
As noted above, these transactions are
not intended to be arm’s-length, marketfacing, or competitively executed under
any circumstance, irrespective of the
type of swap involved. Therefore, the
nature of these transactions mitigates
the potential benefits of their execution
on a SEF or a DCM. The Commission
believes this proposed exemption would
ensure that inter-affiliate counterparties
would be able to efficiently utilize the
risk management approach that best
suits their individual needs, such as
clearing inter-affiliate swaps, without
being unduly influenced by whether
that choice would require them to
execute swaps on a SEF. Notably, the
Commission’s proposed rules would
allow SEFs to provide more flexible
means of execution and, thus, could
880 See
NAL No. 17–67 at 2.
the 2013 Inter-Affiliate Final Rule,
commenters explained that corporate groups can
use a single conduit in the market on behalf of
multiple affiliates within the group, which permits
the corporate group to net affiliates’ trades. This
netting effectively reduces the overall risk of the
corporate group and the number of open positions
with external market participants, which in turn
reduces operational, market, counterparty credit,
and settlement risk. Clearing Exemption for Swaps
Between Certain Affiliated Entities, 78 FR 21750,
21753–54 (Apr. 11, 2013).
882 NAL No. 17–67 at 2.
881 In
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address some of the issues currently
cited with respect to executing interaffiliate transactions on a SEF.
Nevertheless, the Commission believes
that the policy justifications described
above support an exemption for such
inter-affiliate swap transactions from the
trade execution requirement.
The Commission believes, therefore,
that the proposed exemption from the
trade execution requirement for interaffiliate counterparties is appropriate,
and it would be consistent with the
public interest and purposes of the CEA.
Given the limited applicability of this
proposed exemption to transactions
only executed between inter-affiliates,
the Commission believes that the
proposed regulation would not have a
material adverse effect on the ability of
the Commission or any SEF or DCM to
discharge its regulatory or selfregulatory duties under the CEA.
Finally, the Commission notes that
under the proposed exemption, swap
transactions would still be entered into
solely between ECPs, who the
Commission believes, for purposes of
this proposal, to be appropriate
persons.883
Request for Comment
The Commission requests comment
on all aspects of proposed § 36.1(e),
including whether the proposed
exemptive relief is consistent with the
public interest and the other
requirements of CEA section 4(c). In
particular, the Commission requests
comment on the following questions:
(97) Pursuant to its authority in CEA
section 4(c), should the Commission
exempt transactions between interaffiliate counterparties who do not elect
the inter-affiliate clearing exemption
from the trade execution requirement?
(98) Should the Commission also
consider exempting end-users that meet
the criteria for a clearing exception in
CEA section 2(h)(7) from the trade
execution requirement regardless of
whether they elect to use the end-user
clearing exception?
B. § 36.2—Registry of Registered Entities
Listing Swaps Subject to the Trade
Execution Requirement; Appendix A to
Part 36—Form TER
The Commission currently provides
information on its website regarding the
swaps that are subject to the trade
execution requirement. In addition to
providing a chart that identifies those
swaps,884 the Commission also posts the
883 See supra note 857 (discussing the scope of
‘‘appropriate persons’’).
884 CFTC, Industry Filings—Swaps Made
Available to Trade, available at https://
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corresponding MAT determinations
submitted pursuant to part 40’s rule
filing procedures.885 While this
approach has been effective in
informing market participants about the
limited number of swaps currently
subject to the trade execution
requirement, the Commission expects
that the number of swaps that would be
subject to the requirement will increase.
To ensure that market participants have
notice of the swaps that are subject to
the trade execution requirement and the
venues listing those swaps, the
Commission proposes to create a
registry under § 36.2(a) that will set
forth the swaps that are subject to the
trade execution requirement, and the
SEFs and DCMs that list such swaps.886
To help the Commission publish and
maintain such a registry, the
Commission also proposes a
requirement under § 36.2(b) and
Appendix A to part 36 that SEFs and
DCMs submit a standardized Form TER.
Form TER would detail the swaps that
they list that are subject to or
subsequently become subject to the
clearing requirement. The Commission
further proposes to require that a SEF or
DCM submit a Form TER concurrently
with any § 40.2 or § 40.3 product filing
that consists of a swap that is subject to
the clearing requirement. In addition,
the Commission proposes that SEFs and
DCMs file a Form TER, for any swaps
they currently list that are subject to the
clearing requirement, ten business days
prior to the effective date of any final
rule adopted from this notice. To
effectuate this proposed change
initially, the Commission is proposing
that the effective date for proposed
§ 36.2 occur twenty days prior to
effective date for the rest of this
proposed rule. The Commission
believes that this earlier effective period
would provide SEFs and DCMs
sufficient time to file their initial Form
TERs and give Commission staff
sufficient time to review and process
these initial Form TERs. Finally, for
swaps that are listed by a SEF or DCM
that subsequently become subject to the
clearing requirement, the Commission
www.cftc.gov/idc/groups/public/@otherif/
documents/file/swapsmadeavailablechart.pdf.
885 CFTC, Industry Filings—Swaps Made
Available to Trade Determination, available at
https://sirt.cftc.gov/sirt/sirt.aspx?
Topic=%20SwapsMadeAvailableToTrade
Determination.
886 The Commission notes that the proposed
registry would not include information regarding
the swaps subject to the trade execution
requirement that are listed by Exempt SEFs. The
Commission, however, anticipates that it will
provide a list of the Exempt SEFs on which market
participants may execute those swaps, subject to
their availability on those facilities.
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proposes to require that SEFs and DCMs
file Form TER ten business days prior to
the effective date of that requirement for
such swaps. By requiring SEFs and
DCMs to file Form TER prior to the
effective date of such requirements,
Commission staff would have sufficient
time to review, compile Form TERs, and
publish its trade execution requirement
registry on its website.
Form TER in Appendix A to part 36
would require a SEFs or DCM to provide
the specific relevant economic terms of
the swaps that it lists for trading. Each
SEF or DCM that lists a swap that is
subject to or becomes subject to the
clearing requirement would be required
to file an initial Form TER that details
all such listed swaps. Any subsequent
changes to a SEF’s or DCM’s listing of
such swaps, such as additional listed
swaps that later become subject to the
clearing requirement, would require the
SEF or DCM to amend its Form TER to
reflect that scope. For IRS listed for
trading, Form TER would require a SEF
or DCM to specify (i) product class/
specification; (ii) currency; (iii) floating
rate index; (iv) stated termination date;
(v) optionality; (vi) dual currencies; and
(vii) conditional notional amounts. For
CDS listed for trading, Form TER would
require a SEF or DCM to specify (i)
product class/specification; (ii)
reference entities; (iii) region; (iv)
indices; (v) tenor; (vi) applicable series;
and (vii) tranche. The Commission notes
that the scope of required information
corresponds to the scope of information
provided under § 50.4 for IRS and CDS
that are subject to the clearing
requirement.
The Commission believes that Form
TER would provide the information
needed to efficiently produce a trade
execution requirement registry under
§ 36.2. Given the potentially large
number of filings and swaps that would
comprise the trade execution
requirement registry, the Commission
believes that uniform submissions
through a standardized Form TER will
foster efficient processing of the
submissions and uniform presentation
of relevant information in the registry.
The Commission also proposes to
require under § 36.2(c) that DCMs and
SEFs publicly post their respective
Form TER filings on their respective
websites, and promptly amend any
inaccurate Form TERs.
Request for Comment
The Commission requests comment
on all aspects of proposed § 36.2 and
proposed Form TER in Appendix A to
part 36. In particular, the Commission
requests comment on the following
questions:
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62041
(99) Does the proposed Form TER
request appropriate and sufficient
information? If not, then what
information should the Commission
request, and why?
(100) What information should the
Commission include in the trade
execution requirement registry, and
why?
C. § 36.3—Trade Execution Requirement
Compliance Schedule
The Commission observes that with
the proposed elimination of the existing
MAT determination process and the
expanded scope of swaps that would be
subject to the trade execution
requirement under proposed § 36.1,
counterparties may require additional
time to prepare and update their
business practices and technological
and operational capabilities to trade and
execute these swaps on a SEF or DCM.
For example, market participants would
have to directly on-board to a SEF or
DCM, or otherwise avail themselves of
other means of access, to continue
trading those swaps that become newly
subject to the trade execution
requirement. Therefore, the Commission
proposes to eliminate the existing trade
execution requirement compliance
schedule 887 and to replace it with a new
compliance schedule, based on
participant type, for the additional
swaps that become subject to the
expanded trade execution requirement.
The proposed compliance schedule
would be triggered on the effective date
of any final rule adopted from this
notice. The Commission has designed
this proposed compliance schedule to
ensure a smooth and timely
implementation of the expanded
requirement.
In formulating the proposed
compliance schedule, the Commission
considered the expanded scope of
swaps that would become subject to the
trade execution requirement. The
Commission also referred to the
compliance schedule previously
established for the initial
implementation of the clearing
requirement, with a focus on the
defined categories of market
participants and respective levels of
swap trading activity.888 Accordingly,
the proposed approach recognizes that
different categories of counterparties
have different abilities and resources for
achieving compliance and is designed to
provide counterparties with sufficient
time to adapt to the expanded trade
execution requirement.
887 17
888 17
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The proposed schedule would
establish different compliance dates for
different categories of counterparties, as
described below. As specified under
proposed § 36.3(d), however, nothing in
this proposed compliance schedule
should be construed to prohibit
counterparties from voluntarily
complying with the trade execution
requirement sooner than prescribed in
the proposed compliance schedule.
Finally, the Commission notes that
pursuant to proposed § 36.3(b), the
compliance schedule would not apply
to swaps that are already subject to the
trade execution requirement before the
effective date of any final rule.
Accordingly, market participants must
continue to comply with the existing
trade execution requirement for those
swaps.
1. § 36.3(c)(1)—Category 1 Entities
Under § 36.3(c)(1), a Category 1 entity,
which would include swap dealers,
major swap participants, security-based
swap dealers, or major security-based
swap participants, would have ninety
days to comply with the expanded trade
execution requirement when it executes
a swap transaction with another
Category 1 entity or a non-Category 1
entity that voluntarily seeks to execute
the swap on a SEF, a DCM, or an
Exempt SEF. The Commission believes
that a ninety-day time frame would be
a reasonable period for these entities
because they possess experience in the
swaps market and resources to comply
with the requirement sooner than other
counterparties. Further, the Commission
believes that Category 1 entities are
generally the most active participants in
the swaps market, often serving as
market makers and liquidity providers
to other participants. As the initial
category of participants that are required
to comply with the expanded trade
execution requirement, the Commission
believes that Category 1 entities are best
equipped to work internally and with
the trading venues, i.e., SEFs and DCMs,
to operate under the expanded trade
execution requirement.
The Commission also believes that
ninety days is a reasonable period of
time for SEFs and DCMs to prepare to
facilitate trading in additional swaps
that would become subject to the
expanded trade execution requirement.
In particular, the Commission notes that
some SEFs already list many of the
types of swaps that would become
subject to the expanded requirement.889
Therefore, the Commission expects that
the SEFs and DCMs that list these types
of swaps would be both technologically
889 See
supra note 280.
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and operationally ready to offer the
expanded number of swaps within
ninety days.
2. § 36.3(c)(2)—Category 2 Entities
The Commission proposes § 36.3(c)(2)
to provide Category 2 entities with 180
days to comply with the expanded trade
execution requirement when they
execute swap transactions with a
Category 1 entity, another Category 2
entity, or other counterparties that
voluntarily seek to execute the swap on
a SEF, a DCM, or an Exempt SEF.
Category 2 entities would include
commodity pools; private funds as
defined in section 202(a) of the
Investment Advisers Act of 1940; or
persons predominantly engaged in
activities related to the business of
banking, or in activities that are
financial in nature as defined in section
4(k) of the Bank Holding Company Act
of 1956.
The Commission believes that a
significant amount of swaps trading
would migrate to SEFs or DCMs upon
the compliance date for Category 2
entities because they consist of many
active liquidity takers. Nevertheless, the
Commission believes that an additional
ninety days to comply with the
expanded trade execution requirement
would be reasonable for Category 2
entities, given that they may not have
the same level of swaps trading
expertise or resources as Category 1
entities. The Commission believes that
it is essential for these entities to have
sufficient time to transition their trading
to venue-based environments.
3. § 36.3(c)(3)—Other Counterparties
The Commission proposes § 36.3(c)(3)
to provide all entities that are not either
Category 1 entities or Category 2 entities
with 270 days to comply with the
expanded trade execution requirement.
The Commission believes that entities
that do not qualify as either a Category
1 entity or Category 2 entity should be
provided the greatest amount of time to
comply with the expanded trade
execution requirement because they
likely have less sophistication in swaps
trading. Of all of the participants in the
swaps market, the Commission believes
that the participants in this category are
least likely to have on-boarded to or
have experience trading swaps through
SEFs or DCMs. Further, the Commission
understands that onboarding onto such
venues can be an intensive and timeconsuming process. Therefore, the
Commission believes that this
additional time will help ensure that
these participants have sufficient time
to onboard or establish means of access
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and are prepared to trade on a SEF or
DCM.
4. § 36.3(e)—Future Compliance
Schedules
Under proposed § 36.3(e), the
Commission would devise an
appropriate compliance schedule when
additional swaps listed by a SEF or
DCM are subject to the trade execution
requirement in the future i.e., after the
effective date of any final rules that are
associated with this part and upon the
issuance of additional clearing
requirement determinations. The
Commission believes that this approach
will provide it with sufficient flexibility
to promote compliance in a manner that
balances the Commission’s policy goal
of promoting trading on SEFs and DCMs
while also accounting for different
considerations, such as the nature of the
swap products, their availability on
multiple trading venues, and the
readiness of relevant market
participants to trade those products
through a SEF or DCM.
Request for Comment
The Commission requests comment
on all aspects of the proposed
compliance schedule in proposed
§ 36.3. The Commission specifically
requests comment on the following
questions:
(101) Are the proposed compliance
schedules for Category 1 Entities,
Category 2 Entities, and all other entities
appropriate? If not, then should the
Commission consider longer or shorter
compliance time frames and why?
(102) Are the entities included in
Category 1 and Category 2 appropriate?
If not, then please explain why. Should
additional entities be included within
either Category 1 or Category 2 and
why?
(103) Are the compliance schedule
time frames adequate for SEFs and
DCMs to be technologically and
operationally ready for the expanded
trade execution requirement? If not,
then what alternative compliance
schedule time frame should the
Commission consider and why?
(104) How should the Commission
handle the compliance schedules for
any future expansions of the trade
execution requirement?
XXII. Part 43—§ 43.2—Definition of
‘‘Block Trade’’
Section 43.2 defines a swap ‘‘block
trade’’ as a publicly reportable swap
transaction that (i) involves a swap that
is listed on a SEF or DCM; (ii) occurs
away from the SEF’s or DCM’s trading
system or platform and is executed
pursuant to the SEF’s or DCM’s rules
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and procedures; (iii) has a notional or
principal amount at or above the
appropriate minimum block trade size
applicable to such swap; and (iv) is
reported subject to the rules or
procedures of the SEF or DCM and the
rules set forth under part 43, including
the appropriate time delay requirements
set forth under § 43.5.890 In specifying
these elements, the Commission
considered the treatment of block trades
in various swap and non-swap
markets.891 In particular, the
Commission looked to the futures
markets, where futures block trades are
‘‘permissible, privately-negotiated
transaction[s] that equal[ ] or exceed[ ]
a DCM’s specified minimum quantity of
futures or options contracts and is
executed away from the DCM’s
centralized market but pursuant to its
rules.’’ 892 Accordingly, the
Commission’s regulatory definition of a
‘‘block trade’’ for swaps closely tracks
this futures market concept of a block
trade.
Similar to futures block trades, the
Commission requires that swap block
trades ‘‘occur away’’ from a SEF’s or a
DCM’s trading system or platform, but
pursuant to the SEF’s or a DCM’s rules
and procedures.893 The Commission
clarified the ‘‘block trade’’ definition by
stating that ‘‘[a]ny swap that is executed
on a SEF or a DCM’s trading system or
platform, regardless of whether it is for
a size at or above the appropriate
minimum block size for such swap, is
not a block trade under this
definition. . . .’’ 894 Accordingly, to
receive the fifteen-minute public
reporting delay that block trades are
entitled to under § 43.5(d), the swap
transaction not only must have a
notional amount at or above the
appropriate minimum block size, but
must also ‘‘occur away’’ from the SEF’s
or the DCM’s trading system or
platform.895
Given that block trades must occur
away from a SEF’s or a DCM’s trading
system or platform, the enumerated
890 17
CFR 43.2.
Public Reporting of Swap
Transaction Data, 75 FR 76140, 76159 (proposed
Dec. 7, 2010) (discussion of block trades with
respect to futures).
892 Id.
893 17 CFR 43.2.
894 Procedures To Establish Appropriate
Minimum Block Sizes for Large Notional OffFacility Swaps and Block Trades, 78 FR 32866,
32904 n.425 (May 31, 2013).
895 CEA section 2(a)(13) requires the Commission
to establish rules that govern the real-time reporting
of swap transaction and pricing data to the public,
but also directs the Commission, among other
things, to prescribe rules that specify the
appropriate reporting time delay for block trades,
including the criteria for determining what
constitutes a block trade. 7 U.S.C. 2(a)(13).
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891 Real-Time
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prohibition on pre-arranged trading as
an abusive trading practice under
§ 37.203(a) allows block trades as an
exception.896 This exception allows
transactions that meet or exceed the
requisite block size to be privately
negotiated to avoid potentially
significant, adverse price impacts that
would occur if traded on trading
systems or platforms that offer pre-trade
price transparency.
A. § 43.2—Definition—Block Trade;
§ 37.203(a)—Elimination of Block Trade
Exception to Pre-Arranged Trading
During the part 37 implementation
process, SEFs and market participants
informed the Commission that for swap
transactions that are intended to be
cleared, requiring that such swaps to
‘‘occur away’’ from a SEF’s trading
system or platform creates an issue with
carrying out pre-execution credit
screening.897 These market participants
note that, in many cases, clearing FCMs
are unable to conduct pre-execution
credit screening for such block trades
because they are unaware that a block
trade has occurred away from a SEF
until after it has been executed and
reported to the SEF.898 Accordingly,
SEFs were unable to facilitate preexecution credit checks for block trades.
DMO acknowledged this operational
challenge and accordingly has granted
ongoing no-action relief from the
requirement that swap block trades
‘‘occur away’’ from a SEF.899 Based on
Commission staff no-action relief, a SEF
may allow market participants to
896 ‘‘Pre-arranged trading’’ is prohibited as an
abusive trading practice under § 37.203(a). This
prohibition generally applies to market participants
who communicate with one another to prenegotiate the terms of a trade away from a trading
system or platform, but then execute the trade on
the trading system or platform in a manner that
appears competitive and subject to market risk.
Accordingly, the Commission intended the
prohibition to maintain the integrity of price
competition and market risk that is incident to
trading in the market. See supra Section VI.A.2.—
§ 37.203(a)—Pre-Arranged Trading Prohibition;
§ 37.9—Time Delay Requirement.
897 For the Commission’s discussion of preexecution credit screening requirements, see supra
Section XII.B.2.b.(3)—§§ 37.702(b)(2)–(3)—PreExecution Credit Screening.
898 CFTC Letter No. 17–60, Re: Extension of NoAction Relief for Swap Execution Facilities from
Certain ‘‘Block Trade’’ Requirements in
Commission Regulation 43.2 at 2 (Nov. 14, 2017)
(‘‘NAL No. 17–60’’).
899 NAL No. 17–60; CFTC Letter No. 16–74, Re:
Extension of No-Action Relief for Swap Execution
Facilities from Certain ‘‘Block Trade’’ Requirements
in Commission Regulation 43.2 (Oct. 7, 2016); CFTC
Letter No. 15–60, Re: Extension of No-Action Relief
for Swap Execution Facilities from Certain ‘‘Block
Trade’’ Requirements in Commission Regulation
43.2 (Nov. 2, 2015); CFTC Letter No. 14–118, NoAction Relief for Swap Execution Facilities from
Certain ‘‘Block Trade’’ Requirements in
Commission Regulation 43.2 (Sept. 19, 2014).
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62043
execute swap block trades that are
intended to be cleared on a SEF’s nonOrder Book trading system or
platform.900 As a result, FCMs and SEFs
have been able to comply with their
respective pre-execution credit
screening obligations.
The Commission proposes to revise
certain elements of the ‘‘block trade’’
definition under § 43.2. First, the
Commission proposes to eliminate the
‘‘occurs away’’ requirement for swap
block trades. Second, the Commission
proposes to require that to the extent
counterparties seek to execute any swap
that has a notional or principal amount
at or above the appropriate minimum
block trade size applicable to such swap
on a SEF, they must do so on a SEF’s
trading system or platform. For swaps
listed by a SEF for trading that
participants intend to execute on the
SEF and submit for clearing, the
Commission believes that the proposed
revised definition would (i) allow FCMs
to conduct pre-execution credit
screenings in accordance with § 1.73;
and (ii) allow SEFs to facilitate those
screenings in accordance with the
Commission’s proposed requirement
under § 37.702(b).901 In addition, for
swaps listed by a SEF that participants
intend to execute on the SEF, but do not
intend to submit for clearing,
participants would no longer be
permitted to submit an already-executed
block trade to the SEF pursuant to its
rules; such transactions would be
required to be executed on the SEF.
The Commission notes that this
revised block trade definition is
consistent with the provisions of the
Dodd-Frank Act. CEA section 2(a)(13),
as amended by the Dodd-Frank Act,
directs the Commission to prescribe
criteria for determining what constitutes
a block trade for the purpose of
establishing appropriate post-trade
reporting time delays. The provision,
however, does not set forth any pretrade requirements, such as a
requirement that the transaction be
executed away from a SEF. Second,
requiring block trades to be executed on
a SEF for those swaps listed by the SEF,
rather than allowing them to be
executed away from the SEF, would also
facilitate the statutory SEF goal of
promoting swaps trading on SEFs.902
900 NAL
No. 17–60 at 2–3.
Commission notes that proposed
§ 37.702(b) applies to SEFs that list (i) swaps that
are subject to the clearing requirement; and/or (ii)
swaps that are not subject to the clearing
requirement, but for which the SEF facilitates
processing and routing to a DCO for clearing. See
supra Section XII.B.3.—Applicability of § 37.702(b)
to SEFs that Do Not Facilitate Clearing.
902 See 7 U.S.C. 7b–3(e).
901 The
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The revised definition also
corresponds with other proposed
changes to the SEF regulatory
framework. For example, the
Commission believes that allowing SEFs
to use flexible means of execution for
swap transactions negates the need to
allow swap block trade execution to
occur away from SEFs. Similarly, the
Commission’s proposed approach to
pre-execution communications should
facilitate swap block trade execution on
SEFs; proposed § 37.201(b) would
generally prohibit participants from
conducting such communications away
from the SEF, except for
communications regarding a listed swap
that is not subject to the trade execution
requirement, among other
exceptions.903 Accordingly, participants
may pre-negotiate block trades with one
another for those swaps away from a
SEF and submit them to the SEF for
execution. This approach would allow
participants to comply with the
proposed definition, i.e., the swap must
be executed on a SEF, but also facilitate
compliance with pre-execution credit
screening requirements if the swap is
intended to be cleared.
To conform to the amended block
trade definition, the Commission also
proposes to eliminate the block trade
exception to the pre-arranged trading
prohibition under § 37.203(a). Given
that block trades would no longer occur
away from a SEF, but would be
executed on a SEF via flexible means of
execution, the Commission expects that
market participants will have sufficient
ability to continue to execute such
transactions through a SEF’s trading
system or platform.
Request for Comment
The Commission requests comments
on all aspects of proposed § 43.2. The
Commission specifically requests
comment on the following questions:
(105) Should the Commission limit
the type of execution methods that may
be utilized to permit block trades to
receive a public reporting delay as set
forth in Commission regulation
§ 43.5(d)? If so, then which methods of
execution for block trades should be
precluded from receiving a public
reporting delay, and why? Would views
on this question change if the public
dissemination delay for a block trade
was extended beyond fifteen minutes? If
so, then please explain why.
(106) Should the Commission allow
all swap block trades on SEFs to be
negotiated through pre-execution
communications and then submitted to
903 See supra Section VI.A.2.a.—§ 37.201(b)—PreExecution Communications.
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SEFs for execution? Please explain why
or why not.
XXIII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act 904
requires Federal agencies, in
promulgating regulations, to consider
the impact of those regulations on small
businesses. The regulations adopted
herein will directly affect SEFs, DCMs,
DCOs, SDs, MSPs and certain ECPs. The
Commission has previously established
certain definitions of ‘‘small entities’’ to
be used by the Commission in
evaluating the impact of its regulations
on small entities in accordance with the
Regulatory Flexibility Act.905 The
Commission has also previously
determined that SEFs,906 DCMs,907
DCOs,908 SDs,909 MSPs 910 and ECPs 911
are not small entities for the purpose of
the Regulatory Flexibility Act.
Therefore, the Chairman, on behalf of
the Commission, pursuant to 5 U.S.C.
605(b), hereby certifies that the
proposed rules will not have a
significant economic impact on a
substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of
1995, 44 U.S.C. 3501 et seq. (‘‘PRA’’)
imposes certain requirements on
Federal agencies (including the
Commission) in connection with
conducting or sponsoring any
‘‘collection of information,’’ 912 as
defined by the PRA. Among its
purposes, the PRA is intended to
minimize the paperwork burden to the
private sector, to ensure that any
collection of information by a
government agency is put to the greatest
possible uses, and to minimize
duplicative information collections
across the government.913
904 5
U.S.C. 601 et seq.
Statement and Establishment of
Definitions of ‘‘Small Entities’’ for Purposes of the
Regulatory Flexibility Act, 47 FR 18618 (Apr. 30,
1982)(‘‘1982 Policy Statement’’).
906 Core Principles and Other Requirements for
Swap Execution Facilities, 78 FR 33476, 33548 (Jun.
4, 2013).
907 1982 Policy Statement.
908 A New Regulatory Framework for Clearing
Organizations, 66 FR 45604, 45609 (Aug. 29, 2001).
909 Further Definition of ‘‘Swap Dealer,’’
‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap
Participant,’’ ‘‘Major Security-Based Swap
Participant’’ and ‘‘Eligible Contract Participant,’’ 77
FR 30596, 30701 (May 23, 2012).
910 Id.
911 See 66 FR 20740, 20743 (Apr. 25, 2001).
912 For purposes of this PRA discussion, the terms
‘‘information collection’’ and ‘‘collection of
information’’ have the same meaning, and this
section will use the terms interchangeably.
913 44 U.S.C. 3501.
905 Policy
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The PRA applies to all information,
regardless of form or format, whenever
the government is obtaining, causing to
be obtained, or soliciting information,
and includes required disclosure to
third parties or the public, of facts or
opinions, when the information
collection calls for answers to identical
questions posed to, or identical
reporting or recordkeeping requirements
imposed on, ten or more persons.914 The
PRA requirements have been
determined to include not only
mandatory, but also voluntary
information collections, and include
both written and oral
communications.915
The Commission’s proposed
amendments would result in a
collection of information within the
meaning of the PRA, as discussed
below. Under the PRA, an agency may
not conduct or sponsor, and a person is
not required to respond to, a collection
of information unless it displays a
currently valid control number from the
Office of Management and Budget
(‘‘OMB’’). The proposed rulemaking
would amend parts 9, 36, 37, 38, 39, and
43 of the Commission’s regulations to
include new information collections,
eliminate certain existing information
collections, and modify existing
information collections.916
OMB control number 3038–0074
currently covers, among other things, all
information collections arising in part
37 (other than the information
collections related to existing § 37.10)
and part 9.917 OMB control number
914 44
U.S.C. 3502.
CFR 1320.3(c)(1).
916 The proposed amendments would not
substantially or materially modify existing
information collection burdens, or create new
information collection burdens, under parts 9, 39,
and 43.
917 The Commission notes that this OMB control
number covers all information collections in part
37, including Subpart A and the SEF core
principles, i.e., Subparts B through P, and the
appendices thereto, i.e., Appendix A (Form SEF),
Appendix B (guidance and acceptable practices),
and proposed Appendix C (guidance to Core
Principle 3). This OMB control number also
includes all information collections related to part
9 to the extent applicable to SEFs. For clarity,
existing § 37.10(a) is not covered under this OMB
control number, but rather is subject to a separate
information collection under OMB control number
3038–0099. The Commission further notes that in
the most recent request for an extension of OMB
control number 3038–0074, the Commission stated
in the renewal notice that OMB control number
3038–0074 ‘‘covers all information collections in
part 37 of the Commission’s regulations, including
Subpart A and the SEF core principles (i.e.,
Subparts B and C) . . . . [other than] any
information collections related to § 37.10 . . . .’’
The Commission notes that the reference to
‘‘Subparts B and C’’ should specify ‘‘Subparts B
through P’’ instead. Agency Information Collection
Activities Under OMB Review, 81 FR 65630, n.1
(Sep. 23, 2016) (‘‘2016 Part 37 PRA Renewal’’).
915 5
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3038–0052 covers, among other things,
information collections arising in part
38 (other than the information
collections related to § 38.12).918 OMB
control number 3038–0099 covers the
information collections related to the
‘‘available to trade’’ determination
(‘‘MAT determination’’) process under
§ 37.10 and § 38.12. Accordingly, the
proposed rulemaking would amend
OMB control numbers 3038–0074 and
3038–0052; however, the Commission
proposes to eliminate OMB control
number 3038–0099 along with the
corresponding MAT determination
information collections under § 37.10
and § 38.12. Instead, the Commission
proposes to transfer the corresponding
MAT determination information
collections under § 37.10 and § 38.12 to
part 36, and the related information
collections related to the MAT
determination process for SEFs and
DCMs will be incorporated under OMB
control numbers 3038–0074 and 3038–
0052, respectively. The Commission,
therefore, is submitting this proposal to
OMB for review in accordance with 44
U.S.C. 3507(d) and 5 CFR 1320.11.
The collections of information under
these proposed amendments are
necessary to implement certain
provisions of the CEA, as amended by
the Dodd-Frank Act. Among other
provisions in the CEA, CEA section
8a(5) provides the Commission with
authority to promulgate rules as
reasonably necessary to effectuate any of
the provisions or to accomplish any of
the purposes of the CEA.919
If the proposed amendments are
adopted, responses to the proposed
collections of information generally
would be mandatory, although certain
collections of information could vary
based upon a SEF’s discretion or level
of business. For example, a SEF has the
discretion to establish the scope of its
trading operations, e.g., determining
which swaps to list for trading, which
may affect the various burden hours
discussed herein.
The Commission will protect
proprietary information according to the
918 The Commission notes that this OMB control
number covers all information collections in part 38
of the Commission’s regulations, including Subpart
A and the DCM core principles, i.e., Subparts B
through X. This OMB control number also includes
all information collections related to part 9 to the
extent applicable to DCMs. The Commission also
notes for clarity that existing § 38.12 is not covered
under this OMB control number, but rather is
subject to a separate information collection with
OMB control number 3038–0099.
919 The full authority provided under part 37 of
the Commission’s regulations includes: 7 U.S.C. 1a,
2, 5, 6, 6c, 7, 7a–2, 7b–3, and 12a, as amended by
Titles VII and VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Public Law
111–203, tit. VII–VIII, 124 Stat. 1376 (2010).
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Freedom of Information Act and 17 CFR
part 145, ‘‘Commission Records and
Information.’’ In addition, section
8(a)(1) of the CEA strictly prohibits the
Commission, unless specifically
authorized by the CEA, from making
public ‘‘data and information that
would separately disclose the business
transactions or market positions of any
person and trade secrets or names of
customers.’’ The Commission is also
required to protect certain information
contained in a government system of
records according to the Privacy Act of
1974, 5 U.S.C. 552a.
As discussed in the preamble to the
final rules for part 37 (‘‘SEF Core
Principles Final Rule’’), the
methodology the Commission used to
formulate the proposed estimates reflect
an average across all SEFs (and in
respect to proposed part 36, all SEFs
and DCMs).920 By definition, averages
are meant to serve as only a reference
point; the Commission understands that
due to both discretionary and
mandatory requirements, some SEFs
may go above the estimated burden
hours to complete information
collection requirements, while others
may stay below those estimates.921
1. Information Provided by Reporting
Entities/Persons
The following is a brief description of
the information collections for SEFs,
and as applicable DCMs and other
market participants, under the proposed
amendments to parts 36, 37 and 38.922
To the extent that the Commission does
not identify a specific provision, the
Commission does not believe that any
associated change substantively or
materially modifies an existing
information collection burden or creates
a new one.923
The Commission notes that some of
the proposed amendments are covered
by other OMB control numbers. For
example, some amendments would
require SEFs to promulgate new rules
that are required to be submitted to the
920 Core Principles and Other Requirements for
Swap Execution Facilities, 78 FR 33476, 33551 (Jun.
4, 2013).
921 Id.
922 As noted above, the Commission proposes to
eliminate the MAT determination process for DCMs
under § 38.12.
923 For the purposes of the PRA discussion
herein, the Commission will not discuss the
proposed amendments to parts 9, 39, and 43
because it has determined that they would not
impose new information collection burdens or
substantively or materially modify existing burdens
therein. Further, the Commission will not discuss
any proposed amendments to parts 36, 37, and 38
unless the Commission has determined that such
changes would create, eliminate, or substantively or
materially modify existing information collections
or related burden hours.
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Commission pursuant to part 40 of the
Commission’s regulations.924 PRA
burdens, if any, related to the
submission by a SEF to the Commission
of new rules, policies and procedures,
and amendments have been accounted
for in the previous information
collection burden estimate associated
with part 40, which governs the process
by which SEFs must submit rules and
amendments to the Commission.925
Additionally, some of the hours
associated with those information
collections would not be deemed to be
‘‘burden hours’’ if they result from
‘‘usual and customary’’ business
practices.926
a. § 37.3(a)—Requirements for
Registration
The Commission expects that as a
result of the proposed application of the
SEF registration requirement under
§ 37.3(a), additional swaps broking
entities will register as SEFs. For PRA
purposes, the Commission previously
had revised the current number of
registered SEFs from 23 927 to the
current 25 928 and had estimated
approximately 4 new SEF applicants per
year.929
The Commission notes that based on
data from the National Futures
Association (‘‘NFA’’), more than 300
interdealer brokers that are registered
924 For example, proposed §§ 37.201(a)(1)–(3)
would require a SEF to establish rules governing its
operation that specify (i) the protocols and
procedures for trading and execution, including
entering, amending, cancelling, or executing orders
for each execution method; (ii) the manner or
circumstances in which the swap execution facility
may exercise discretion in facilitating trading and
execution for each execution method; and (iii) the
sources and methodology for generating any market
pricing information provided to facilitate trading
and execution for each execution method.
925 Provisions Common to Registered Entities, 76
FR 44776, 44789 (July 27, 2011).
926 5 CFR 1320.3(b)(2). For example, proposed
§ 37.6(b)(2)(iii) would require a SEF to establish and
enforce rules to require the intermediary to transmit
the confirmation or trade evidence record to the
respective counterparty ‘‘as soon as technologically
practicable’’ upon receipt of the confirmation or
trade evidence record from the SEF. The
Commission notes that SEF members and market
participants acting in an intermediary capacity and
executing swaps on behalf of customers, as a matter
of industry practice, generally make such
confirmations available to their customers, i.e., the
swap counterparties. Accordingly, this proposed
amendment reflects an existing ‘‘usual and
customary practice’’ that would create a new
information collection but would not impose any
associated burden hours.
927 2016 Part 37 PRA Renewal at 65631.
928 Agency Information Collection Activities:
Notice of Intent To Revise Collection Numbers
3038–0052 and 3038–0074, Core Principles and
Other Requirements for Designated Contract
Markets, and Core Principles and Other
Requirements for Swap Execution Facilities, 83 FR
1609, 1611 (Jan. 12, 2018).
929 2016 Part 37 PRA Renewal at 65631.
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with the NFA as ‘‘introducing brokers’’
are also ‘‘swap firms,’’ i.e., interdealer
brokers that are registered as
introducing brokers and also designated
to deal with swap products. The
Commission, however, does not expect
that proposed § 37.3(a) will result in all
swap interdealer brokers registering as
SEFs. The Commission understands that
some of these entities may (i) already be
affiliated with current SEFs and could
operate as part of their respective
affiliated SEFs rather than registering as
new, separate SEFs; (ii) merge, become
affiliated with, or otherwise be acquired
by registered SEFs; or (iii) adjust their
business practices such that they would
not be required to register as a SEF.
Additionally, some of these entities may
be currently registered as introducing
broker swap firms, but are not currently
in the business of swaps trading and
therefore do not trigger the SEF
registration requirement. Additionally,
the Commission notes that certain nonU.S. interdealer brokers may also be
affiliated with platforms that are
currently exempt or may become
exempt in the future from Commission
registration, and therefore, would not
need to separately register as SEFs.
The Commission initially estimates
that up to 60 swaps broking entities,
including interdealer brokers, and one
Single-Dealer Aggregator Platform
would register as SEFs as a result of the
proposed application of the SEF
registration requirement under
§ 37.3(a).930 Consequently, for the
purposes of this PRA analysis, the
Commission estimates that the proposed
application of § 37.3(a) will impose an
initial, non-recurring information
collection burden of 295 burden hours
associated with the SEF registration
process for these 60 entities.931 The
Commission does not believe that the
proposed application of the SEF
registration requirement in § 37.3(a)
would impose new information
collection burdens or substantively or
930 The Commission estimates that approximately
40–60 swaps broking entities, including interdealer
brokers would be required to register as SEFs as a
result of the proposed application of the SEF
registration requirement in § 37.3(a). Similarly, the
Commission is aware of one Single-Dealer
Aggregator Platform, which is affiliated with a SEF.
For the purposes of this PRA, the Commission
estimates and assumes that 60 such swaps broker
entities and the one Single-Dealer Aggregator
Platform of which it is aware would register as
SEFs. For further discussion, see infra Section
XXIII.C.3.c.—Costs (cost discussion related to the
SEF registration requirement).
931 As noted below, based on the proposed
changes to the SEF registration requirements
described herein, the Commission is reducing the
estimated burden hours associated with the
registration process by 5 hours from 300 hours to
295 hours.
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materially modify existing burdens for
registered SEFs.
In connection with the Commission’s
proposed clarification of the registration
requirement, the Commission would
propose to delay the application of the
registration requirement with respect to
(i) swaps broking entities, including
interdealer brokers for a six-month
period; and (ii) foreign swaps broking
entities, including foreign interdealer
brokers that facilitate swaps trading for
U.S. persons for two-year period,
provided that in each case the subject
entity submits a request to the
Commission with certain
information.932 As noted above, the
Commission expects in the aggregate
that approximately 60 such entities,
including swaps broking entities and
foreign swaps broking entities, would be
required to register as SEFs, and the
Commission estimates that all such
relevant entities would request a delay.
Accordingly, the Commission estimates
that the voluntary request to delay the
registration requirement will impose an
initial, non-recurring information
collection burden of 1 burden hour
associated with the SEF registration
process for each of these 60 entities. The
Commission does not believe that the
clarification in proposed § 37.3(a) would
impose new information collection
burdens or substantively or materially
modify existing burdens for registered
SEFs.
b. § 37.3(b)—Procedures for Registration
Proposed § 37.3(b) would streamline
Form SEF by consolidating, amending,
and eliminating several of the existing
exhibits.933 The Commission believes
that these changes would establish a
clearer and more simplified application
for SEF applicants that would still
provide the Commission with sufficient
information needed to determine
compliance. The Commission believes
that the proposed streamlined Form SEF
will reduce the initial, non-recurring
burden hours associated with the
932 The request would include the (i) entity’s
name as it appears in the entity’s charter; (ii) name
and address of the entity’s ultimate parent
company; (iii) any names under which the entity
does business; (iv) address of principal executive
office; (v) a contact person’s name, address, phone
number, and email address; (vi) asset classes and
swap products for which the entity facilitates
trading; and (vii) any registrations, authorizations,
or licenses held. Foreign broking entities
additionally would need to provide (viii)
certification that it currently arranges or negotiates
swap transactions for U.S. persons; (ix) home
country regulator or regulators; and (x) any
registrations, authorizations, or licenses held in the
entity’s home country.
933 For further discussion on the specific changes,
see supra Section IV.C.3.b.—§ 37.3(b)(1)—
Application for Registration.
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application process for SEF registration
by approximately 5 burden hours.
c. § 37.3(c)—Amendment to an Order of
Registration
Proposed § 37.3(c) would eliminate
the requirement that a SEF amend Form
SEF when requesting an amended order
of registration from the Commission.
Instead, a registered SEF would file a
request with the Commission for an
amended order pursuant to proposed
§ 37.3(c), but would no longer be
required to file updated exhibits to
Form SEF, although a SEF would be
required to provide the Commission
with any additional information and
documentation as the Commission
deems necessary.934 The Commission
estimates that approximately 1 SEF per
year seeks to amend its registration
order and that the proposed change
would save that SEF approximately 2
burden hours.
d. § 37.5(c)—Provision of Information
Relating to a Swap Execution Facility
Proposed § 37.5(c) would amend the
existing notification requirements
related to transfers of equity interest in
a SEF. Proposed § 37.5(c)(1) would
require a SEF to file a notice with the
Commission regarding any transaction
that results in the transfer of direct or
indirect ownership of fifty percent or
more of the equity interest of a SEF as
opposed to only direct ownership
transfers as currently required.935 As
part of that notification, a SEF may
934 The Commission notes that it proposes to
eliminate the existing language under § 37.3(b) that
specifies the use of part 40 to file application
amendments subsequent to registration. The
Commission emphasizes that not all of the
information from the Form SEF exhibits need to be
updated pursuant to part 40 subsequent to
registration—for example, certain part 37 provisions
already require SEFs to update their information on
an ongoing basis. Under § 37.1306, a SEF is
required to file financial reports, including fiscal
year end reports, which precludes the need to
amend new Exhibit G (existing Exhibit I) and file
it through part 40. As discussed above, the
Commission clarifies that part 40 only applies to
information from application exhibits that
constitute a ‘‘rule,’’ as defined under § 40.1(i). The
Commission generally interprets the § 40.1(i) rule
definition broadly to encompass governance
documentation (proposed Exhibit C); fees (proposed
Exhibit H); rulebooks (proposed Exhibit J);
compliance manuals (proposed Exhibit K);
participant agreements (proposed Exhibit L); SDRrelated agreements (proposed Exhibit M); clearingrelated agreements (proposed Exhibit N); other
third-party agreements (proposed Exhibit O); and
information related to execution methods (proposed
Exhibit P). Therefore, registered SEFs have already
been submitting changes to these types of
documentation pursuant to the part 40 rule filing
procedures.
935 Transfer of ownership in an ‘‘indirect’’ manner
may occur through a transaction that involves the
transfer of ownership of a SEF’s direct parent or an
indirect parent, and therefore, implicates effective
change in ownership of the SEF’s equity interest.
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incur burdens that are similar to those
incurred when providing a notice of a
direct change, including providing
details of the proposed transaction and
how the transaction would not
adversely impact the SEF’s ability to
comply with the SEF core principles
and the Commission’s regulations,
responding to any requests for
supporting documentation from the
Commission, and updating any ongoing
changes to the transaction. Accordingly,
the Commission estimates that
approximately 1 additional SEF per year
would need to notify the Commission as
a result of an indirect equity transfer
and that the proposed amendment
would impose a one-time, non-recurring
information collection of approximately
10 burden hours on such SEF.
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e. § 37.6(b)(1)—Legally Binding
Documentation
Proposed §§ 37.6(b)(1)(i)–(ii) would
amend the existing swap documentation
requirements by establishing separate
transaction documentation requirements
for cleared and uncleared swaps,
respectively. Under existing § 37.6(b), a
SEF is required to provide each
counterparty to a transaction with a
written ‘‘confirmation’’ that contains all
of the terms of a swap transaction at the
time of the swap’s execution for both
cleared and uncleared swap
transactions, including (i) ‘‘economic
terms’’ specific to the transaction and
(ii) non-transaction specific
‘‘relationship terms’’ governing the
relationship between the two
counterparties.936 To include all of the
terms of a uncleared swap into a
confirmation, a SEF would comply with
§ 37.6(b) by incorporating by reference
the relevant terms set forth in the
previously-negotiated agreements and
documents, as long as the SEF had
obtained these agreements prior to
execution.937
Proposed § 37.6(b)(1)(i), which would
continue to apply the existing
confirmation requirement to cleared
swap transactions, would not alter the
information collection burdens with
respect to cleared swaps. For uncleared
swaps, however, proposed
§ 37.6(b)(1)(ii) would require a SEF to
provide a ‘‘trade evidence record’’ that
memorializes the terms that are agreed
upon by the counterparties on the SEF.
936 As noted above, economic terms include, for
example, swap product, price, trade date,
settlement date, and notional amount.
‘‘Relationship terms’’ generally govern all
transactions between two counterparties, e.g.,
default provisions, margin requirements, and
governing law. See supra Section IV.F.—§ 37.6—
Enforceability.
937 SEF Core Principles Final Rule at 33491 n.195.
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In contrast to the requirement for
cleared swaps, proposed § 37.6(b)(1)(ii)
would not require the trade evidence
record to include all the terms of the
swap transaction, including relationship
terms contained in underlying
documentation between the
counterparties, nor would the SEF need
to obtain or maintain the underlying
agreements prior to the execution of the
swap transaction.938 To the extent that
such terms either (i) are agreed upon
between the counterparties in
underlying documentation established
away from the SEF and continue to
govern the transaction post-execution or
(ii) are not required to establish legal
certainty for a specific transaction, a
SEF would not be required to
incorporate those terms into a trade
evidence record. The proposed
approach would address the challenges
that have prevented SEFs from fully
complying with § 37.6(b) by reducing
the administrative burdens for SEFs,
who under the proposal would not be
required to obtain, incorporate, or
reference those previous agreements;
and for counterparties, who would not
be required to submit all of their
relevant documentation with other
potential counterparties to the SEF.
As a result, the Commission believes
that the proposed amendments would
reduce a SEF’s annual recurring
information collection burden for
uncleared swap transactions.
Accordingly, the Commission estimates
that proposed § 37.6(b)(1)(ii) would
reduce annual recurring information
collection burdens by about 375 hours
per SEF.939
938 The Commission anticipates that the terms
listed in a trade evidence record would include, at
a minimum, the transaction’s ‘‘economic terms,’’
e.g., trade date, notional amount, settlement date,
and price.
939 The Commission previously estimated that the
process to obtain, review, incorporate, and maintain
the previously-negotiated agreements takes
approximately 1.5 hour per SEF participant and
that on average, a SEF has about 375 participants.
For purposes of this PRA discussion herein,
however, the Commission is revising its estimate of
the number of burden hours that the proposal
would eliminate and will assume that each such
agreement takes approximately 1.0 hours per SEF
participant. Accordingly, 375 participants × 1.0
hour per participant = 375 estimated burden hours.
The Commission also notes that this estimate of 375
burden hours includes the burden estimates in
connection with § 37.1001, which establishes a
SEF’s recordkeeping obligations. Supporting
Statement for New and Revised Information
Collections, Core Principles and Other
Requirements for Swap Execution Facilities, OMB
Control Number 3038–0074, (Sept. 23, 2016),
https://www.reginfo.gov/public/do/PRAViewICR
?ref_nbr=201609-3038-005.
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f. § 37.203(d)—Automated Trade
Surveillance System
Proposed § 37.203(d) would eliminate
the prescriptive automated trade
surveillance system capabilities
requirements enumerated in existing
§ 37.203(d), except for the ability of a
SEF to reconstruct sequence of market
activity, and would instead require that
a SEF’s automated trade surveillance
system be capable of detecting and
‘‘reconstructing’’ potential trade practice
violations.940
As a result, the proposed rule would
provide each SEF with the flexibility to
determine what capabilities its
automated trade surveillance system
must have, based on the nature of the
SEF’s trading systems or platforms, to
satisfy its core principle compliance
responsibilities. Although it is possible
that SEFs use their discretion to
decrease the information collections and
related burden hours, SEFs would still
be obligated to comply with the same
underlying core principle obligations
with which they must currently comply.
As a result, the Commission estimates
and assumes that SEFs would continue
to fulfill their information collection
burdens in a manner similar to the
status quo. Accordingly, the
Commission assumes that proposed
§ 37.203(d) would not impose new
information collection burdens or
substantively or materially affect SEFs’
total burden hours.
g. § 37.203(e)—Error Trade Policy
Proposed § 37.203(e) would require
SEFs to establish an error trade policy
that, among other things, would notify
all market participants of (i) any swap
transaction that is under review; (ii) any
determination by the SEF that the swap
transaction under review either has
been determined to be or not to be an
error trade; and (iii) the resolution of
any error trade, including any trade
term adjustment or trade cancellation.
To the extent that SEFs currently are not
explicitly required to provide market
participants with notice of any of these
events, proposed § 37.203(e) would
impose a new information collection
burden on SEFs.941 The Commission
940 The Commission notes that this proposed
change is consistent with the proposed
amendments to §§ 37.205(b)(2)–(3), as discussed
below, that would similarly limit a SEF’s electronic
transaction history database and electronic analysis
capability requirements. The Commission, however,
emphasizes that a SEF must continue to have the
capability to load and process all executed trades,
including those resulting from orders entered by
voice or certain other electronic communications,
such as instant messaging and email.
941 The Commission notes that existing
§ 37.203(e) provides SEFs with the authority to
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estimates that proposed § 37.203(e)
would increase a SEF’s annual recurring
information collection burden by
approximately 15 burden hours, based
on an estimate that a SEF on average
would incur approximately 15 error
trade reviews per year.942 Because most
SEFs already have established and
currently maintain the necessary
personnel and systems to provide such
notices to its market participants, the
Commission believes that the proposed
amendment would not require SEFs to
expend initial, non-recurring burden
hours in order to comply.
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h. § 37.205(a)—Audit Trail Required
Proposed § 37.205(a) would make
several changes to SEFs’ audit trail
compliance obligations. First, the
proposed amendment would replace the
requirement that SEFs must ‘‘detect,
investigate, and prevent’’ customer and
market abuse with a requirement
instead that SEFs must be able to
‘‘reconstruct all trading on its facility,
detect and investigate customer and
market abuses, and take appropriate
disciplinary action.’’ Second, the
Commission proposes to move the
requirement that audit trail data shall be
sufficient to reconstruct all indications
of interest, requests for quotes, orders
and trades, to the guidance to Core
Principle 2 in Appendix B.943 Third, the
Commission proposes to eliminate the
requirement that SEFs capture postexecution allocation information in
cancel or adjust prices for error trades if necessary
to mitigate market disruption; in connection with
this authority, existing § 37.203(e) also requires
SEFs to make any such adjustments and
cancellations transparent to market participants. 17
CFR 37.203(e). To the extent that proposed
§ 37.203(e) requires SEFs to provide notice to
market participants for error trades in additional
circumstances, the proposed amendment imposes a
new collection of information.
942 As noted above, proposed § 37.203(e) would
require a SEF to provide market participants with
a first notice upon the initiation of a review of an
alleged error trade, a second notice upon any
determination as to whether such swap transaction
is or is not an error trade, and a third notice upon
the resolution of the review, including any trade
term adjustment or trade cancellation. The
Commission estimates that each notice requires
about 1⁄3 burden hours, for a total of 1 burden hour
per error trade (1⁄3 burden hours × 3 notices = 1
burden hour per error trade for notices). Further,
the Commission estimates that each SEF on average
will have approximately 15 error trade reviews per
year. Accordingly, 1 burden hour × 15 error trade
reviews per year = 15 burden hours per year. The
Commission notes, however, that certain error
trades may be resolved more quickly than 1 hour
or take longer than 1 hour depending on the
availability and coordination of the counterparties
and relevant SEF personnel.
943 The Commission proposes to add this
guidance to paragraph (a)(4) to Core Principle 2 in
Appendix B. The Commission proposes to
eliminate the existing language in paragraph (a)(4).
See infra Section VII.E.2.—§ 37.206(b)—
Disciplinary Program.
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their audit trail data; in lieu of requiring
the audit trail track a customer order
through ‘‘fill, allocation, or other
disposition,’’ the Commission proposes
to require SEFs to capture the audit trail
data only through execution on the SEF
since the Commission has learned from
SEFs’ representations that SEFs are
unable to routinely obtain postallocation information as required by
§§ 37.205(a) and (b)(2) from third
parties, such as DCOs and SDRs.
To the extent that the Commission is
providing SEFs with greater discretion
in fulfilling their information collection
obligations with respect to audit trail
requirements under § 37.205, the
Commission estimates and assumes that
SEFs would continue to fulfill their
information collection burdens in a
manner similar to the status quo.
Accordingly, the Commission assumes
that proposed § 37.205(a) would not
substantively or materially affect a SEF’s
total information collection burden
hours.944
i. § 37.205(b)—Elements of an
Acceptable Audit Trail Program
Proposed § 37.205(b) would narrow
the scope of audit trail data that must be
captured in a transaction history
database under existing § 37.205(b)(2)
by eliminating the requirement that
SEFs include in their electronic
transaction history database ‘‘all
indications of interest, requests for
quotes, and order and trades entered
into’’ a SEF’s trading system or
platform. Instead, the SEFs would be
required to include only ‘‘trades’’
executed via voice or via entry into a
SEF’s electronic trading system but
944 As the Commission discussed above, certain
existing requirements under § 37.205(a) are either
unfeasible or impose greater information collection
burdens than the Commission originally had
estimated, e.g., the requirement to collect postexecution trade allocation information.
Subsequently, Commission staff provided no-action
relief with respect to such obligations. See, e.g.,
CFTC Letter No. 15–68, Re: No-Action Relief for
Swap Execution Facilities from Certain Audit Trail
Requirements in Commission Regulation 37.205
Related to Post-Execution Allocation Information
(Dec. 22, 2015) (subsequently extended in CFTC
Letter No. 17–54, Re: No-Action Relief for Swap
Execution Facilities from Certain Audit Trail
Requirements in Commission Regulation 37.205
Related to Post-Execution Allocation Information
(Oct. 31, 2017)). Accordingly, the 2016 Part 37 PRA
Renewal took into consideration in its revised PRA
burden hour estimates the unfeasibility with
complying with such requirements and the
corresponding no-action relief. As a result, the
Commission’s proposal to eliminate such
information collections under the proposal would
not result in a net change to a SEF’s aggregate
burden hours because the 2016 Part 37 PRA
Renewal already considered such relief and noncompliance with such requirements in its revised
estimate. The Commission notes that, otherwise, the
burden hour estimate in the 2016 Part 37 PRA
Renewal would have been even greater.
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must include all ‘‘orders’’ that are
entered into an electronic trading
system. The Commission additionally
proposes to eliminate the remaining
requirements of § 37.205(b)(2) detailing
the information that must be included
in transaction history database.
Consistent with the changes to
§ 37.205(b)(2), the Commission further
proposes to amend § 37.205(b)(3) to
clarify that a SEF’s electronic analysis
capability must enable the SEF to
reconstruct transactions, rather than
‘‘indications of interest, requests for
quotes, orders, and trades.’’
To the extent that the Commission is
providing SEFs with greater discretion
in fulfilling their information collection
obligations with respect to audit trail
requirements under § 37.205, the
Commission estimates and assumes that
SEFs would continue to fulfill their
information collection burdens in a
manner similar to the status quo.
Accordingly, the Commission assumes
that proposed § 37.205(b) would not
substantively or materially affect a SEF’s
total information collection burden
hours.
j. § 37.205(c)—Audit Trail
Reconstruction
Proposed § 37.205(c) would eliminate
the existing requirements for a SEF to
establish an annual audit trail review
and a related enforcement program and
instead require the SEF to ‘‘establish a
program to verify its ability to
comprehensively and accurately
reconstruct all trading on its
facility. . . .’’ The Commission believes
that this change will provide SEFs with
discretion regarding what records they
must maintain in order to comply with
their information collection
requirements, i.e., to determine what
components of their audit, if incomplete
or inaccurate, could impair their ability
to conduct effective surveillance, and to
determine and implement the most
effective means for enforcing
compliance with their audit trail and
recordkeeping requirements.945 The
Commission also proposes to adopt
guidance to Core Principle 2 in
Appendix B specifying that an effective
audit trail reconstruction program
should annually review an adequate
sample of executed and unexecuted
orders and trades from each execution
945 Notwithstanding these proposed changes, the
Commission notes that to comply with the general
audit trail requirement under proposed § 37.205(a),
a SEF must capture all audit trail data necessary to
reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take
disciplinary action, the SEF must ensure that
market participants are submitting accurate and
complete audit trail data.
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method offered to verify compliance
with § 37.205(c).946
To the extent that the Commission is
providing SEFs greater discretion in
fulfilling their information collection
obligations with respect to audit trail
requirements under § 37.205, the
Commission estimates and assumes that
SEFs would continue to fulfill their
information collection burdens in a
manner similar to the status quo.
Accordingly, the Commission will
assume that proposed § 37.205(c) would
not substantively or materially affect a
SEF’s total information collection
burden hours.
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k. §§ 37.206(b)–(d)—Disciplinary
Program
The Commission proposes to
eliminate the existing requirements
under (i) § 37.206(c), which currently
specify certain minimum requirements
for a SEF disciplinary hearing,
including providing a transcript of the
hearing to a respondent under certain
conditions; and (ii) § 37.206(d), which
requires that a disciplinary panel render
a written decision promptly following a
hearing, along with a detailed list of
information that the SEF must include
in the decision. Proposed § 37.206(b)
would generally require a SEF to
establish a disciplinary program to
enforce its rules and provide the SEF
with the discretion to administer that
program through compliance staff
instead of mandatory disciplinary
panels. The Commission also proposes
to add guidance to Core Principle 2 in
Appendix B to specify that a SEF’s rules
governing the adjudication of a matter
by the SEF’s disciplinary panel should
be fair, equitable, and publicly available
and that a SEF’s rules should require the
disciplinary panel to promptly issue a
written decision following a hearing or
the acceptance of a settlement offer.947
To the extent that the Commission is
providing SEFs greater discretion in
fulfilling their information collection
requirements with respect to carrying
out disciplinary hearing and issuing
hearing decisions, the Commission
estimates and assumes that SEFs would
continue to fulfill their information
collection burdens in a manner similar
to the status quo. Accordingly, the
Commission will assume that proposed
§§ 37.206(b)–(d) would not
946 The Commission proposes to add this
guidance to paragraph (a)(5) to Core Principle 2 in
Appendix B. 17 CFR part 37 app. B. As discussed
below, the Commission proposes to eliminate the
existing language in paragraph (a)(5) to Core
Principle 2 in Appendix B, see supra Section
VII.E.2.—–§ 37.206(b)—Disciplinary Program.
947 The Commission proposes to add this
guidance as part of a new paragraph (a)(7) to Core
Principle 2 in Appendix B.
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substantively or materially affect a SEF’s
total information collection burden
hours.
l. § 37.401—General Requirements for
Monitoring of Trading and Trade
Processing
Proposed § 37.401(b) would require
that a SEF collect and evaluate data on
its market participants’ trading activity
outside of the SEF ‘‘as necessary’’ rather
than ‘‘on an ongoing basis’’ as currently
required.948 Similarly, proposed
§ 37.401(c) would require a SEF to
monitor and evaluate general market
data to detect and prevent manipulative
activity ‘‘as necessary.’’ 949 The
Commission anticipates that this will
reduce annual recurring information
collection burden hours by
approximately 50 burden hours per SEF.
m. § 37.1301(b)—General Requirements
for Financial Resources
Proposed § 37.1301(b) would permit
SEFs that also operate as DCOs to file a
single financial report under § 39.11 that
covers both the SEF and DCO. Because
this proposed approach would
streamline and simplify the SEF
financial reporting requirement process
under § 37.1306, the Commission
estimates that the proposed change
would decrease annual recurring
information collection burden by 5
burden hours. The Commission also
estimates that 1 SEF will take advantage
of this approach per year.
n. § 37.1306—Financial Reporting to the
Commission
Proposed § 37.1306 would make
several changes that would affect SEFs’
information collection burden hours.
First, proposed § 37.1306(a) would
require SEFs’ quarterly financial
statement to be prepare in accordance
with GAAP.950 Because GAAPcompliant financial statements generally
require additional effort compared to
non-GAAP compliance financial
statements, the Commission estimates
that the proposed change would
increase annual recurring information
collection burden hours by 10 burden
948 The proposed amendment would renumber
existing subsection (a) to subsection (b).
949 The proposed amendment would renumber
existing subsection (b) to subsection (c).
950 Alternatively, if a SEF is not domiciled in the
United States and is not otherwise required to
prepare financial statements in accordance with
GAAP, then proposed § 37.1306(a)(2)(ii) would
allow the SEF to submit financial statements
prepared in accordance with either International
Financial Reporting Standards issued by the
International Accounting Standards Board, or a
comparable international standard that the
Commission may otherwise accept in its discretion.
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62049
hours and not impose an initial, nonrecurring burden.
Second, proposed § 37.1306(c), among
other things, would require a SEF to
determine all of the costs that a SEF
would incur to wind down its
operations and the amount of time for
the projected wind-down period, as well
as explain the basis for its
determinations. The Commission
estimates that proposed § 37.1306(c)
will impose an initial, non-recurring
information collection of 20 burden
hours associated with the SEF’s
obligation to provide a description of
the costs and timing of a projected
wind-down scenario, along with the
basis for its determination.
Additionally, the Commission estimates
that this information collection burden
would impose 5 annual recurring
information collection burden hours
after the initial year to update this
information.951
o. § 37.1401(g)—Program of Risk
Analysis and Oversight Technology
Questionnaire
Proposed § 37.1401(g) would require a
SEF to annually submit an up-to-date
questionnaire that would be located in
Appendix A to part 37
(‘‘Questionnaire’’) based on the existing
Operational Capability Technology
Questionnaire located in Exhibit V to
Form SEF in Appendix A.952 A SEF
951 The Commission notes that existing
§ 37.1306(c) requires a SEF to provide ‘‘[s]ufficient
documentation’’ explaining both the methodology it
used to compute its financial resources requirement
as well as the basis for its determinations regarding
its liquidity requirements. In addition to the change
discussed above, proposed § 37.1306(c) would
clarify the type of information that SEFs must
include in the financial statements they submit to
the Commission, including (i) list all of its
expenses, without exclusion, and (ii) identification
of all expenses that the SEF excluded or pro-rated
in its projected operating cost calculations and
explain the basis for excluding or pro-rating any
expenses. The Commission believes that these
changes are neither an addition nor modification to
existing burden hours since the Commission is
merely clarifying the type of documentation that
must be provided to be deemed ‘‘sufficient’’ and are
not intended to increase burden hours or the
information that the Commission originally
intended for SEFs to provide. Accordingly, other
than as discussed above, the Commission believes
that the proposed amendment to § 37.1306(c) would
not impose new information collection burdens on
SEFs or substantively or materially modify existing
burdens.
952 The Commission notes that based on the
proposed amendments to Form SEF in Appendix A,
Exhibit V would be re-designated as Exhibit Q of
Form SEF. The up-to-date questionnaire would be
called the ‘‘Program of Risk Analysis and Oversight
Technology Questionnaire’’ and would be located
in Appendix A to part 37. To the extent that stillcurrent information and documents were provided
in the most recent update to the Questionnaire, a
SEF responding to a System Safeguards
Examination document request would be able to
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would only need to submit new changes
to the Questionnaire and would not
need to resubmit any information that
has not changed. An applicant for SEF
registration is required to file the
Questionnaire pursuant to Form SEF in
order to demonstrate compliance with
Core Principle 14 and § 37.1401.953 The
majority of the updated Questionnaire
would remain unchanged, although the
proposal would additionally include
enterprise technology risk assessments,
board of director and committee
information, third-party service
provider information, and cybersecurity
threat intelligence capabilities in order
to keep up-to-date with the rapidly
changing field of system safeguards and
cybersecurity.
The Commission believes that the
aggregate burden hours imposed on
SEFs are mitigated for several reasons.
First, an annually-updated
Questionnaire would limit the work
required of SEFs in responding to a
System Safeguards Examination
document requests to providing updated
information and documents for sections
of Exhibit Q that have changed since the
last annual filing. Second, SEFs
currently must provide similar
information under existing
§§ 37.1401(f)–(g).954 Third, much of the
reference that fact, rather than resubmitting such
information and documents.
953 The current version of the Questionnaire
requests documents and information pertaining to
the following nine areas of an applicant’s program
of risk analysis and oversight, including: (i)
Organizational structure, system descriptions,
facility locations, and geographic distribution of
staff and equipment, including organizational
charts and diagrams; (ii) enterprise risk
management program and governance, including
information regarding the Board of Directors,
audits, and third-party providers; (iii) information
security, including storage of records, access
controls, and cybersecurity threat intelligence
capabilities; (iv) business continuity and disaster
recovery plan and resources, including testing and
recovery time objectives; (v) capacity planning and
testing; (vi) system operations, including
configuration management and event management;
(vii) systems development methodology, including
quality assurance; (viii) physical security and
environmental controls; and (ix) testing, including
vulnerability, penetration, and controls testing.
954 The Commission notes that proposed
subsection (h) (renumbered from existing
subsection (g)) requires a SEF to provide to the
Commission system safeguards-related books and
records, including (1) current copies of its business
continuity-disaster recovery plans and other
emergency procedures; (2) all assessments of its
operational risks or system safeguards-related
controls; (3) all reports concerning system
safeguards testing and assessment required by this
chapter; and (4) all other books and records
requested by Commission staff in connection with
Commission oversight of system safeguards or
maintenance of a current profile of the SEF’s
automated systems. Moreover, § 37.1401(f) requires
a SEF to provide Commission staff with timely
advance notice of all material planned changes to
automated systems that may impact reliability,
security, or adequate scalable capacity of such
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information comprising a SEF’s annual
compliance report would be able to be
used for the Questionnaire.
Accordingly, the Commission estimates
that proposed § 37.1401(g) would
establish a new collection of
information with annual recurring
burden hours of 8 burden hours per
SEF.
p. § 37.1501(d)—Preparation of Annual
Compliance Report
Proposed § 37.1501(d) 955 would make
several changes that would generally
reduce burden hours for SEFs. First,
under proposed § 37.1501(d) a SEF
would no longer need to include in its
annual compliance report (‘‘ACR’’)
either a review of all the Commission
regulations applicable to a SEF or
identify the written policies and
procedures designed to ensure
compliance with the Act and
Commission regulations. Instead, the
Commission believes that requiring an
ACR to include a description and selfassessment of the effectiveness of the
SEF’s written policies and procedures to
‘‘reasonably ensure’’ compliance with
the Act and applicable Commission
regulations is more closely aligned with
the corresponding provisions of Core
Principle 15 and would still allow the
Commission to properly assess the
SEF’s compliance and self-regulatory
programs. Accordingly, the Commission
estimates that proposed § 37.1501(d)
would reduce annual recurring
information collection burden hours by
approximately 10 burden hours per SEF.
Second, proposed § 37.1501(d)(3)
would maintain the current requirement
that an ACR describe the ‘‘financial,
managerial, and operational resources’’
set aside for compliance with the Act
and Commission regulations, but would
eliminate the requirement that a SEF
specifically discuss its compliance
staffing and structure; a catalogue of
investigations and disciplinary actions
taken over the last year; and a review of
disciplinary committee and panel
performance. The Commission estimates
that proposed § 37.1501(d)(3) would
reduce annual recurring information
collection burden hours by
approximately 5 burden hours per SEF.
Third, to facilitate the Commission’s
ability to assess a SEF’s written policies
and procedures regarding compliance
matters, proposed § 37.1501(d)(4) would
require a SEF to discuss only material
noncompliance matters and explain the
corresponding actions taken to resolve
systems and planned changes to the SEF’s program
of risk analysis and oversight.
955 The proposed amendment would renumber
existing subsection (e) to subsection (d).
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such matters.956 The Commission
believes that requiring SEFs to focus on
describing material non-compliance
matters, rather than describing all
compliance matters in similar depth,
will streamline this requirement and
provide more useful information to the
Commission. Further, the Commission
proposes to eliminate the enumerated
mechanisms for identifying noncompliance issues, which conforms to
the ability of a chief compliance officer
(‘‘CCO’’) to establish procedures to
address non-compliance issues through
‘‘any means,’’ as described above.
Accordingly, the Commission estimates
that this change would reduce annual
recurring information collection burden
hours per SEF by 3 burden hours.
Fourth, proposed § 37.1501(d)(5)
would limit a SEF CCO’s certification of
an ACR’s accuracy and completeness to
‘‘all material respects’’ of the report. The
Commission understands that CCOs
have been hesitant to certify that an
entire ACR is accurate and complete
under the penalty of the law, without
regard to whether a potential inaccuracy
or omission would be a material error or
not. Accordingly, since the Commission
believes that the proposed change
would entail fewer burdens for a CCO
to collect the necessary information to
enable the CCO to certify the ACR, the
Commission estimates that this change
would reduce annual recurring
information collection burden hours per
SEF/CCO by 10 burden hours.
q. Part 36—Trade Execution
Requirement
Proposed part 36 would address the
swap trade execution requirement and
would eliminate the MAT
determination process under existing
§ 37.10 and § 38.12, as well as the
associated compliance schedules set
forth under § 37.11 and § 38.11.
Proposed § 36.2 would require SEFs and
DCMs to each respectively file a
standardized form (‘‘Form TER’’) to the
Commission that details the swaps that
they list for trading that are subject to
the trade execution requirement, as well
as include such information on their
respective websites. The Commission
estimates that filing these forms and
providing the related information on
their website will create a new
information collection with an initial,
non-recurring burden of approximately
5 burden hours per SEF to complete and
submit Form TER. Additionally, the
Commission estimates that this
956 The Commission proposes to renumber
paragraph (e)(5) to paragraph (d)(4) and adopt the
amendments as described above and other nonsubstantive amendments.
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requirement will impose approximately
5 annual recurring burden hours per
SEF related to updating, or confirming
no changes need to be made to, Form
TER. As noted above, there are 25 SEFs
currently registered with the
Commission, and the Commission
expects up to another 60 SEFs to register
as a result of the Commission’s
proposed application of the SEF
registration requirement. Accordingly,
the Commission estimates that the
information collection burdens related
to Form SEF will impose an aggregate of
425 initial, non-recurring burden hours
across 85 entities and an aggregate of
425 annual recurring burden hours
across the same.957
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2. Information Collection Comments
The Commission invites the public to
comment on any aspect of the
paperwork burdens discussed herein,
particularly for those provisions for
which the Commission proposes to
eliminate specific requirements and
instead provide SEFs with discretion in
complying with their information
collection obligations. Copies of the
supporting statements for the
collections of information from the
Commission to OMB are available by
visiting RegInfo.gov. Pursuant to 44
U.S.C. 3506(c)(2)(B), the Commission
solicits comments in order to (i)
evaluate whether the proposed
collections of information are necessary
for the proper performance of the
functions of the Commission, including
whether the information will have
practical utility; (ii) evaluate the
accuracy of the Commission’s estimate
957 The current 25 registered SEFs + the 60
entities that the Commission expects would register
as a result of the Commission’s proposed
application of the SEF registration requirement = 85
total entities. Accordingly, 85 total entities × 5
hours per entity = 425 total hours for all SEF
entities. The Commission notes that the related
burden hours for the current MAT determination
process are included in separate OMB control
number 3038–0099, which estimates 5 annual
recurring responses that average 16 burden hours
per response, for a total estimate of 80 annual
recurring burden hours across all SEFs and DCMs.
The Commission proposes to eliminate OMB
control number 3038–0099 and transfer the relevant
burden to OMB control numbers 3038–0052 and
3038–0074. While the Commission expects
additional swap products and transactions would
become subject to the Commission’s revised
interpretation of the trade execution requirement in
CEA section 2(h)(8), the Commission also expects
that 60 additional entities would register as SEFs as
a result of the Commission’s application of the SEF
registration requirement. See supra Section
XXIII.B.1.a.—§ 37.3(a)—Requirements for
Registration. Accordingly, the Commission expects
that any additional burden hours associated with
any increase in the number of swap products traded
on SEF or in swap transaction volume would be
covered by the additional burden hours associated
with the 60 new entities that the Commission
expects to register as SEFs.
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of the burden of the proposed
collections of information; (iii)
determine whether there are ways to
enhance the quality, utility, and clarity
of the information proposed to be
collected; and (vi) minimize the burden
of the proposed collections of
information on those who are to
respond, including through the use of
appropriate automated collection
techniques or other forms of information
technology.
Those desiring to submit comments
on the proposed information collection
requirements should submit them
directly to the Office of Information and
Regulatory Affairs, OMB, by fax at (202)
395–6566, or by email at
OIRAsubmissions@omb.eop.gov. Please
provide the Commission with a copy of
submitted comments so that all
comments can be summarized and
addressed in the final rule preamble.
Refer to the ADDRESSES section of this
notice of proposed rulemaking for
comment submission instructions to the
Commission.
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the
Commission to consider the costs and
benefits of its actions before
promulgating a regulation under the
CEA or issuing certain orders.958
Section 15(a) further specifies that the
costs and benefits shall be evaluated in
light of the following five broad areas of
market and public concern: (1)
Protection of market participants and
the public; (2) efficiency,
competitiveness, and financial integrity
of futures markets; (3) price discovery;
(4) sound risk management practices;
and (5) other public interest
considerations. The Commission
considers the costs and benefits
resulting from its discretionary
determinations with respect to the
section 15(a) factors further below. Prior
to the section 15(a) consideration for
each set of rules, the Commission
separately discusses the costs, benefits,
and potential alternatives to the
approach for the proposed regulations,
organized in the following manner:
• SEF Registration
(1) Application of SEF Registration
Requirement
(2) SEF Registration Process and Related
Forms
• Market Structure and Trade Execution
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
(2) Trade Execution Requirement and
Elimination of MAT Process
958 7
PO 00000
U.S.C. 19(a).
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•
•
•
•
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(3) Pre-Execution Communications and
Block Trades
(4) Impartial Access
Compliance and SRO Responsibilities
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ‘‘Market Participant’’
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and
Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence
Record
(iii) Information-Sharing
(6) System Safeguards
Design and Monitoring of Swaps
(1) Swaps Not Readily Susceptible to
Manipulation
(2) Monitoring of Trading and Trade
Processing
Financial Integrity of Transactions
Financial Resources
The Commission recognizes that the
proposed rules may impose costs, but
currently lacks the requisite data and
information to reasonably estimate
them. This lack of data and information
is attributable in part to the discretion
that a SEF would have under the
proposed rules to achieve compliance
by adopting different measures.
Accordingly, the Commission cannot
predict the approach that each SEF
would adopt to achieve such
compliance. Additionally, the initial
and recurring compliance costs for any
particular SEF or market participant
would depend on the size, existing
infrastructure, level of swap activity,
and practices and cost structure of the
relevant entity. Costs or benefits may be
impacted, for example, if certain entities
seek to avoid the regulations attendant
to SEFs by reducing their swap
activities. In situations where the
Commission is unable to quantify the
costs and benefits, the Commission
identifies and considers the costs and
benefits of the applicable proposed rules
in qualitative terms.
The Commission notes that this
consideration is based on its
understanding that the swaps market
functions internationally with (i)
transactions that involve U.S. firms
occurring across different international
jurisdictions; (ii) some entities
organized outside the U.S. that are
prospective Commission registrants; and
(iii) some entities typically operating
both within and outside the U.S. who
follow substantially similar business
practices wherever located. Where the
Commission does not specifically refer
to matters of location, the cost-benefit
discussion below refers to the effects of
the proposed rules on all subject swaps
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activity, whether based on their actual
occurrence in the U.S. or on their
connection with, or effect on, U.S.
commerce pursuant to CEA section
2(i).959
The Commission generally requests
comment on all aspects of its costbenefit considerations, including the
identification and assessment of any
costs and benefits not discussed therein;
the potential costs and benefits of the
alternatives that the Commission
discussed in this release; data and any
other information to assist or otherwise
inform the Commission’s ability to
quantify or qualitatively describe the
costs and benefits of the proposed rules;
and substantiating data, statistics, and
any other information to support
positions posited by commenters with
respect to the Commission’s discussion.
Commenters may also suggest other
alternatives to the proposed approach
where the commenters believe that they
would be appropriate under the CEA
and would provide a more appropriate
cost-benefit profile.
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2. Baseline
The primary focus of the proposed
rules is to amend requirements set forth
for swap execution facilities under part
37 of the Commission’s regulations; 960
the process for a SEF or DCM to make
a swap ‘‘available to trade’’ under parts
37 and 38, respectively; 961 and related
regulations under parts 39 and 43.
Hence, the Commission believes that the
baseline for the consideration of costs
and benefits is the existing regulations
set forth in part 37; § 37.10 and § 38.12;
§ 39.12(b)(7); and § 43.2. For this reason,
the Commission is considering the
changes to costs and benefits, as
compared to the baseline, resulting from
the proposed regulations discussed
herein. The Commission notes that
some of the proposed rules would
959 Pursuant to CEA section 2(i), activities outside
of the U.S. are not subject to the swap provisions
of the CEA, including any rules prescribed or
regulations promulgated thereof, unless those
activities either have a direct and significant
connection with activities in, or effect on,
commerce of the United States; or contravene any
rule or regulation established to prevent evasion of
a Dodd-Frank Act-enacted provision of the CEA. 7
U.S.C. 2(i).
960 The Commission adopted the part 37
regulations in 2013. Core Principles and Other
Requirements for Swap Execution Facilities, 78 FR
33476 (Jun. 4, 2013) (‘‘SEF Core Principles Final
Rule’’).
961 The Commission adopted the regulation
establishing the process for a SEF or DCM to make
a swap ‘‘available to trade’’ in 2013. Process for a
Designated Contract Market or Swap Execution
Facility To Make a Swap Available to Trade, Swap
Transaction Compliance and Implementation
Schedule, and Trade Execution Requirement Under
the Commodity Exchange Act, 78 FR 33606 (Jun. 4,
2013) (‘‘MAT Final Rule’’).
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codify existing, time-limited no-action
relief and other guidance issued by
Commission staff that market
participants and SEFs may have relied
upon to alter their compliance practices
with respect to certain existing rules. To
the extent that market participants have
relied upon such relief or staff guidance,
the magnitude of the actual costs and
benefits of the proposed rules may not
be as significant. The Commission’s
cost-benefit discussion will note
instances where the Commission
believes that market participants or
SEFs have operated under relevant noaction relief or staff guidance.
3. SEF Registration
a. Overview
(1) Application of SEF Registration
Requirement
The Commission proposes to apply
the SEF registration requirements in
CEA section 5h(a)(1) and § 37.3(a)(1) to
both (i) swaps broking entities,
including interdealer brokers, that
facilitate multiple-to-multiple swaps
trading away from SEFs; and (ii) SingleDealer Aggregator Platforms that
aggregate single-dealer pages.
Accordingly, these entities would be
required to either register as a SEF or
become a part of an existing SEF. Other
alternatives, however, include adjusting
their activity to avoid the SEF
registration requirement; or in the case
of foreign swaps broking entities, which
includes foreign interdealer brokers that
currently facilitate trading, i.e.,
negotiation or arrangement, of swaps
transactions for U.S. persons (‘‘Eligible
Foreign Swaps Broking Entities’’),
working with the appropriate regulator
within their country of domicile to seek
an exemption from registration pursuant
to CEA section 5h(g).962
The Commission is also proposing to
delay the compliance date of any final
rule that applies the SEF registration
requirement. For foreign swaps broking
entities, the Commission proposes to
delay the compliance date for a period
of two years. This proposed delay
would provide more time for the
Commission to further develop its crossborder regulatory regime, including
clarifying the cross-border jurisdictional
reach of the SEF registration
requirement under CEA section 2(i). For
U.S. swaps broking entities, including
interdealer brokers, the Commission
962 Pursuant to CEA section 5h(g), the
Commission may exempt facilities from SEF
registration if the facility is subject to comparable,
comprehensive supervision and regulation on a
consolidated basis by the appropriate governmental
authorities in the home country of the facility. 7
U.S.C. 7b–3(g).
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proposes to delay the compliance date
for a period of six months in order to
provide such entities time to obtain SEF
registration.
(2) SEF Registration Process and Related
Forms
The Commission proposes several
clarifying and streamlining amendments
to Form SEF. Some of the proposed
amendments would amend or eliminate
several of the information requirements
set forth in the existing exhibits. For
example, the Commission is proposing
to consolidate certain exhibits regarding
governance (existing Exhibits C and G)
and personnel (existing Exhibits E and
F), as well as eliminate an exhibit
regarding the financial resources of any
affiliates (existing Exhibit J). The
Commission is also proposing to clarify
certain information requirements not
explicitly enumerated in the existing
requirements, but which have been
incorporated in practice as part of the
existing SEF application review process.
For example, SEF applicants would
need to provide additional information
in Form SEF about, among other things,
the asset classes the SEF applicant
intends to list and submit for clearing
(new Exhibit N). The Commission is
also proposing to eliminate the
requirement to use Form SEF to request
an amended order of registration; under
the proposed rules, a registered SEF
would be able to file a request with the
Commission for an amended order of
registration.
Finally, the Commission proposes to
revise § 37.4 to exclude product
submissions from the SEF registration
process. Section 37.4 currently permits
a SEF applicant to submit the terms and
conditions of swaps that it intends to
list for trading as part of its application
for registration. Section 37.4 also
requires the Commission to consider
such swaps for approval at the time that
the Commission issues a SEF’s
registration order or, for a dormant SEF,
reinstatement of registration. As
proposed, a SEF applicant would have
to obtain registration prior to submitting
product terms and conditions or related
amendments under § 40.2 or § 40.3,
which govern the submission of new
product terms and conditions or related
amendments by registered entities.
b. Benefits
(1) Application of SEF Registration
Requirement
The Commission believes that
ensuring that all entities operating
trading systems or platforms that
facilitate swaps trading between
multiple market participants are subject
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to the SEF registration requirement
would impart substantial benefits on the
swaps market (emphasis added).
Ensuring that ‘‘multiple-to-multiple’’
swaps trading activity occurs on a
registered SEF should concentrate the
liquidity formation on SEFs and provide
oversight benefits and efficiencies that
enhance market integrity. The proposed
application of the SEF registration
requirement should help to ensure that
the entire swaps trading process,
including pre-trade and post-trade
protocols, occurs on a SEF in most
cases; combined with the proposed
interpretation of the trade execution
requirement discussed below, which
would require additional swaps to be
executed on a SEF, the proposed
application of the registration
requirement should bring a material
amount of swaps trading activity under
SEF oversight. The transition of greater
trading to a SEF should improve market
oversight by allowing a SEF to monitor
a broader swath of the swaps market,
which would result in an enhancement
of the Commission’s own oversight
capabilities.
Further, increased swaps trading on a
SEF also should benefit market
participants, including, among other
things, protections to mitigate abusive
trading or other market disruptions via
a facility’s audit trail, trade surveillance,
market monitoring, recordkeeping, and
anti-fraud and market manipulation
rules. Additionally, the use of SEF
mechanisms would help to enhance
post-trade efficiencies and facilitate
compliance with related Commission
requirements, including pre-trade credit
screening and the submission of
transactions for clearing and reporting.
Among other things, the Commission
believes that access to such services
could benefit certain market
participants more than others, in
particular those who have not
previously established access to such
services.
(2) SEF Registration Process and Related
Forms
The proposed amendments to Form
SEF may benefit potential SEF
applicants, including those swaps
broking entities and Single-Dealer
Aggregator Platforms that the
Commission anticipates would elect to
register as SEFs, by making a more
efficient and potentially less
burdensome SEF registration process.
The Commission anticipates that certain
changes to Form SEF would reduce
duplicative information requirements,
while also continuing to ensure that it
receives sufficient information to
determine whether the applicant is in
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compliance with the core principles and
Commission regulations. The additional
proposed information requirements
include information that Commission
staff has been requesting in practice as
part of the SEF registration process after
applicants submit Form SEF. Thus,
requiring this information on Form SEF
should increase the efficiency of the
SEF registration process by reducing the
number of follow-up questions and
requests. The Commission also
anticipates that these proposed
requirements will reduce the amount of
time that the Commission needs to
review a completed application.
The Commission also proposes
conforming amendments to Form SEF
that are consistent with the proposed
regulations. The proposed amendments
prompting the revision or elimination of
certain existing information
requirements relate to, among other
things, proposed amendments to
existing execution method and financial
resource requirements, as discussed
below. The proposal to eliminate the
temporary registration provisions that
have expired should have no direct
impact on costs or benefits.
Additionally, the Commission proposes
to exclude product submissions from
the SEF application process. The
Commission believes that separating
these two processes would likely
promote efficiency for both Commission
staff and SEF applicants. Otherwise, the
review of a SEF applicant’s registration
application could be unnecessarily
delayed or stayed because Commission
staff may require additional
consideration or analysis of the novelty
or complexity of the proposed product.
c. Costs
(1) Application of SEF Registration
Requirement
Any swaps broking entity or SingleDealer Aggregator Platform that elects to
register as a SEF would incur the costs
of registering, owning, and operating a
SEF. The Commission previously
discussed the costs of registering and
operating a SEF in the SEF Core
Principles Final Rule; 963 these costs and
benefits are further modified by the
proposed amendments described in the
preamble above and cost-benefit
considerations discussed further below.
These entities are likely to incur
initial setup costs to upgrade or create
their existing systems or platforms to
comply with the SEF core principles
and Commission regulations applicable
to SEFs, including the SEF registration
requirement. The Commission
963 SEF
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recognizes that the additional ongoing
marginal and fixed costs of maintaining
a SEF could be significant for some of
these entities. For example, some of
these entities would have to educate
their employees on SEF compliance
practices; hire additional employees
such as a CCO; and develop additional
functions such as audit trail, trade
surveillance, recordkeeping, and market
monitoring.
To avoid or mitigate some of these
costs, some swaps broking entities may
become a part of a SEF with whom they
are affiliated, thereby leveraging existing
resources; nevertheless, they would
likely still incur one-time costs and
some ongoing costs. The Commission
also notes that many swaps broking
entities are currently registered with the
Commission as introducing brokers
(‘‘IBs’’); as such, they already follow
certain similar regulatory requirements,
including those related to oversight and
recordkeeping. Therefore, the SEF
registration costs to these entities would
likely be lower since they already
adhere to similar regulatory obligations.
A Single-Dealer Aggregator Platform
also would need to register as or join a
SEF, thereby likely incurring similar
costs.964 Similarly, the Commission
believes that the cost for an unaffiliated
Single-Dealer Aggregator Platform to
become a SEF or join a SEF would be
greater than the cost for a Single-Dealer
Aggregator Platform already affiliated
with a SEF.
The Commission estimates that there
are approximately 40–60 swaps broking
entities, including interdealer brokers,
that would need to either register as a
SEF or join a SEF as a result of the
Commission’s proposed application of
the SEF registration requirement.965 For
some of these entities, the cost to
become a SEF or affiliate with a SEF
may compel them to cease operating
trading systems or platforms that
facilitate multiple-to-multiple swaps
trading between market participants. To
mitigate these registration costs, the
Commission is proposing a six-month
delay to the compliance date for
applicable U.S. swaps broking entities.
This proposed delay would provide
additional time for U.S. swaps broking
entities to become registered as SEFs,
thereby increasing the opportunity for
964 The Commission is aware of one Single-Dealer
Aggregator Platform that is currently affiliated with
a SEF.
965 These estimates are based on introducing
broker information made available from the
National Futures Association (‘‘NFA’’). The NFA
information indicates that there more than 300
registered IBs currently designated as a ‘‘swap firm’’
that broker swap products.
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them to continue operating without
interruption.
Smaller swaps broking entities or
smaller Single-Dealer Aggregator
Platforms may be more likely than larger
entities or platforms to abstain from SEF
activities to avoid the SEF registration
requirement. Smaller entities or
platforms are less likely to have existing
technology and procedures or available
resources to comply with new SEF
requirements; therefore, their initial
costs of compliance with those
requirements may be larger or have a
proportionally greater effect on smaller
entities. Market participants may also
bear some costs if some entities abstain
from SEF activities. For example,
market participants who have utilized
these entities to trade swaps would no
longer be able to do so for swaps that
must be traded on a SEF or swaps that
they would otherwise want to execute
on a SEF. Therefore, these participants
would incur costs that could include
search and transition costs to identify
and onboard to new SEFs. In
transitioning to a new platform, those
market participants may incur less
favorable financial terms or have access
to reduced services.
The Commission estimates that
approximately 10–20 of the swaps
broking entities that would potentially
need to either register as a SEF or join
a SEF are located outside of the U.S. or
otherwise have operations outside of the
U.S. (‘‘Eligible Foreign Swaps Broking
Entities’’). To mitigate these registration
costs, the Commission is proposing a
two-year delay to the compliance date
for Eligible Foreign Swaps Broking
Entities. The proposed delay is likely
sufficient for these entities either to
register as SEFs in an orderly manner or
to become subject to comparable and
comprehensive supervision from their
home regulators, and thus become
eligible for an exemption to the SEF
registration requirement pursuant to
CEA section 5h(g). This proposed delay
would also allow these entities more
time to avoid operational disruptions,
which should mitigate costs for these
entities and limit disturbances in the
swaps markets, while the Commission
addresses the application of CEA
section 2(i).
The delayed compliance date for
Eligible Foreign Swaps Broking Entities
would also delay the prospective
benefits discussed above for those
swaps trading on these foreign entities.
However, the Commission does not
anticipate that this delay would draw
trading volume away from domestic
SEFs. The Commission understands that
market participants generally use
Eligible Foreign Swaps Broking Entities
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to trade swaps outside of standard
business hours in the U.S. and/or to
access liquidity in other non-U.S.
markets. The proposed six-month
implementation window for U.S. swaps
broking entities would also delay the
benefits discussed above, but the
amount of time needed for an entity to
obtain SEF registration renders the
compliance with the registration
requirement by the compliance date of
any final rule impractical.
Additionally, some customers of
swaps broking entities and SingleDealer Aggregator Platforms may incur
the costs of ‘‘onboarding’’ with a SEF, to
the extent that these market participants
are not currently customers of a SEF.
The Commission’s proposal to expand
the trade execution requirement to
include all swaps subject to the clearing
requirement that are listed on a SEF
would prevent market participants from
trading these swaps off-SEF in most
instances. Accordingly, those market
participants who wish to continue to
trade these swaps would have to
onboard to a SEF. The Commission
estimates that up to 807 market
participants in the interest rate swaps
(‘‘IRS’’) market trade cleared swaps
exclusively off-SEF and thus may need
to onboard to a SEF.966 While the IRS
market is the largest market by both
trading volume and by notional amount
outstanding 967 among all swap asset
classes, additional market participants
trading cleared swaps in the credit asset
class may also need to onboard to a
SEF.968 Market participants that must
966 To estimate the number of market participants
in the IRS market that would choose to onboard
with a SEF, the Commission first analyzed IRS
trading during January 2018 and identified market
participants who traded cleared IRS but did not
trade an IRS on a SEF during that month. Then, the
Commission compared the list of legal entity
identifiers (‘‘LEIs’’) associated with those market
participants to the LEIs of market participants who
transacted on a SEF within the 2017 calendar year
and identified the LEIs that have never transacted
on a SEF during the sample period analyzed. The
Commission identified 807 unique LEIs who traded
a cleared IRS in January 2018 but did not trade an
IRS on a SEF in 2017 or in January 2018. The
Commission notes that these 807 LEIs made up 21
percent of total IRS notional traded in January 2018
and accounted for 38 percent of the trades.
967 According to the International Swaps and
Derivatives Association (‘‘ISDA’’) SwapsInfo, the
notional volume of trading in IRS in 2017 was about
$192 trillion, as compared to about $7 trillion for
credit. ISDA, ISDA SwapsInfo Weekly Analysis:
Week Ending December 22, 2017, https://
analysis.swapsinfo.org/2017/12/ird-and-cdsweekly-trading-volume-week-ending-december-222017/ (‘‘2017 ISDA SwapsInfo Weekly Analysis’’).
According to the Bank of International Settlement
statistics on the global OTC derivatives market, IRS
constitute 69 percent of the total OTC derivatives
market, by notional. Bank of International
Settlement, https://stats.bis.org/statx/srs/table/d5.1.
968 The Commission has not estimated the
number of additional market participants in the
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onboard to a SEF would incur costs to
integrate their system with a SEF’s
interface as well as to train personnel to
comply with a SEF’s rulebook. For some
market participants, this may require
programming new ways to view,
receive, and export information.
Onboarding would also subject these
market participants and their trading to
the SEF’s jurisdiction, which market
participants may view as another
disadvantage. As a result of the costs
related to onboarding and trading on
SEFs, certain market participants may
reduce their use of swaps.969
To the extent that a market
participant’s swaps are already executed
on a SEF after being arranged by a
swaps broking entity, however, the
Commission does not anticipate that the
market participant would incur
significant additional internal costs by
using the SEF for the entire trading
process. Some SEFs may charge higher
fees for these trades due to the
additional oversight the Commission
contemplates that the SEF would
provide.
(2) SEF Registration Process and Related
Forms
The Commission proposes to reduce
some information requirements as part
of the proposed Form SEF, but would
require additional information in other
areas. As a result, the Commission
believes that some proposed changes to
Form SEF would reduce costs while
others would increase costs. However,
the Commission believes that the cost of
preparing Form SEF, as proposed to be
amended, is likely to be comparable to
the cost of preparing the existing Form
SEF. Since the additional information
required by Form SEF generally consists
of information that the Commission has
been requesting as part of the
registration process, SEF applicants
already likely incur the costs associated
with providing that information.
Additionally, the Commission proposes
to remove the product submission
process from the SEF application
process. SEF applicants may incur
additional administrative costs
associated with completing the product
submission apart from a SEF
credit asset class (who do not also trade IRS) that
may onboard to a SEF as a result of the proposal.
969 Similar to the point made above regarding
entities potentially refraining from SEF activities,
any perceived disadvantages of transacting on SEFs
may cause some market participants to alter their
risk management processes to avoid or reduce their
transactions on SEFs. If these market participants
were to use more costly or less effective risk
management strategies in place of swaps, this could
increase the cost or reduce the effectiveness of risk
management in general.
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application.970 However, the
Commission believes these additional
costs will mostly be related to the
format and manner of submission, as the
content of a product submission would
materially remain the same.
d. Section 15(a) Factors 971
(1) Protection of Market Participants and
the Public
The Commission believes that the
proposed application of the statutory
SEF registration requirement to certain
entities not currently registered as SEFs
should protect market participants and
the public by helping to ensure that
entities that meet the SEF definition
provide the protections associated with
SEF core principles and the
Commission’s regulations. As noted
above, these protections include audit
trail, trade surveillance, market
monitoring, recordkeeping, and antifraud and market manipulation rules.
The proposed amendments to the SEF
registration process should maintain the
protection of market participants and
the public by continuing to help ensure
that SEF applicants provide the
Commission with the information it
needs to determine whether the SEF
applicant will be able to comply with
the SEF core principles and
Commission regulations.
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(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
The Commission believes that the
proposed application of the statutory
SEF registration requirement to certain
entities not currently registered should
enhance the competitiveness and
financial integrity of markets since these
registered SEFs would be subject to
relevant SEF core principles, including,
among others, Core Principles 2, 4, and
15. The Commission also believes that
the proposal would subject entities
providing similar services to
comparable regulations, thus increasing
the competitiveness of SEFs. The greater
use of SEF functions, such as pre-trade
970 The Commission notes that this change—and
the concomitant benefits and costs—also would
affect dormant SEFs, which like SEF applicants
currently may include proposed products as part of
their process to obtain reinstatement of their
registration from dormancy.
971 The discussion here and in the other section
15(a) discussions below cover the proposed
amendments that the Commission has identified as
being relevant to the areas set out in section 15(a)
of the CEA: (i) Protection of market participants and
the public; (ii) efficiency, competitiveness, and
financial integrity of futures markets; (iii) price
discovery; (iv) sound risk management practices;
and (v) other public interest considerations. For
proposed amendments that are not specifically
addressed within the respective CEA section 15(a)
factor discussion, the Commission has not
identified any effects.
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credit screening, submission to DCOs
for clearing, and reporting to SDRs
should also enhance efficiencies in the
swaps market. Proposed Form SEF
should continue to provide a means for
SEF applicants to demonstrate
compliance with core principles related
to financial integrity, including Core
Principle 13 regarding SEF financial
resources.
(3) Price Discovery
The Commission believes that the
application of the statutory SEF
registration requirement to certain
entities not registered as SEFs may
further price discovery in swaps, given
that more swap transactions would be
traded on SEFs and more market
participants would be participating on
SEFs. This increased trading may
enhance the liquidity of the swaps
market on SEFs. The Commission
believes that, generally, market
participants would have access to better
price discovery in more liquid markets.
(4) Sound Risk Management Practices
The Commission believes that the
proposed application of the statutory
SEF registration requirement to certain
entities not currently registered as SEFs
may further sound risk management
practices by helping to ensure that
swaps trading occurs subject to the rules
of the SEF and receive the protections
associated with the SEF core principles
and Commission regulations.
(5) Other Public Interest Considerations
The Commission believes that the
proposal that entities that meet the SEF
definition must register as SEFs should
further the public interest consideration
of promoting trading of swaps on SEFs
as stated in CEA section 5h(e).
Request for Comment
The Commission requests comment
on all aspects of the consideration of the
costs and benefits of the provisions
related to SEF registration. The
Commission estimates that there would
be 40 to 60 newly-registered SEFs. For
those newly-registered SEFs, and with
the understanding that costs will vary
depending on the entity, what would be
the average cost for a newly-registered
SEF to comply with the Commission’s
proposed new SEF regime? If possible,
please provide itemized costs per
requirement. What would be the ongoing costs to comply with that regime?
The Commission believes that many
swaps broking entities, including
interdealer brokers, are currently
affiliates of a registered SEF. As a result,
the cost of integrating a swaps broking
entity’s non-registered SEF into its
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current SEF registration regime will be
significantly less than those of newlyregistered SEFs, i.e., those entities that
do not have a registered SEF as an
affiliate. Is the Commission’s
assumption correct? If not, then why
not? What would be the cost of
integrating and updating an entity’s
compliance program to reflect the
proposed rule’s new and amended
requirements? What would be the ongoing costs to comply?
4. Market Structure and Trade
Execution
a. Overview
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
Based on its increased understanding
of swaps trading dynamics and the
increased scope of swaps that would
become subject to the trade execution
requirement, the Commission proposes
to eliminate the prescribed execution
methods under § 37.9 for swaps subject
to the trade execution requirement. In
addition, the Commission proposes to
eliminate the minimum trading
functionality and Order Book provisions
under §§ 37.3(a)(2)–(3). As a result, for
any swap that it lists, a SEF would be
able to offer any execution method that
is consistent with the SEF definition in
CEA section 1a(50) and the general rules
related to trading and execution
consistent with the SEF core principles
and proposed part 37 rules. In
particular, a SEF would be allowed to
offer flexible methods of execution for
any swap that it lists for trading,
regardless of whether or not the swap is
subject to the trade execution
requirement.
In order to effect Core Principle 2, the
existing rules under § 37.201 would be
replaced with new general, disclosurebased trading and execution rules that
would apply to any execution method
offered by a SEF. Proposed § 37.201(a)
would require a SEF to specify (i) the
protocols and procedures for trading
and execution; (ii) the extent to which
the SEF may use its ‘‘discretion’’ in
facilitating trading and execution; and
(iii) the sources and methodology for
generating any market pricing
information.
(2) Trade Execution Requirement and
Elimination of MAT Process
The Commission proposes to
eliminate the ‘‘Made Available to
Trade’’ (‘‘MAT’’) process and proposes
to interpret the trade execution
requirement in CEA section 2(h)(8) to
require swaps to be executed on a SEF
or DCM if a swap is both subject to the
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clearing requirement in section 2(h)(1)
of the Act and listed for trading on a
SEF or DCM. The current rule, by
contrast, creates a process for a swap to
be categorized as ‘‘MAT’’ under § 37.10
and § 38.12 that is largely driven by a
registered SEF or DCM.
The Commission further proposes to
use its authority pursuant to CEA
section 4(c) 972 to exempt four different
types of swap transactions from the
trade execution requirement.
Specifically, the Commission proposes
that counterparties be exempted from
the trade execution requirement for (i)
swap transactions involving swaps that
are listed for trading only by an Exempt
SEF (as opposed to a registered SEF or
DCM); (ii) swap transactions that are
subject to and meet the requirements of
the clearing exception under 2(h)(7) of
the Act or the clearing exceptions or
exemptions under part 50 of the
Commission’s regulations; (iii) swap
transactions that are executed as a
component of a package transaction that
includes a component that is a new
issuance bond; and (iv) swap
transactions between ‘‘eligible affiliate
counterparties’’ (‘‘inter-affiliate
counterparties’’) that elect to clear such
transactions, notwithstanding their
ability to elect the clearing exemption
under § 50.52.
To facilitate compliance with the
proposed interpretation of the trade
execution requirement, the Commission
proposes a compliance schedule, based
on participant type, for the additional
swaps that would become subject to the
trade execution requirement. Under the
proposal, entities would fall into
categories based on their swaps trading
experience and resources: Category 1
entities would have a 90-day
compliance timeframe; Category 2
entities would have 180 days, and all
other relevant entities would have 270
days to allow them to onboard onto a
SEF, a DCM, or an Exempt SEF and to
comply with the trade execution
requirement. The Commission also is
proposing to establish a centralized
registry on its website to identify those
SEFs and DCMs that list swaps subject
to the trade execution requirement and
the particular swaps listed on each
entity. To establish the registry, the
Commission is proposing to require
SEFs and DCMs to file a standardized
Form TER, concurrently with any § 40.2
or § 40.3 product filing, that would
972 CEA section 4(c) empowers the Commission,
if certain conditions are met and subject to certain
limitations, to ‘‘promote responsible economic or
financial innovation and fair competition’’ by
exempting any transaction or class of transactions,
including swaps, from the provisions of the CEA.
7 U.S.C. 6(c).
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detail the swaps that they list for trading
that are subject to the clearing
requirement. In turn, Form TER would
provide a streamlined process to allow
the Commission to provide market
participants with a public registry of the
SEFs and DCMs that list particular
swaps for trading. Finally, the
Commission is also proposing that
DCMs and SEFs be required to publicly
post their Form TER on their respective
websites.
(3) Pre-Execution Communications and
Block Trades
For swaps subject to the trade
execution requirement, proposed
§ 37.201(b) would require a SEF to
prohibit its market participants from
engaging in pre-execution
communications away from its facility,
including negotiating or arranging the
terms and conditions of a swap prior to
its execution on the SEF via the SEF’s
methods of execution. In conjunction
with prohibiting pre-execution
communications and pre-arranged
trading under § 37.203, the Commission
is eliminating the fifteen-second time
delay requirement under § 37.9(b).
Under proposed § 37.203, SEFs must
prohibit pre-arranged trading for trading
systems or platforms such as Order
Books, where pre-arranged trading
would be considered to be an abusive
trading practice. This prohibition,
however, would be subject to certain
proposed exceptions. First, swap
transactions that are not subject to the
trade execution requirement would be
excluded from the proposed
prohibition. Second, package
transactions that also include
components that are not subject to the
trade execution requirement would also
be excluded from that proposed
prohibition.
The Commission also proposes to
revise the definition of ‘‘block trade’’ in
existing § 43.2 to eliminate the ‘‘occurs
away’’ requirement for swap block
trades on SEFs. Pursuant to the revised
definition, counterparties that seek to
execute swaps at or above the block
trade size on a SEF must do so on a
SEF’s trading system or platform, rather
than away from the SEF pursuant to its
rules as currently required. For swaps
subject to the trade execution
requirement, counterparties would not
be able to conduct pre-execution
communications to negotiate or arrange
a block trade away from the SEF.973
973 The Commission notes that market
participants may pre-negotiate or pre-arrange block
trades for swaps that are not subject to the trade
execution requirement subject to an exception to
the proposed prohibition on pre-execution
communications under proposed § 37.201(b).
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Commission staff has provided timelimited no-action relief from the ‘‘occurs
away’’ requirement of the block trade
definition under § 43.2, and the
Commission understands that some
market participants have elected to
execute their block trades on-SEF
pursuant to that relief.974
(4) Impartial Access
Proposed § 37.202 would modify the
impartial access requirements to allow a
SEF to devise its participation criteria
based on its own trading operations and
market. Specifically, a SEF would be
required to establish rules that set forth
impartial access criteria for accessing its
markets, market services, and execution
methods; such impartial access criteria
must be transparent, fair, and nondiscriminatory and applied to all
similarly situated market participants.
Based on this approach, the
Commission would not require a SEF to
maintain impartial access in a manner
that promotes an ‘‘all-to-all’’ trading
environment. Rather, a SEF would be
allowed to serve different types of
market participants or have different
access criteria for different execution
methods in order to facilitate trading for
a desired market.
In addition to amending the impartial
access requirement, the Commission
also proposes several other related
amendments. Under proposed
§ 37.202(a)(1), a SEF would no longer be
required to provide impartial access to
ISVs. Further, under proposed
§ 37.202(a)(2), a SEF would be allowed
to establish fee structures in a fair and
non-discriminatory manner. This
revision would eliminate the existing
requirement under § 37.202(a)(3), which
requires a SEF to set ‘‘comparable fees’’
for ‘‘comparable access.’’
b. Benefits
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
The Commission believes that
eliminating the minimum trading
functionality requirement would
provide several benefits. Based on its
experience, the Commission has
observed that market participants have
generally not used Order Books for
swaps trading on SEFs despite their
availability for all SEF-listed swaps.975
974 CFTC Letter No. 17–60, Re: Extension of NoAction Relief for Swap Execution Facilities from
Certain ‘‘Block Trade’’ Requirements in
Commission Regulation 43.2 (Nov. 14, 2017).
975 A recent research study finds that for index
CDS, a minimal amount of trading activity on the
two highest-volume SEFs occurs via an order book.
Lynn Riggs, Esen Onur, David Reiffen & Haoxiang
Zhu, Mechanism Selection and Trade Formation on
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The Commission recognizes that market
participants view Order Books as
unsuitable for trading in a large segment
of the swaps market and believes that
eliminating this requirement would
reduce costs by enabling SEFs to
discontinue their use as a method of
execution or limit their availability,
based on their own discretion, to swaps
that are liquid enough to support such
trading.976 Moreover, new SEFs would
be able to register without setting up an
Order Book, which should significantly
reduce the cost of establishing a SEF.
The Commission also believes that
eliminating the required methods of
execution for swaps subject to the trade
execution requirement and instead
allowing flexible means of execution on
SEFs together with expanding the scope
of swaps subject to the trade execution
requirement, may further the statutory
goal of promoting the trading of swaps
on SEFs more effectively than the
current SEF framework. As a result of
their bespoke or customized structure,
the Commission recognizes that swaps
that currently are not MAT, but that
would become subject to the trade
execution requirement under the
Commission’s proposal, may be less
liquid than current MAT swaps, and
therefore, may be less suited for
execution via an Order Book or a
request-for-quote system that sends a
quote to no less than three unaffiliated
market participants and operates in
conjunction with an Order Book (‘‘RFQ
System’’).
Under the proposed approach, market
participants would be allowed to utilize
execution methods that best suit their
trading needs and the swap being
traded.977 These needs may include the
desire to minimize potential
information leakage and front-running
risks and/or the need to account for
market conditions for those swaps at a
given time.978 Allowing market
Swap Execution Facilities: Evidence from Index
CDS 10 (2017), https://www.cftc.gov/idc/groups/
public/@economicanalysis/documents/file/oce_
mechanism_selection.pdf (‘‘2017 Riggs Study’’).
976 The Commission notes that additional factors,
such as the use of name give-up and the lack of
certain trading features, may have also contributed
to the limited use of Order Books.
977 For example, Michael Barclay, Terrence
Hendershott and Kenneth Kotz studied mechanism
choice for U.S. Treasury securities and have found
that Treasury securities move from primarily
electronic trading to primarily voice trading when
there is an exogenous decline in trading volume.
Michael Barclay, Terrence Hendershott, Terrence &
Kenneth Kotz, Automation versus intermediation:
Evidence from Treasuries going off the run, 61 J.
Fin. 2395–14 (2006).
978 The 2017 Riggs Study finds that in the index
CDS market customers exercise discretion over
transacting via RFQ versus streaming quotes
depending on the size of their trades or the urgency
of their trading needs. The study also shows that
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participants to choose the appropriate
method of execution for their trading
needs may increase market efficiency
and lower transaction costs since market
participants are expected to seek out the
most efficient and cost-effective method
of execution to carry out their swaps
trading needs and to select the
appropriate level of pre-trade
transparency for their transactions.979
For example, a market participant
whose primary goal is obtaining best
execution in the market can choose the
execution method that provides the
appropriate degree of pre-trade
transparency, based on the swap’s
characteristics and the trader’s
execution options and their individual
trading needs, including submitting a
RFQ to more than three liquidity
providers. A market participant that
perceives benefits from maintaining a
relationship with a particular liquidity
provider (such a relationship may
extend beyond the swap market) can
choose an execution method that
facilitates that goal.980
SEFs would have broader latitude to
innovate and develop new and different
methods of execution tailored to their
markets. Accordingly, the proposed
flexibility would enable SEFs to provide
their market participants with
additional choices for executing swaps
subject to the trade execution
requirement beyond the Order Book or
RFQ System. Such methods could be
more efficient for a broader range of
swaps and various market liquidity
conditions, which may allow SEFs to
effectively promote appropriate
counterparty and swap-specific levels of
pre-trade price transparency.981 This
customers can choose to send RFQs to more than
the minimum required number of three participants
when their trade size is smaller and again when
their transactions are more urgent. 2017 Riggs Study
at 10.
979 Terrence Hendershott and Ananth Madhavan
looked at trading in corporate bonds where
customers can trade bonds either through voice
solicitation of dealer quotes or through an
electronic exchange that initiates an RFQ. Broadly
speaking, Hendershott and Madhavan find that
bonds that have characteristics associated with
more frequent trading are more likely to be traded
through the RFQ process, while trading tends to
move to a voice mechanism when bonds go off-therun and liquidity falls. Comparing the costs
between execution methods, they found that
electronic trades are associated with lower trading
costs for small trades, but that voice solicitation is
cheaper for larger trades. Terrence Hendershott &
Ananth Madhavan Click or call? Auction versus
search in the over-the-counter market, 70 J. Fin.
419–47 (2015).
980 The 2017 Riggs Study finds that in the index
CDS market, customers are more likely to seek
quotes via the RFQ process from dealers affiliated
with their clearing members, as well as from dealers
who make up a larger fraction of the customer’s past
trading volume. 2017 Riggs Study at 27.
981 For example, Darrell Duffie and Haoxiang Zhu
suggest that work-ups can sometimes be a more
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potential innovation of efficient,
transparent, and cost-effective trading
means would facilitate natural market
evolution via SEFs, which may
ultimately lower transaction costs and
increase trading efficiency.
This approach may also increase SEF
competition as SEFs seek to differentiate
from one another based on execution
methods that they offer. The
Commission believes that such
increased competition may lead to
reduced costs and increased
transparency for market participants.
The Commission further believes that
flexible means of execution may provide
opportunities for new entrants in the
SEF market. New entrants would be able
to utilize unique or novel execution
methods that are not currently offered
by incumbent SEFs. The Commission
believes that new entrants would help
increase competition in the market,
which may lead to reduced transaction
costs.
The Commission anticipates that SEFs
with active Order Books would continue
to offer them, such that customers who
wish to transact on Order Books would
continue to be able to do so. The
Commission also notes that swap
transactions on SEFs will continue to be
subject to the part 43 real-time reporting
requirements, so market participants
would continue to benefit from the posttrade transparency associated with
access to information about the most
recent transaction price.
While the Commission is proposing to
allow SEFs to utilize flexible methods of
execution, the Commission is
concurrently proposing under
§ 37.201(a) to require that SEFs
implement various trading and
execution-related rules, which would
require SEFs to disclose in their
rulebook the protocols and procedures
of the execution methods they offer,
including any discretion the SEF may
have in facilitating trading and
execution, e.g., in regards to price
formation or bid/offer matching. The
Commission believes that these rules
should provide market participants a
requisite level of transparency by
requiring SEFs to disclose information
regarding their execution methods,
trading systems, and operations. By
requiring such disclosure, the
Commission believes that SEFs would
provide market participants with a
consistent level of information so that
they are better able to make fully
informed decisions when selecting a
SEF or particular execution method.
efficient means of transacting than a limit order
book. See Darrell Duffie & Haoxiang Zhu, Size
Discovery, 30 Rev. Fin. Stud. 1095–1150 (2017).
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The Commission believes that
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(2) Trade Execution Requirement and
Elimination of MAT Process
The Commission believes that
expanding the scope of swaps that must
be traded and executed on SEFs or
DCMs would directly promote more SEF
trading, which is one of the Dodd-Frank
Act’s statutory goals. As noted above,
data analyzed by Commission staff
indicates that the percentage of IRS
trading volume that is subject to the
trade execution requirement declined
from approximately 10 to 12 percent of
total reported IRS volume in 2015 to
approximately 7 to 9 percent of total
reported IRS volume in 2017 and the
first half of 2018.982 According to an
ISDA analysis, the share of total
reported IRS volumes that occurred on
SEFs since 2015 has ranged between
approximately 55 to 57 percent of total
reported IRS volumes.983
A recent ISDA analysis also shows
that more than 85 percent of IRS trading
volume is subject to the clearing
requirement.984 The Commission
believes that much, but not all, of that
trading volume consists of swaps that
are listed for trading on a SEF. With
respect to credit default swaps (‘‘CDS’’),
ISDA’s analysis has shown that 71 to 79
percent of trading volume in index CDS
has occurred on SEFs since 2015,985
982 Commission staff conducted an analysis of
publicly available data accessed via Clarus
Financial Technology (‘‘Clarus’’). In a separate
analysis, ISDA found that only 5 percent of trading
volume in IRS during 2015 and the first three
quarters of 2016 consisted of IRS subject to the
trade execution requirement. ISDA, ISDA Research
Note: Trends in IRD Clearing and SEF Trading 1,
3, 11 (Dec. 2016), https://www.isda.org/a/xVDDE/
trends-in-ird-clearing-and-sef-trading1.pdf (‘‘2016
ISDA Research Note’’).
983 See, e.g., ISDA, ISDA SwapsInfo Weekly
Analysis: Week Ending October 19, 2018, https://
analysis.swapsinfo.org/2018/10/interest-rate-andcredit-derivatives-weekly-trading-volume-weekending-october-19-2018/ (‘‘2018 ISDA SwapsInfo
Weekly Analysis’’); ISDA, ISDA SwapsInfo Weekly
Analysis: Week Ending December 22, 2017, https://
analysis.swapsinfo.org/2017/12/ird-and-cdsweekly-trading-volume-week-ending-december-222017/ (‘‘2017 ISDA SwapsInfo Weekly Analysis’’);
ISDA, ISDA SwapsInfo Weekly Analysis: Week
Ending December 24, 2015, https://
analysis.swapsinfo.org/2015/12/ird-and-cdsweekly-analysis-week-ending-december-24-2015/
(‘‘2015 ISDA SwapsInfo Weekly Analysis’’).
984 ISDA, ISDA Research Note: Actual Cleared
Volumes vs. Mandated Cleared Volumes: Analyzing
the US Derivatives Market 3 (July 2018), https://
www.isda.org/a/6yYEE/Actual-Cleared-Volumes-vsMandated-Cleared-Volumes.pdf (‘‘2018 ISDA
Research Note’’).
985 See, e.g., 2018 ISDA SwapsInfo Weekly
Analysis; 2017 ISDA SwapsInfo Weekly Analysis;
2015 ISDA SwapsInfo Weekly Analysis. These
market share estimates are based on total SEF
volume in the asset class divided by total volume
in the asset class. In both cases, the volume is
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while just over 89 percent of CDS
trading volume is subject to the clearing
requirement.986 Since only a portion of
IRS and CDS trading that is also subject
to the clearing requirement has occurred
on SEFs, the Commission believes that
additional IRS and CDS trading may
transition to SEFs as a result of the
proposed expansion of the trade
execution requirement to cover all
swaps that are subject to the clearing
requirement and listed for trading on a
SEF or DCM.
The Commission believes that the
expanded trade execution requirement
would ensure that more swaps trading
occurs on SEFs. In turn, increased
swaps trading on SEFs would help
foster and concentrate liquidity and
price discovery on SEFs. This may help
increase market efficiency and
competition between market
participants, which would further
decrease transaction costs. Further, the
Commission believes that a broad trade
execution requirement, in conjunction
with the proposed prohibition on preexecution communications, would
ensure that swaps trading occurs on
SEFs, which may further amplify the
preceding benefits.
Bringing more swaps trading on to
SEFs, including the entire liquidity
formation process, would allow these
swap trades to directly benefit from SEF
oversight (including audit trail, trade
surveillance, market monitoring,
recordkeeping, and anti-fraud and
market manipulation rules) and services
that enhance market integrity (including
pre-trade credit checks, straight through
processing, and reporting to SDRs).
Additionally, the Commission expects
liquidity pools on SEFs to improve for
various products that would become
subject to the expanded trade execution
requirement as a result of an increase in
the number of market participants. This
may further improve liquidity, and an
increase in the number of products
traded on SEFs, which would allow
market participants to have direct access
to more price observations for these
products compared to the current SEF
framework. With an increase in the
amount of transactions on SEFs, the
Commission also believes, that since
SEFs would have more market data,
they may be better equipped to fulfill
their Core Principle 4 duties, as
discussed further below. As such, the
Commission believes that with direct
expressed in notional amount and includes both
cleared and uncleared swaps. Since ISDA uses part
43 data that contains capped notional amounts
pursuant to § 43.4(h), while the actual notional
amounts are not capped, the Commission notes that
these estimates likely overstate SEF market share.
986 2018 ISDA Research Note at 15–16.
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access to more trades, a SEF may be
better situated to prevent manipulation,
price distortion, or disruptions to the
functioning of an orderly market, which
is likely to benefit all market
participants.
In conjunction with the Commission’s
proposed interpretation of the trade
execution requirement, the Commission
is proposing to exempt certain
transactions from this requirement. The
proposed exemptions in CEA section
4(c) cover (i) swap transactions
involving swaps that are listed for
trading only by an Exempt SEF; (ii)
swap transactions that are subject to and
meet the requirements of the clearing
exception in CEA section 2(h)(7) or the
clearing exceptions or exemptions
under part 50 of the Commission’s
regulations; (iii) swap transactions that
are executed as a component of a
package transaction that includes a
component that is a new issuance
bond; 987 and (iv) swap transactions
between inter-affiliate counterparties
that elect to clear such transactions,
notwithstanding their ability to elect the
clearing exemption under § 50.52. The
Commission believes that exempting
these swap transactions that would
otherwise be subject to the trade
execution requirement would be
beneficial for the swaps markets. These
exemptions would appropriately
calibrate the trade execution
requirement to appropriate market
participants and swap transactions,
which can reduce the cost of trading.
The Commission is proposing to
exempt swaps that are listed only by an
Exempt SEF from triggering the trade
execution requirement. Since it may be
burdensome for a U.S. person to identify
and onboard with an Exempt SEF that
is the only platform listing a swap that
is subject to the expanded trade
execution requirement, the Commission
believes that exempting these swaps
from the trade execution requirement
until they are listed by a registered SEF
or a DCM would reduce such burdens.
The Commission is also proposing to
exempt from the expanded trade
execution requirement those
transactions that are excepted or
exempted from the clearing
987 The Commission understands that a bond
issued and sold in the primary market that may
constitute part of a package transaction is a
‘‘security,’’ as defined in section 2(a)(1) of the
Securities Act of 1933 or section 3(a)(10) of the
Securities Exchange Act of 1934. To the extent that
counterparties may be facilitating package
transactions that involve a security, or any
component agreement, contract, or transaction over
which the Commission does not have exclusive
jurisdiction, the Commission does not opine on
whether such activity complies with other
applicable law and regulations.
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requirement. The Commission believes
that swap transactions exempted from
the clearing requirement may benefit
from the proposed exemption by
providing counterparties with flexibility
regarding where they can trade or
execute such swaps, which the
Commission believes may help
counterparties reduce transaction costs
that they would otherwise incur from
mandatory trading or execution on a
SEF.
Furthermore, the Commission is
proposing to exempt ‘‘package
transactions’’ that involve swap and
new issuance bond components. In light
of the involvement of the bond issuer
and the underwriter in arranging and
executing a package transaction in
conjunction with a new issuance bond
and the unique negotiation and fit-forpurpose nature of these package
transactions, the Commission
understands that it remains difficult or
impossible to trade these package
transactions on a SEF. Market
participants currently may rely on
Commission staff’s temporary no-action
relief to trade MAT swaps that involve
new issuance bonds away from a
SEF.988 The proposed rule would ensure
that package transactions involving new
issuance bonds can be traded off-SEF on
an ongoing basis.
Finally, the Commission proposes to
exempt from the trade execution
requirement any swap transaction
between inter-affiliate counterparties
that elect to clear such transactions,
notwithstanding their ability to elect the
clearing exemption under § 50.52.
Under the current rules, inter-affiliate
transactions are only exempt from the
trade execution requirement if the interaffiliate counterparties elect not to clear
the transaction. However, despite these
transactions not being intended to be
price-forming or arm’s length and
therefore not suitable for trading on
SEFs, inter-affiliate counterparties that
elect to clear their inter-affiliate
transactions are subject to the trade
execution requirement. This proposal
instead would treat cleared and
uncleared inter-affiliate swap
transactions the same with respect to
the trade execution requirement. The
Commission believes that this approach
would be beneficial because interaffiliate swap transactions do not
change the ultimate ownership and
control of swap positions (or result in
netting) and permitting them to be
988 See CFTC Letter No. 17–55, Re: Extension of
No-Action Relief from Sections 2(h)(8) and 5(d)(9)
of the Commodity Exchange Act and from
Commission Regulations 37.3(a)(2) and 37.9 for
Swaps Executed as Part of Certain Package
Transactions (Oct. 31, 2017) (‘‘NAL No. 17–55’’).
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executed internally (provided that they
qualify for the clearing exemption under
existing § 50.52) may reduce costs
relative to requiring that they be
executed on SEF. Finally, the
Commission believes that this
exemption may help ensure that interaffiliate counterparties are not
discouraged from clearing their interaffiliate swap transactions in order to
avoid having to trade them on SEFs
subject to the trade execution
requirement, which may have systemic
risk benefits.989
The proposed trade execution
requirement compliance schedule is
intended to recognize that different
categories of counterparties have
different abilities and resources for
achieving compliance with the trade
execution requirement. As such, a
phased compliance schedule should
benefit counterparties by providing
them with more time to adapt to the
expanded trade execution requirement.
Proposed Form TER, which would
provide for a uniform submission by
SEFs and DCMs of information on
swaps subject to the clearing
requirement that are listed by such SEFs
and DCMs, is intended to provide the
Commission with the information
needed to create a trade execution
registry. This registry, in combination
with the proposal requiring that DCMs
and SEFs publicly post their Form TER
on their websites, should benefit market
participants and the public by
facilitating determinations of whether a
swap is subject to the trade execution
requirement.
(3) Pre-Execution Communications and
Block Trades
The Commission proposes to prohibit
pre-execution communications for
transactions subject to the trade
execution requirement. The
Commission believes that this
prohibition would ensure that for swaps
subject to the trade execution
requirement, the trading of such swaps
actually occurs within the confines of
the SEF, which the Commission
believes, in conjunction with the
proposed interpretation of the trade
execution requirement, would help
foster and concentrate liquidity and
price discovery which may help
increase market efficiency and decrease
989 The Commission notes that the Division of
Market Oversight had previously provided noaction relief that mirrors this proposal so these
benefits may have already been realized. See CFTC
Letter No. 17–67, Re: Extension of No-Action Relief
from Commodity Exchange Act Section 2(h)(8) for
Swaps Executed Between Certain Affiliated Entities
that Are Not Exempt from Clearing Under
Commission Regulation 50.52 (Dec. 14, 2017)
(‘‘NAL No. 17–67’’).
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62059
transaction costs, as discussed above.
Further, the Commission believes that
with trading occurring within the SEF,
market participants would receive the
protections associated with SEF trading,
as discussed above. With an expanded
scope of swaps subject to the trade
execution requirement, the Commission
is concerned that allowing a
disproportionate amount of SEF
transactions to be pre-arranged or prenegotiated away from the facility under
the pretense of trading flexibility would
undercut the impact of the expansion of
the requirement. Without a limitation
on pre-execution communications that
occur away from the SEF, the SEF’s role
in facilitating swaps trading would be
diminished, undermining the statutory
goals of promoting greater swaps trading
on SEFs and pre-trade price
transparency.
The Commission does not intend to
impose this prohibition on swap
transactions not subject to the trade
execution requirement and certain
package transactions. These exceptions
would allow those participants who
wish to voluntarily execute such trades
on a SEF to do so without having to
alter their current trading practices.
These exceptions are intended to
recognize the practical realities of
executing these types of swaps, which
are often highly customized, on SEFs.
The Commission also proposes to
amend the block trade definition to
require that counterparties that seek to
execute swaps that are above the block
trade size on a SEF must do so on a
SEF’s trading system or platform and
not away from the SEF pursuant to its
rules. Requiring market participants to
execute swap block trades on a SEF
should help SEFs facilitate the preexecution screening by futures
commission merchants (‘‘FCM’’) of
transactions against risk-based limits in
an efficient manner through SEF-based
mechanisms. Further, the proposed
amendments regarding block trades on
SEFs would promote the statutory goal
in CEA section 5h(e) of promoting
swaps trading on SEFs. The
Commission notes that many market
participants currently rely on no-action
relief under which some block trades
currently trade on-SEFs, and that this
benefit has largely already been realized
for these swaps.990
(4) Impartial Access
Proposed § 37.202 would allow SEFs
greater discretion to establish certain
990 See CFTC Letter No. 17–60, Re: Extension of
No-Action Relief for Swap Execution Facilities from
Certain ‘‘Block Trade’’ Requirements in
Commission Regulation 43.2 at 2 (Nov. 14, 2017)
(‘‘NAL No. 17–60’’).
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types of trading markets for certain
types of participants through the use of
access criteria, including fees. The
Commission recognizes that many SEFs
believe they are limited in the types of
trading markets and services that they
can develop and maintain because the
current impartial access rule can be
applied to promote an ‘‘all-to-all’’
trading environment, which is neither
required under Core Principle 2 nor is
consistent with swaps market structure.
The Commission recognizes that some
SEFs would like to target specific
sectors of the swaps market and tailor
their trading systems or platforms, as
well as swap products, for trading
among certain types of market
participants. The Commission believes
that affirmatively allowing SEFs the
ability to target and design their SEFs to
cater to certain market participants
should result in an overall increase in
swap market liquidity.
The proposed clarification to the
impartial access requirement should
allow SEFs to adapt to existing trading
practices in the swaps market, which
feature different types of access-related
practices. For example, the Commission
recognizes that some entities in the
dealer-to-dealer market, e.g., interdealer
broker operations, operate based on fee
structures that account for a host of
business considerations, including
discounts based on past or current
trading volume attributable to the
market participant, market maker
participation, or pricing arrangements
related to services provided by a SEFaffiliated entity involving other nonswap products. The Commission’s
proposed approach to fee requirements
under § 37.202(a)(2) would allow these
types of entities, which would be
subject to the SEF registration
requirement under the Commission’s
clarification of § 37.3(a), to continue to
facilitate certain trading markets and
maintain existing pools of liquidity.
Maintaining certain types of markets,
such as the dealer-to-dealer market,
should be beneficial to all market
participants, including participants in
the dealer-to-client market. In
particular, the availability of liquidity
and certain pricing to a dealer’s clients
in the dealer-to-client market may be
dependent upon the ability of dealers to
operate in a dealer-to-dealer market,
where it is easier to offload risk. The
Commission expects that continuing to
apply the existing approach—
‘‘comparable fees’’ for ‘‘comparable
services’’—to the dealer-to-dealer
environment may diminish the
economic benefits of, and therefore
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impede, SEFs from developing
additional services to facilitate trading.
The Commission notes that the
benefits from this proposed change may
already be realized to some degree as de
facto dealer-to-dealer SEFs already exist
under the current rule, and it is difficult
to predict what innovative services, if
any, SEFs may offer in the future.
However, the proposed rule would
explicitly allow SEFs to provide tailored
services, as long as they meet the
requirement that their access rules are
transparent, fair, and nondiscriminatory.
c. Costs
(1) Elimination of Minimum Trading
Functionality and Execution Method
Requirements
The Commission proposes to
eliminate the minimum trading
functionality requirement that SEFs
offer an Order Book for all swap
transactions. The Commission notes that
some market participants may not
perceive a significant cost from the lack
of availability of an Order Book because
the Order Books on many SEFs exhibit
little or no trading activity and contain
few or no bids and offers, despite SEFs
maintaining them over the past few
years. This suggests that market
participants are not currently using the
available Order Books and may
therefore not perceive a cost if the Order
Books are eliminated.991 As noted
above, the Commission anticipates that
SEFs with active Order Books would
continue to offer them; however, the
Commission also believes that these
existing Order Books, as a result of
greater flexibility in execution methods,
may see a negative impact to liquidity,
which may be offset by an increase in
liquidity on SEFs that offer other means
of execution. Market participants may
incur costs to integrate their systems
with the new trading methodologies
offered by SEFs. For some market
participants, this may require
programming new ways to interact with
SEFs. Expanding the requirement to use
SEFs for swap transactions would also
increase the extent of SEFs’ jurisdiction
over market participants’ trading, which
991 To the extent that requiring SEFs to offer
Order Books facilitates their eventual use, the
proposed elimination of the minimum trading
functionality under § 37.3 creates a potential
decrease in future pre-trade price transparency. If
SEFs decide to stop offering Order Books pursuant
to this proposal, some swaps markets may not be
able to move onto an Order Book even if there is
future interest from some market participants. This
cost would be mitigated to the extent that SEFs can
always reinstate their order books in response to
customer demand or offer other execution methods
that provide similar pre-trade price transparency
benefits.
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market participants may view as a
disadvantage or an increased cost. If
market participants react to this by
using other means of risk management
in place of the swaps that are required
to be traded on SEF, then their risk
management processes may be more
disadvantageous or costlier.
As noted above, the Commission
anticipates that competitive pressures
may drive SEFs to offer flexible
execution methods, which may impose
additional costs on SEFs. The
Commission believes that these
additional costs may be mitigated, as
SEFs would have the option, under the
proposal, of continuing their existing
execution practices.
The Commission recognizes that the
overall amount of pre-trade price
transparency in swap transactions
currently subject to the trade execution
requirement may decline if the Order
Book and RFQ-to-3 requirement under
existing § 37.9 are eliminated. This
potential reduction in pre-trade price
transparency could reduce the liquidity
of certain swaps trading on SEFs and
increase the overall trading costs. The
Commission believes that this increased
cost may be most severe for smaller
customers that trade infrequently, and
therefore may not be aware of current
swaps pricing without pre-trade price
transparency.
The purpose of the § 37.9 requirement
that transactions in swaps subject to the
trade execution requirement be
executed using an Order Book or an
RFQ System is to ensure that all activity
in these swaps benefit from a baseline
amount of pre-trade price transparency,
i.e., knowledge of multiple bids and
offers that may be available. While the
proposal may result in a reduction of
the benefits from the existing system,
this cost may be mitigated because every
SEF still has the option of offering an
Order Book and continuing to offer
market participants the ability to submit
RFQs to multiple liquidity providers on
the SEF. Accordingly, the Commission
anticipates that market participants
would not need to forgo the pre-trade
transparency associated with these
means of execution. Further, the
Commission notes that to the extent that
SEFs and other market participants
respond to the proposed approach by
offering flexible execution methods,
market participants should benefit by
having the opportunity to choose an
execution method with a more
appropriate level of pre-trade
transparency for their transactions and
their swaps trading needs.
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According to a Commission staff
research paper 992 that analyzed SEF
trading in index CDS 993 subject to the
trade execution requirement,
approximately 45 percent of the RFQs
were sent to three liquidity providers
and the remaining 55 percent were sent
to four or more. The mean number of
RFQ recipients was 4.12.994 The
Commission anticipates that all or most
of the market participants making RFQs
to four or more liquidity providers
would continue to send RFQs to
multiple participants, even absent a rule
requiring them to do so. Some
percentage of those market participants
currently sending RFQs to exactly three
liquidity providers would probably send
requests to only one or two liquidity
providers if they were allowed to, but
the Commission is unable to estimate
what percentage of market participants
would choose to send RFQs to fewer
liquidity providers. As noted, those
market participants sending RFQs to
only one liquidity provider would be
forgoing pre-trade transparency, but
would be doing so voluntarily.
The Commission notes that the cost of
a potential decline in pre-trade price
transparency may be offset by the
possible benefits from greater liquidity
by permitting SEFs to offer other
execution methods in episodically
liquid markets. Additional execution
methods like auction systems, to the
extent SEFs decide to offer them, and
other potential execution methods may
be offered in response to the proposal
and could be used to facilitate pre-trade
price transparency at lower costs,
particularly if SEFs also offer indicative
quotes or indicative market clearing
prices to participants.995
Proposed § 37.201(a), which would
require SEFs to disclose in their
rulebook the protocols and procedures
of execution methods they offer,
including any discretion in facilitating
trading and execution would impose
administrative costs on SEFs. The
Commission believes that those costs
are similar to those imposed by existing
§ 37.201(a), which establishes similar
disclosure requirements, but would be
more tailored to existing SEF execution
methods.
992 2017
Riggs Study at 11.
Commission has not performed a similar
analysis for IRS.
994 The Commission understands that one of the
two SEFs analyzed currently limits the number of
liquidity providers receiving a single RFQ-to-five
participants.
995 The Commission is aware of existing periodic
auction mechanisms that aim to aggregate the buy
and sell interests for a given swap and to clear the
market by displaying the market mid-price to the
market participants and allowing them to transact
on that price.
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993 The
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(2) Trade Execution Requirement and
Elimination of MAT Process
The proposed elimination of § 37.10
and § 38.12 and the proposed
interpretation of the trade execution
requirement as codified under § 36.1(a)
would likely require some market
participants to onboard to a SEF or
DCM, if they have not already done so,
in order to continue trading swaps. The
costs for a market participant to
onboard, along with the time various
market participants would have to join
a SEF or DCM under the compliance
schedule, and trade on a SEF, discussed
above, are also relevant.
To the extent more swaps are traded
on SEFs or DCMs as a result of the
proposed interpretation of the trade
execution requirement as set out under
§ 36.1(a), SEFs and DCMs may incur
additional costs, as part of their normal
course of business, to update their
systems to accommodate the increased
number of products listed. Because this
would be an expansion built on top of
existing systems, the Commission does
not expect the costs associated with this
expansion to be substantial.
Additionally, the Commission believes
that the proposed exemptions for certain
swaps from the trade execution
requirement would not impose new
costs on market participants or on SEFs.
The Commission expects there to be
some cost to SEFs and DCMs related to
the proposed Form TER requirement,
where they would have to submit the
specific relevant economic terms of the
swaps they list for trading to the
Commission (and posted on the website)
in a timely manner. These costs are
discussed in relation to the
Commission’s analysis above of
information collection burdens under
the PRA that are affected by the
proposed rules.
(3) Pre-Execution Communications and
Block Trades
Under the proposal, pre-execution
communications for swaps subject to
the trade execution requirement would
have to occur within the confines of a
SEF and could not occur outside of the
SEF’s facilities. In practice, this would
mean that pre-execution
communications between dealers and
their customers could not occur through
non-SEF telephones, email systems,
instant messaging systems, or other
means of communication outside of the
SEF. SEFs would incur costs if they
choose to set up telephone conference
lines, proprietary instant messaging or
email systems, or any other system
within the SEF to facilitate pre-
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execution communications within the
confines of the SEF.
SEFs could potentially use existing
technology to facilitate pre-execution
communications on SEF, thus
mitigating some potential costs. The
proposal could also impose costs on
dealers and their customers since they
commonly communicate via telephone
or other systems today and may have to
change their communication or trading
practices to comply with the proposed
rule. The costs for market participants
would be mitigated to the extent that
SEFs elect to incur the costs of
providing telephone or other systems for
their market participants to use for preexecution communications, but costs
may then increase correspondingly for
SEFs.
The proposed amendment to the
block trade definition to require that
counterparties that seek to execute
swaps that are above the block trade size
on a SEF must do so on a SEF’s trading
system or platform would cause these
transactions to incur the costs of trading
on a SEF as discussed above. To the
extent market participants react to these
costs by reducing their use of block
trades, they may be disadvantaged,
incur additional costs, or hinder the
effectiveness of their risk management
program.
(4) Impartial Access
The proposed changes to the impartial
access requirement, which would not
require an ‘‘all-to-all’’ market as
envisioned by the current rules, may
inhibit the ability of certain market
participants to access certain trading
markets and liquidity pools. Under the
proposed changes, SEFs may be able to
offer markets that feature levels of
liquidity and competitive pricing that
only a limited category of participants
could access. For example, SEFs that
desire to serve the dealer-to-dealer
segment of the market may have access
criteria that certain participants cannot
meet, thus preventing those participants
from onboarding and from providing
bids and offers, which could be
disadvantageous to those participants
and otherwise reduce access to
favorable prices and impede price
competition. Although the proposed
changes to impartial access would
require a SEF to allow those who seek
and are able to meet set criteria to
participate on its trading system or
platform, this approach may still permit
SEFs to impose barriers to access.
Additionally, allowing different
trading markets to operate and
accommodate a limited set of market
participants for similar or the same
swaps may impose costs through
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information asymmetries. For example,
a SEF that serves a dealer-to-dealer
segment and a SEF that services a
dealer-to-client segment may feature
different pricing for certain
standardized IRS. Participants in the
dealer-to-client market, who do not have
access to the pricing and volume
information of these dealer-to-dealer
SEFs, may not have beneficial pricing
information available on the latter that
would otherwise help to inform their
trading. This may increase costs for
those market participants with
information disadvantages.
The Commission notes, however, that
the current SEF market structure and
participation have generally continued
to develop along these traditional
market segments, absent the proposed
access criteria. Therefore, the
Commission anticipates that costs to
market participants may not change
much from the current situation.
d. Section 15(a) Factors
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(1) Protection of Market Participants and
the Public
The Commission anticipates that the
proposed interpretation of the trade
execution requirement, which may
result in an expanded scope of swaps
being required to trade on SEFs,
coupled with the proposed ban on preexecution communications for swaps
subject to the trade execution
requirement away from the facility,
would help improve the protection of
market participants and the public by
allowing SEFs to more effectively
surveil their markets and prevent
manipulation and disruption to the
functioning of an orderly swaps market.
The proposed rules are expected to
facilitate more transactions on SEFs,
ensure that such transactions are
executed entirely on SEFs, and facilitate
more market participants trading on
SEFs, effectively allowing SEFs to have
direct access to more data and have
direct visibility to a larger portion of the
market.
The Commission anticipates that the
proposed exemptions for certain swaps
from the trade execution requirement
should not materially affect the
protection of market participants and
the public. The proposed exemptions
are intended to allow a limited number
of swap transactions otherwise subject
to the trade execution requirement to
occur off-SEF where there is good
reason to do so. These include
transactions that involve end-users who
are eligible for the end-user exception to
both the clearing requirement and the
trade execution requirement,
transactions that are currently exempt
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under Part 50 from the clearing
requirement, and transactions that
cannot readily be executed on a
registered SEF, even in light of the
proposed rules allowing flexibility of
execution methods.
The Commission believes that the
proposed flexible execution methods
should promote protection of market
participants and the public by
facilitating the trading of swaps on
SEFs, including those swaps newly
subject to the trade execution
requirement. The Commission also
believes that the proposed amendment
to the block trade definition should help
protect market participants and the
public by moving block trades to SEFs
with the associated protections
described above. The proposal to
prohibit pre-execution communications
for transactions subject to the trade
execution requirement away from the
facility should help to ensure that the
entire process of trading and executing
a transaction would occur on SEF.
Swaps traded on SEFs receive the
protections associated with the SEF core
principles and Commission regulations,
including, among other things,
monitoring of trading and prohibitions
against manipulation and other abusive
trading practices. The Commission
believes that proposed § 37.201(a),
which would require SEFs to disclose in
their rulebook the protocols and
procedures of execution methods they
offer, including any discretion in
facilitating trading and execution,
should help protect market participants
and the public by ensuring that they are
informed about how these various
execution methods operate.
The elimination of the mandatory
Order Book and RFQ System execution
methods for Required Transactions may
reduce the benefits associated with pretrade price transparency. In the absence
of pre-trade price transparency, a
counterparty may not obtain swaps at
current market prices. However, the
Commission believes that the approach
taken in the proposed rule should
promote pre-trade price transparency in
the swaps market by allowing execution
methods that maximize participation
and concentrate liquidity during times
of episodic liquidity.
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
The Commission anticipates that the
proposed interpretation of the trade
execution requirement, which may
result in an expanded scope of swaps
being required to trade on SEFs, should
improve the efficiency and
competitiveness of the swaps markets.
Although SEFs and market participants
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may incur costs in trading an expanded
scope of swaps on SEFs, the
Commission expects that markets would
become more efficient as a whole, since
an increase in the number of market
participants trading on SEFs should
allow liquidity demanders to more
efficiently locate liquidity providers and
trade with them. These efficiency gains
may be attenuated, however, if the costs
of SEF trading are higher than expected
or if market participants respond to the
expanded trading requirement by
reducing their use of swaps that are
required to be traded on SEF.
The Commission believes
competitiveness can also improve
through more market participants
trading on SEFs that offer a variety of
trading mechanisms, some of which can
be designed to improve competitiveness
and liquidity formation in the market.
To the extent these market participants
did not have access to such trading
mechanisms, they should benefit from
increased competition and liquidity
formation. Improvements in
competiveness would be attenuated,
however, if the increase in trading on
SEFs is less than anticipated.
The Commission anticipates that the
proposed exemptions from the trade
execution requirement, as discussed
above, may maintain the current
efficiency of those trades and thus
maintain the financial integrity of the
counterparties. The Commission
believes that the proposed exemptions
are narrowly tailored and thus, should
not materially affect the competitiveness
of the swap markets.
The Commission believes that the
proposed rules allowing flexible
execution methods should enhance the
efficiency and financial integrity of
markets by providing an opportunity for
SEFs to offer more execution methods
that may be more efficient and costeffective for their customers than those
currently offered. The proposal to
prohibit pre-execution communications
for transactions subject to the trade
execution requirement away from the
facility should enhance the financial
integrity of markets by helping to ensure
that such communications receive the
protections to financial integrity
associated with SEF core principles,
including Core Principle 7. Under the
proposal, market participants should
continue to have access to pre-trade
price transparency, which should
continue to promote competitive bid-ask
spreads, e.g., by submitting RFQs to
multiple liquidity providers or by using
additional execution methods that
should be just as good at promoting pre-
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trade price transparency as order books
and RFQ systems.996
Additionally, the Commission’s
proposal to create and publish the trade
execution requirement registry on its
website should benefit market
participants and increase efficiency by
reducing uncertainty about whether a
swap is required to be traded on a
certain platform. Similarly, the
Commission’s proposal that a SEF
publicly post its Form TER on its
website also reinforces the efficiency
benefit for market participants, albeit at
the expense incurred by DCMs and SEFs
related to Form TER filings, as
discussed above.
The Commission believes that the
proposed changes to impartial access
may enhance the efficiency,
competitiveness, and financial integrity
of markets by allowing SEFs to develop
trading platforms and fee structures that
better reflect the underlying features of
the products traded on the SEF and
customer needs. This can facilitate
competition between liquidity
providers, leading to better pricing for
all traders that participate in the
relevant segment of the market. The
proposed revision to the impartial
access rule might impair competition by
preventing some traders from providing
or accessing liquidity on some SEFs or
having access to the most up-to-date
pricing information. Impaired access to
liquidity or pricing information may
result in some market participants
transacting in swaps at uncompetitive
terms.
(3) Price Discovery
The Commission believes that in
general market participants should have
access to better price discovery in more
liquid markets under the proposed rule,
because it should result in a higher
number of products being traded on
SEFs by an increased number of market
participants. With increased
transactions on SEFs, through an
increase in number of products as well
as in market participants, SEFs would
offer more price points on the same or
comparable products and potentially
more bids and offers. This increased
trading on SEFs may also offset any
impairment to price discovery resulting
from a loss in pre-trade price
transparency from the elimination of the
mandate to offer specified trading
996 As noted above, however, to the extent that
the Order Book and other methods of execution
mandated by the current rule promote pre-trade
price transparency, the proposed elimination of this
mandate may impair competition if it reduces
market participants’ ability to observe pre-trade
prices, and thereby lose insight into competitive
conditions in the market.
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methods. The Commission expects all of
these improvements to culminate in
better and faster price discovery for
market participants, although
improvements in price discovery may
be attenuated if the increase in trading
on SEFs is less than anticipated.
While, as a general matter, the
Commission believes that price
discovery in swaps subject to the trade
execution requirement should occur on
SEFs, the Commission nevertheless
believes that the proposed exemptions
from the trade execution requirement
should not materially impact price
discovery in the U.S. swaps markets.
Many of the transactions eligible for the
exemptions, such as inter-affiliate
trades, are not price-forming or involve
end-users, while other eligible
transactions in swaps that are only
listed by Exempt SEFs cannot readily be
traded on a registered SEF.
The Commission believes that the
proposal to prohibit pre-execution
communications for transactions subject
to the trade execution requirement away
from the facility should further price
discovery on SEFs by helping to ensure
that all negotiations related to price
discovery occur on SEFs. The proposed
amendment to the block trade definition
would also tend to encourage more
price discovery on SEFs. The proposed
flexible execution methods would
provide SEFs an opportunity to develop
innovative execution methods that
could enhance the price discovery
process.
To the extent that the revised
impartial access rules lead to a less
competitive market, the market also may
suffer from reduced price discovery.
(4) Sound Risk Management Practices
The Commission believes the
proposed expansion of the trade
execution requirement may further
sound risk management practices by
requiring that a larger set of swap
transactions are negotiated, arranged,
and executed in a manner that is subject
to the rules of a SEF and that those
trades receive the protections associated
with SEF core principles and
Commission regulations.
The Commission anticipates that the
proposed exemptions from the trade
execution requirement should not
significantly impair the furtherance of
sound risk management practices
because firms using the exemptions
should continue to be able to move
swap positions between affiliates and
take advantage of the statutory end-user
exception from the clearing
requirement. Exempting certain
transactions that cannot readily be
executed on a SEF, such as package
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62063
transactions involving new issuance
bonds and transactions in swaps that are
only listed by Exempt SEFs, should
allow entities using these swaps to
continue their sound risk management
practices.
The Commission believes that the
proposed rules enabling flexible
execution methods and requiring that
pre-execution communications for
transactions subject to the trade
execution requirement occur on-SEF
may further sound risk management
practices by requiring that these trades
are negotiated, arranged, and executed
on a SEF and that these trades receive
the protections associated with SEF core
principles and Commission regulations.
Similarly, the Commission believes that
the proposed rules enabling flexible
execution methods should promote
trading on SEFs and increase the
number of transactions receiving these
protections, thereby facilitating greater
choice by market participants in
execution methods that better suit their
risk management needs, including
allowing market participants to reduce
potential information leakage and frontrunning risks. These improvements may
be attenuated if the increase in trading
on SEFs is less than anticipated. The
proposed amendment to the block trade
definition may further sound risk
management practices by requiring
block trades to occur on SEFs, while
still allowing reporting delays pursuant
to Part 43, which may give liquidity
providers time to hedge such block
trades before they are reported.
(5) Other Public Interest Considerations
The Commission believes the
proposed interpretation of the trade
execution requirement and the proposed
flexibility in execution methods would
further the public interest consideration
of promoting trading on SEFs as stated
in CEA section 5h(e), while also
continuing to provide market
participants with access to the pre-trade
price transparency offered by certain
SEF execution methods. While the
Commission is proposing to eliminate
the minimum trading functionality
requirement that SEFs offer an Order
Book or other prescribed trading
methods for all swap transactions, the
Commission anticipates that market
participants would still be able to
realize pre-trade price transparency by
sending RFQs to multiple market
participants or using other multiple-tomultiple execution methods offered by
SEFs that seek to encourage
transparency and concentrate liquidity
formation.
The Commission believes that the
proposal to prohibit pre-execution
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communications for transactions subject
to the trade execution requirement away
from the facility and the proposed
amendment to the block trade definition
should also further the public interest
consideration of promoting trading on
SEFs by moving additional trading
activity to SEFs.
Request for Comment
The Commission requests comment
on all aspects of the consideration of the
costs and benefits of the provisions
related to market structure and trade
execution.
5. Compliance and SRO Responsibilities
a. Overview
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(1) SEF Trading Specialists
The Commission is proposing to
adopt regulations under § 37.201(c) that
would categorize certain persons
employed by a SEF as a ‘‘SEF trading
specialist.’’ The Commission proposes
to define a SEF trading specialist as any
natural person who, acting as an
employee (or in a similar capacity) of a
SEF, facilitates the trading or execution
of swaps transactions (other than in a
ministerial or clerical capacity), or who
is responsible for direct supervision of
such persons. The Commission
proposes to require a SEF to ensure that
its SEF trading specialists are not
subject to a statutory disqualification
under sections 8a(2) or 8a(3) of the Act,
have met certain proficiency
requirements, and undergo ethics
training on a periodic basis. Proposed
§ 37.201(c) also would require a SEF to
establish standards of conduct for its
SEF trading specialists, and to diligently
supervise their activities.
Proposed § 37.201(c)(2) would
prohibit a SEF from permitting a person
who is subject to a statutory
disqualification under section 8a(2) or
8a(3) of the Act to serve as a SEF trading
specialist if the SEF knows, or in the
exercise of reasonable care should
know, of the statutory disqualification.
There are certain exceptions for persons
who have retained registration in other
categories despite the
disqualification.997
997 Specifically, the Commission proposes an
exception to the prohibition under § 37.201(c)(2) for
any person listed as a principal or registered with
the Commission as an associated person of a futures
commission merchant, retail foreign exchange
dealer, introducing broker, commodity pool
operator, commodity trading advisor, or leverage
transaction merchant, or any person registered as a
floor broker or floor trader, notwithstanding that
such person is subject to a disqualification from
registration under sections 8a(2) or 8a(3) of the Act.
The Commission is proposing an additional
exception to the requirement under § 37.201(c)(2)
for any person otherwise subject to a
disqualification from registration for whom a
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Proposed § 37.201(c)(3) would require
a SEF to establish and enforce standards
and procedures, including taking and
passing an examination 998 to ensure
that its SEF trading specialists have the
proficiency and knowledge necessary to
fulfill their responsibilities to the SEF as
SEF trading specialists; and comply
with applicable provisions of the Act,
Commission regulations, and the rules
of the SEF.
Proposed § 37.201(c)(4) would require
a SEF to establish and enforce policies
and procedures to ensure that its SEF
trading specialists receive ethics
training on a periodic basis.
Proposed § 37.201(c)(5) would require
a SEF to establish and enforce policies
and procedures that require its SEF
trading specialists, in dealing with
market participants and fulfilling their
responsibilities to the SEF, to satisfy
standards of conduct as established by
the SEF.
Finally, proposed § 37.201(c)(6)
would require a SEF to diligently
supervise the activities of its SEF
trading specialists in facilitating trading
on the SEF.
(2) Rule Compliance and Enforcement
(i) Definition of ‘‘Market Participant’’
Proposed § 37.2(b) would define
‘‘market participant.’’ Part 37 specifies
that a SEF’s jurisdiction applies to
various market participants who may be
involved in trading or executing swaps
on its facility; to date, SEFs have been
relying on preamble language describing
a ‘‘market participant’’ provided in the
SEF Core Principles Final Rule to
determine the scope of jurisdiction. By
clarifying and codifying the market
participant definition in the part 37, the
Commission would maintain the
existing recordkeeping responsibilities
of traders that meet the proposed
definition, as well as the jurisdiction
SEFs have with respect to those traders.
For example, under § 37.404(b), a SEF is
required to adopt rules that require its
market participants to keep records of
their trading, including records of their
activity in any index or instrument used
as a reference price, the underlying
commodity, and related derivatives
markets. In addition, a SEF is required
to have means to obtain that
information.
The key change to the proposed
definition of market participant from the
registered futures association (‘‘RFA’’), provides a
notice stating that if the person applied for
registration with the Commission as an associated
person, the registered futures association would not
deny the application on the basis of the statutory
disqualification.
998 Such an examination would be developed and
administered by an RFA.
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existing approach under part 37 is the
exclusion of clients of asset managers or
other similar situations. As noted above,
‘‘market participants’’ are subject to
certain recordkeeping requirements, and
under this definition, such clients
would not be subject to these
recordkeeping requirements.
(ii) Audit Trail and Surveillance
Program
The Commission proposes a number
of changes to the existing rules
regarding SEF audit trail and
surveillance programs. First, the
Commission proposes amending the
audit trail requirements by moving
certain § 37.205(a) requirements to
guidance to Core Principle 2 in
Appendix B. This guidance would state
that audit trail data should be sufficient
to reconstruct all indications of interest,
requests for quotes, orders, and trades.
The Commission also proposes to
remove the requirement to capture posttrade allocation information. Second,
the Commission proposes to eliminate
the prescriptive requirements that
specify the nature and content of the
original source documents under
§ 37.205(b)(1). Third, the Commission
would replace § 37.205(c)’s audit trail
enforcement requirement with an audit
trail reconstruction requirement, which
would be focused on verifying a SEF’s
ability to reconstruct audit trail data
rather than enforcing audit trail
requirements on market participants.
Fourth, the Commission proposes
amending § 37.203(d), § 37.205(b)(2),
and § 37.205(b)(3) to relieve a SEF’s
obligation to conduct automated
surveillance on orders that are not
entered into an electronic trading
system or platform, e.g., orders entered
by voice or certain other electronic
communications, such as instant
messaging and email.999 Fifth, the
Commission proposes amending
§ 37.203(d) to eliminate the enumerated
capabilities that every automated
surveillance system must have and to
instead require that the automated
surveillance system be able to detect
and reconstruct potential trade practice
violations.
(iii) Compliance and Disciplinary
Programs
The Commission proposes several
amendments to the rules that address a
SEF’s compliance program. First, the
999 Sections 37.203(d), 37.205(b)(2), and
37.205(b)(3) require a SEF that offers any form of
voice trading functionality, as a condition to its
registration, to establish a voice audit trail
surveillance program to ensure that it can
reconstruct a sample of voice trades and review
such trades for possible trading violations.
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Commission proposes to amend
§ 37.203(f)(1) to state that SEFs must
establish and maintain procedures
requiring compliance staff to conduct
investigations, including the
commencement of an investigation
upon the receipt of a request from
Commission staff or upon the discovery
or receipt of information by the SEF that
indicates the existence of a reasonable
basis for finding that a violation may
have occurred or will occur.1000 Second,
the Commission proposes eliminating
existing § 37.203(f)(2)’s 12-month
requirement for completing
investigations and providing SEFs the
ability instead to complete
investigations in a timely manner taking
into account the facts and circumstances
of the investigation.1001
Third, the Commission proposes
several amendments to the rules that
address a SEF’s disciplinary program.
Proposed § 37.206(b) requires that a SEF
administer its disciplinary program
through one or more disciplinary
panels, as currently allowed, or through
its compliance staff. The Commission
also proposes to simplify a SEF’s
disciplinary procedures by eliminating
the following requirements: (1) Existing
§ 37.206(c), which sets forth minimum
requirements for a hearing, and (2)
existing § 37.206(d)’s requirement that a
disciplinary panel render a written
decision promptly following a hearing,
along with detailed items required to be
included in the decision, and replacing
it with guidance for proposed
§ 37.206(b) to specify that a SEF’s rules
should require the disciplinary panel to
promptly issue a written decision
following a hearing or the acceptance of
a settlement offer. Consistent with the
changes to § 37.206(b), the Commission
proposes to eliminate paragraphs
(a)(11)–(12) from the guidance to Core
Principle 2 in Appendix B addressing
§ 37.206(b), which provides specific
guidelines for a SEF’s ability to provide
rights of appeal to respondents and
issue a final decision.
1000 The Commission proposes adding language
in the guidance to Core Principle 2 in Appendix B
stating that compliance staff should submit all
investigation reports to the CCO or other
compliance department staff responsible for
reviewing such reports and determining next steps
in the process, and that the CCO or other
responsible staff should have reasonable discretion
to decide whether to take any action, such as
presenting the investigation report to a disciplinary
panel for disciplinary action. 17 CFR part 37 app.
B.
1001 For purposes of § 37.203(f)(2), the
Commission proposes to provide SEFs with
reasonable discretion to determine the timely
manner in which to complete investigations
pursuant to the guidance to Core Principle 2 in
Appendix B. 17 CFR part 37 app. B.
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Additionally, proposed § 37.206(c)
would establish certain requirements for
warning letters that already apply to
sanctions, and would allow more than
one warning letter within a rolling 12month period for entities, as well as for
individuals for rule violations related to
minor recordkeeping or reporting
infractions. As a streamlining and
conforming change, the Commission
also proposes to eliminate the existing
warning letter requirement from
§ 37.203(f)(5), and combine this
requirement into proposed § 37.206(c).
(iv) Regulatory Service Provider
The Commission proposes several
amendments to the rules that address a
SEF’s use of regulatory service
providers. Proposed § 37.204(a) expands
the scope of entities that may provide
regulatory services to include any nonregistered entity approved by the
Commission. The Commission also
proposes to combine and amend
existing §§ 37.204(b)–(c), resulting in
several changes to the supervision
requirements of a regulatory services
provider (‘‘RSP’’). First, proposed
§ 37.204(b) eliminates the requirement
that the SEF hold regular meetings and
conduct periodic reviews of the
provider and instead allows SEFs to
determine the necessary processes for
supervising their RSP. Second, under
proposed § 37.204(b) a SEF may allow
its RSP to make substantive decisions,
provided that, at a minimum, the SEF is
involved in such decisions. Third, the
Commission proposes to eliminate the
requirement under § 37.204(c) that a
SEF document where its actions differ
from the RSP’s recommendations,
deferring instead to the SEF and its RSP
to mutually agree on the method it will
use to document substantive decisions.
(3) Error Trade Policy
Proposed § 37.203(e) would require
that SEFs establish and maintain rules
and procedures that facilitate the
resolution of error trades in a fair,
transparent, consistent, and timely
manner as opposed to the requirement
in existing § 37.203(e) that SEFs have
the authority to adjust trade prices or
cancel trades in certain situations. The
definition of ‘‘error trade’’ under
§ 37.203(e) would include any swap
transaction executed on a SEF that
contains an error in any term of the
swap transaction, including price, size,
or direction. However, this definition
would not include a swap that is
rejected from clearing for credit reasons,
and a SEF’s error policy would not
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apply.1002 At a minimum, such error
policy would have to provide the SEF
with the authority to adjust an error
trade’s terms or cancel the error trade,
and specify the rules and procedures for
market participants to notify the SEF of
an error trade, including any time limits
for notification. The proposed rule
would also impose the new requirement
that a SEF notify all of its market
participants, as soon as practicable of (i)
any swap transaction that is under
review pursuant to the SEF’s error trade
rules and procedures; (ii) a
determination that the trade under
review is or is not an error trade; and
(iii) the resolution of any error trade,
including any trade term adjustment or
cancellation.
(4) Chief Compliance Officer
The Commission proposes several
amendments to the chief compliance
officer (‘‘CCO’’) regulations. First, the
Commission proposes to allow the
senior officer 1003 of a SEF to have the
same oversight responsibilities with
respect to the CCO as the SEF’s board
of directors. Specifically, the
Commission proposes to (i) amend
existing § 37.1501(b)(1)(i) to allow a
CCO to consult with either the board of
directors or senior officer of the SEF as
the CCO develops the SEF’s policies and
procedures; (ii) amend existing
§ 37.1501(c)(1)(iii) 1004 to allow a CCO to
meet with either the senior officer of the
SEF or the board of directors on an
annual basis; (iii) amend existing
§ 37.1501(c)(1)(iv) 1005 to allow the CCO
to provide self-regulatory program
information to the SEF’s senior officer
or to the board of directors; and (iv)
eliminate the restriction under existing
§ 37.1501(c)(3) that removal of the CCO
requires approval of a majority of the
board of directors or a senior officer if
the SEF does not have a board of
directors, and instead permit the board
of directors or the senior officer to
remove the CCO under
§ 37.1501(b)(3)(i).
Second, the Commission proposes to
consolidate and amend existing
§§ 37.1501(d)(5)–(6) 1006 to allow a CCO
to identify noncompliance matters
through ‘‘any means,’’ in addition to the
currently prescribed detection methods,
1002 Consistent with proposed § 37.702(b)(1), a
SEF would deem any swap that is rejected from
clearing for credit reasons as void ab initio.
1003 As discussed below, the Commission
proposes to define ‘‘senior officer’’ to mean the
chief executive officer or other equivalent officer of
the swap execution facility.
1004 This requirement is in proposed § 37.1501(b).
1005 This requirement is in proposed
§ 37.1501(b)(6).
1006 This requirement is in proposed
§ 37.1501(c)(5).
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and to clarify that the procedures
followed to address noncompliance
issues must be ‘‘reasonably designed’’
by the CCO to handle, respond,
remediate, retest, and resolve
noncompliance issues identified by the
CCO. The Commission also proposes to
amend the CCO’s duty to resolve
conflicts of interest under existing
§ 37.1501(d)(2).1007 The Commission
proposes to refine the scope of the
CCO’s duty to address ‘‘reasonable
steps’’ to resolve ‘‘material’’ conflicts of
interest that may arise.
Third, the Commission is proposing
certain amendments to the annual
compliance report (‘‘ACR’’) regulations
in existing § 37.1501(e),1008 that would
eliminate duplicative or unnecessary
information requirements and
streamline existing requirements. The
Commission proposes to eliminate
existing § 37.1501(e)(2)(i), which
requires an ACR to include a review of
all of the Commission regulations
applicable to a SEF and identify the
written policies and procedures
designed to ensure compliance with the
Act and Commission regulations and
eliminate certain specific content
required under existing
§ 37.1501(e)(4).1009 The Commission
also proposes to amend existing
§ 37.1501(e)(5) 1010 to require a SEF to
only discuss material noncompliance
matters and explain the corresponding
actions taken to resolve such matters,
rather than describing all compliance
matters. The Commission proposes to
amend existing § 37.1501(e)(6) 1011 to
limit a SEF CCO’s certification of an
ACR’s accuracy and completeness to
‘‘all material respects’’ of the report. The
Commission also proposes to streamline
and reorganize the remaining ACR
content requirements, including
consolidating the CCO’s required
description of the SEF’s policies and
procedures under existing
§ 37.1501(e)(1) 1012 with the CCO’s
required assessment of the effectiveness
of these policies and procedures under
existing § 37.1501(e)(2)(ii) and also
consolidating the CCO’s required
1007 This requirement is in proposed
§ 37.1501(c)(2).
1008 This requirement is in proposed § 37.1501(d).
1009 This requirement is in proposed
§ 37.1501(d)(3). The proposed eliminated
provisions currently require a discussion of the
SEF’s compliance staffing and structure, a catalogue
of investigations and disciplinary actions taken over
the last year, and a review of disciplinary
committee and panel performance.
1010 This requirement is in proposed
§ 37.1501(d)(4).
1011 This requirement is in proposed
§ 37.1501(d)(5).
1012 This requirement is in proposed
§ 37.1501(d)(1).
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narrative of any material changes made
during the prior year with the CCO’s
required narrative of any forthcoming
recommended changes and areas of
improvement to the compliance
program as required under existing
§ 37.1501(e)(3) and existing
§ 37.1501(e)(2)(iii),1013 respectively.
Fourth, the Commission proposes
several amendments to simplify the
ACR submission procedures. The
Commission proposes to amend existing
§ 37.1501(f)(2) 1014 to provide SEFs with
an additional 30 days to file the ACR
with the Commission, but no later than
90 calendar days after a SEF’s fiscal year
end. Additionally, the Commission
proposes to eliminate the ‘‘substantial
and undue hardship’’ standard required
for filing ACR extensions and replace it
with a ‘‘reasonable and valid’’ standard
currently set forth in existing
§ 37.1501(f)(4).1015 The Commission
also proposes to clarify existing
§ 37.1501(f)(3) 1016 to provide that, as
required for initial compliance reports,
the CCO must submit an amended ACR
to the SEF’s board of directors or, in the
absence of a board of directors, to the
senior officer of the SEF, for review
prior to submitting the amended ACR to
the Commission.
In addition to these substantive
changes, the Commission proposes a
number of conforming, clarifying, and
streamlining changes that would not
impose new costs or result in new
benefits and are not discussed in the
cost and benefit sections below. The
Commission proposes to eliminate the
CCO’s obligations to the regulatory
oversight committee (‘‘ROC’’), including
existing § 37.1501(c)(1)(iii), which
requires a quarterly meeting with the
ROC, and existing § 37.1501(c)(1)(iv),
which requires the CCO to provide selfregulatory program information to the
ROC. The proposal would not impact
SEFs as there is no requirement that a
SEF have a ROC.
Additionally, the Commission
proposes to consolidate existing
§§ 37.1501(b)–(c) into proposed
§ 37.1501(b). The Commission proposes
to eliminate existing § 37.1501(b)(1),
which requires a SEF to designate a
CCO, and existing § 37.1501(c)(2),
which requires the CCO to report
directly to the board of directors or the
senior officer of the SEF, as these
1013 This requirement is in proposed
§ 37.1501(d)(2).
1014 This requirement is in proposed
§ 37.1501(e)(2).
1015 This requirement is in proposed
§ 37.1501(e)(4).
1016 This requirement is in proposed
§ 37.1501(e)(3).
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requirements are already contained
under § 37.1500.
The Commission proposes to
eliminate the requirement under
existing § 37.1501(f)(1) that a SEF must
document the submission of the ACR to
the SEF’s board of directors or senior
officer in board minutes or some other
similar written record. This requirement
is already covered in the general
recordkeeping requirements in proposed
§ 37.1501(f), which is existing
§ 37.1501(g).
The Commission proposes a nonsubstantive amendment to
§ 37.1501(a)(2) to define a ‘‘senior
officer’’ as ‘‘the chief executive officer or
other equivalent officer of the swap
execution facility.’’ 1017 In addition,
proposed § 37.1501(f), currently set
forth under § 37.1501(g), would require
a SEF to keep records in a manner
consistent with the recordkeeping
requirements under §§ 37.1000–1001.
Finally, the Commission proposes a
new acceptable practice to Core
Principle 15 in Appendix B that would
provide a non-exclusive list of factors
that a SEF may consider when
evaluating an individual’s qualifications
to be a CCO.1018 The proposal would
provide a safe harbor and not impose
new obligations.
(5) Recordkeeping, Reporting, and
Information-Sharing
(i) Equity Interest Transfer
The Commission is proposing to
amend the existing notification
requirements related to transfers of
equity interest in a SEF. Proposed
§ 37.5(c)(1) would require a SEF to file
a notice with the Commission regarding
any transaction that results in the
transfer of direct or indirect ownership
of fifty percent or more of the equity
interest of a SEF as opposed to only
direct ownership transfers as currently
required. Transfer of ownership in an
‘‘indirect’’ manner may occur through a
transaction that involves the transfer of
ownership of a SEF’s direct parent or an
indirect parent, and therefore,
implicates effective change in
ownership of the SEF’s equity interest.
(ii) Confirmation and Trade Evidence
Record
The Commission is proposing several
amendments to the existing
confirmation requirement under
1017 In the SEF Core Principles Final Rule, the
Commission noted that it would not adopt a
definition of ‘‘senior officer,’’ but noted that the
statutory term would only include the most senior
executive officer of the legal entity registered as a
SEF. See SEF Core Principles Final Rule at 33544.
1018 17 CFR part 37 app. B.
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§ 37.6(b).1019 First, the Commission
proposes § 37.6(b)(1)(ii)(B) to allow a
SEF to issue a ‘‘trade evidence record’’
for uncleared swap transactions that are
executed on its facility. As defined
under proposed § 37.6(b)(1)(ii)(B), a
trade evidence record means a legally
binding written documentation that
memorializes the terms of a swap
transaction agreed upon by the
counterparties and legally supersedes
any conflicting term in any previous
agreement that relates to the swap
transaction between the counterparties.
The trade evidence record, at a
minimum, would be required to include
the necessary terms to serve as a legally
binding record of the transaction that
supersedes any conflicting term in any
previous agreements, but is not required
to contain all of the terms, in particular
relationship terms contained in
underlying documentation between the
counterparties.
Second, the Commission proposes
§ 37.6(b)(2)(i) to require a SEF to
provide counterparties with a
confirmation document or trade
evidence record ‘‘as soon as
technologically practicable’’ after the
execution of the transaction on the SEF.
Third, the Commission proposes
§ 37.6(b)(2)(iii) to allow a SEF to issue
a confirmation document or trade
evidence record to the intermediary
trading on behalf of a counterparty,
provided that the SEF establish and
enforce rules to require transmission of
the document or record to the
counterparty as soon as technologically
practicable.
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(iii) Information-Sharing
The Commission proposes to amend
§ 37.504 to generally allow a SEF to
share information with third-parties as
necessary to fulfill its self-regulatory
and reporting responsibilities by
eliminating the specifically enumerated
list of entities with whom a SEF must
share information.
(6) System Safeguards
The Commission proposes to move
the requirement in existing
§ 37.205(b)(4) that a SEF must protect
audit trail data from unauthorized
alteration and accidental erasure or
other loss to proposed § 37.1401(c). The
Commission proposes a new
§ 37.1401(g) to require SEFs to annually
prepare and submit an up-to-date
Exhibit Q (existing Exhibit V) 1020 to
1019 The Commission notes that the confirmation
requirements in proposed § 37.6(b)(1)(i)(A) are not
changing.
1020 The Commission proposes to renumber
existing Exhibit V to Form SEF as proposed Exhibit
Q to Form SEF. 17 CFR part 37 app. A.
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Form SEF (‘‘Technology
Questionnaire’’) for Commission staff.
b. Benefits
(1) SEF Trading Specialists
The Commission expects that SEF
trading specialists would exercise a
level of discretion and judgment in
facilitating trading that is informed by
their knowledge and understanding of
the market and the products traded on
it, and their communications with
market participants. The role of SEF
trading specialists and their use of
discretion will likely increase under the
Commission’s proposed approach to
allow SEFs to offer flexible execution
methods and to expand the trade
execution requirement. The dual and
integral role that SEF trading specialists
play in exercising that discretion—
interacting with market participants,
while facilitating fair, orderly, and
efficient trading and overall market
integrity—calls for a regulatory
approach that aims to maintain market
integrity and provide appropriate
protections for market participants.
The Commission believes that
establishing a new category of SEF
personnel, ‘‘SEF trading specialists,’’
and requiring SEFs to subject SEF
trading specialists to fitness
requirements, proficiency testing,
standards of conduct for SEF trading,
and ethics training, and to diligently
supervise them, would enhance
proficiency and professionalism among
SEF trading specialists, and would
promote market integrity and
confidence of market participants. The
Commission also believes that these
requirements would increase protection
of market participants and the public by
promoting fair dealing. Furthermore,
diligent supervision of SEF trading
specialists would increase compliance
with legal and regulatory requirements
and SEF rules.
Proposed § 37.201(c)(2)(i) would
enhance protections for market
participants by seeking to ensure that
SEFs do not employ persons subject to
a statutory disqualification as a SEF
trading specialist, subject to the
proposed exception as discussed below.
Sections 8a(2) or 8a(3) of the Act set
forth numerous bases upon which the
Commission may refuse to register a
person, including, without limitation,
felony convictions, commodities or
securities law violations, and bars or
other adverse actions taken by financial
regulators. The Commission believes
that by restricting SEFs from permitting
such persons from intermediating and
facilitating SEF trading (except in a
clerical or ministerial capacity), market
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participants and the public would be
better protected from abusive and
fraudulent trading practices. Moreover,
given the role SEF trading specialists
play in facilitating orderly and fair
trading, the Commission believes that
proposed § 37.201(c)(2)(i) would
enhance market integrity and fairness,
and the confidence of SEF market
participants.
Proposed § 37.201(c)(2)(ii)(A) would
allow SEFs to employ as a SEF trading
specialist a person the National Futures
Association (‘‘NFA’’) has permitted to
be listed as a principal or to register
with the Commission based on the
NFA’s determination that the incident
giving rise to the person’s statutory
disqualification is insufficiently serious,
recent, or otherwise relevant to
evaluating the person’s fitness.
Similarly, proposed § 37.201(c)(2)(ii)(B)
would allow a SEF to employ as a SEF
trading specialist a person subject to a
statutory disqualification who provides
a written notice from an RFA stating
that if the person were to apply for
registration as an associated person, the
RFA would not deny the application on
the basis of the statutory
disqualification.
Proposed § 37.201(c)(2)(ii) would
benefit SEFs and their prospective SEF
trading specialists by allowing SEFs to
employ a person as a SEF trading
specialist where the incident giving rise
to the person’s statutory disqualification
is insufficiently serious, recent, or
otherwise relevant to evaluating the
person’s fitness for registration with the
Commission. The Commission believes
that, where an RFA provides a notice
that such circumstances are present, the
benefits of the prohibition under
§ 37.201(c)(2)(i)—in particular the
protection of market participants and
the public and enhancing market
integrity—are not implicated, and thus
a SEF should be permitted to employ
such persons as a SEF trading specialist.
Given the level of discretion SEF
trading specialists exercise, the
Commission believes that proposed
§ 37.201(c)(3)(i) would benefit market
participants and the public by helping
to ensure that SEF trading specialists
have the requisite proficiency and
knowledge to fulfill their
responsibilities and to comply with the
Act, Commission regulations, and SEF
rules. The proficiency examination
requirement under § 37.201(c)(3)(ii)
would further ensure that all SEF
trading specialists maintain a baseline
level of proficiency. This would
increase protection of market
participants and better ensure that
trading on SEFs is conducted in a fair,
orderly, and efficient manner. The
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Commission expects the proposed
requirements to enhance the confidence
of market participants and the public in
the integrity and fairness of SEF
markets.
Proposed §§ 37.201(c)(4)–(6) would
respectively require a SEF to ensure that
SEF trading specialists receive ethics
training on a periodic basis, subject SEF
trading specialists to standards of
conduct in dealing with market
participants and fulfilling their
responsibilities, and diligently
supervise the activities of its SEF
trading specialists.
Overall, these proposed rules would
promote public and market participants’
confidence in the trading of swaps on
SEFs and may bring additional volumes
of trading and liquidity to SEFs.
(2) Rule Compliance and Enforcement
(i) Definition of ‘‘Market Participant’’
The primary benefit of the rule change
is an anticipated reduction in
recordkeeping costs for clients of asset
managers and SEFs.
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(ii) Audit Trail and Surveillance
Program
Many of the proposed changes to the
audit trail and surveillance
requirements described above are
expected to result in savings in terms of
compliance staff and resources for most
SEFs. For example, SEFs that offer voice
trading are currently required to
conduct regular voice audit trail
surveillance in lieu of the electronic
analysis capability requirements of
§ 37.205(b)(3). These SEFs dedicate
compliance staff and resources to
establishing and conducting the voice
audit trail surveillance programs,
including contracting with the NFA for
the performance of the reviews.
However, under the proposed changes
to § 37.203(d), § 37.205(b)(2), and
§ 37.205(b)(3), these SEFs would no
longer be required to conduct regular
automated surveillance on indications
of interest, requests for quotes, and
orders that are not entered into a SEF’s
electronic trading system or platform.
Therefore, new SEFs would not incur
the cost to implement this requirement
and all SEFs would not incur the
ongoing cost to maintain a regular voice
audit trail surveillance program.
Additionally, eliminating § 37.205(c)’s
requirement to enforce audit trail
requirements through annual reviews
should result in cost savings to all SEFs,
as they would no longer need resources,
either internal compliance staff or the
NFA, to perform audit trail reviews.
However, the Commission proposes to
replace these requirements with a
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requirement to perform audit trail
reconstructions, which is expected to
reduce some of the cost savings as
described above.1021 The proposed
changes to the audit trail rules under
§ 37.205(a) are intended to address the
current challenges SEFs face with
respect to obtaining post-trade
allocation information and conducting
surveillance on orders that are not
entered into an electronic trading
system or platform. Similarly, proposed
§ 37.203(d) would no longer require SEF
automated surveillance systems to have
certain capabilities that they cannot
perform.
(iii) Compliance and Disciplinary
Programs
SEF compliance programs should
benefit from the proposed changes
related to conducting investigations. For
example, changes proposed to
§ 37.203(f) seek to simplify the
procedures for SEFs to conduct
investigations and prepare investigation
reports. Specifically, eliminating the 12month requirement for completing
investigations under § 37.203(f)(2), and
replacing it instead with a general
statement that permits SEFs to complete
investigations ‘‘in a timely manner
taking into account the facts and
circumstances of the investigation’’
would provide SEFs with greater
discretion to manage their workload,
and allow them to prioritize their other
compliance responsibilities as needed.
SEFs also may benefit from the
additional clarity and flexibility
provided in language related to
investigation reports in the guidance to
Core Principle 2 in Appendix B. The
language states that compliance staff
should submit all investigation reports
to the CCO or other compliance
department staff responsible for
reviewing such reports and determining
next steps in the process, and that the
CCO or other responsible staff should
have reasonable discretion to decide
whether to take any action, such as
presenting the investigation report to a
disciplinary panel for disciplinary
action.
SEFs may realize additional cost
savings under the proposed changes to
the disciplinary rules under § 37.206.
Proposed § 37.206(b) would allow a SEF
to administer its disciplinary program
through not only one or more
disciplinary panels as currently
1021 The Commission also notes that some of the
new costs associated with the reconstruction
program requirement in proposed § 37.205(c) are
offset by to the statutory mandate in Core Principle
4 that already requires a SEF to have methods for
conducting comprehensive and accurate trade
reconstructions.
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allowed, but also through its
compliance staff. This proposed rule
would provide SEFs with more
flexibility to adopt a cost effective
disciplinary structure that better suits
their markets and market participants,
while still effectuating the requirements
and protections of Core Principle 2. The
Commission anticipates that SEFs that
choose to administer their disciplinary
programs through their compliance staff
would incur the greatest cost savings.
These SEFs would not incur the cost
associated with establishing or
maintaining disciplinary panels.
Additionally, to the extent that a SEF
chooses to administer its disciplinary
programs through compliance staff, the
SEF may no longer incur certain costs
associated with conducting hearings or
appeals, such as preparing materials and
presentations for hearings before the
disciplinary panel, or the time spent by
SEF employees preparing written
disciplinary decisions. A SEF also may
benefit from increased efficiencies that
they can leverage from compliance
staff’s knowledge about the SEF and its
trading practices to adjudicate matters
more quickly than under the traditional
disciplinary structure.
(iv) Regulatory Service Provider
A SEF may realize cost savings from
the proposed changes under § 37.204.
Expanding the scope of entities that may
provide regulatory services under
proposed § 37.204(a) to include any
non-registered entity approved by the
Commission may result in an increase
in competition among RSPs, and reduce
the overall cost of securing an RSP.
Under the proposed changes to
§ 37.204(b), a SEF and its RSP may also
mutually agree on the method it will use
to document substantive decisions,
rather than documenting every instance
where the SEF’s actions differ from the
RSP’s recommendations, which may
reduce the administrative costs
associated with documentation created
and maintained by a SEF and its RSP.
Providing SEFs with the option under
proposed § 37.204(b) to allow their RSPs
to make substantive decisions, should
better enable an RSP to promptly
intervene and take action, as it deems
necessary. Finally, eliminating the
requirement under § 37.204(c) that a
SEF document where its actions differ
from the RSP’s recommendations,
deferring instead to the SEF and its RSP
to mutually agree on the method it will
use to document substantive decisions,
may encourage better communication
among SEFs and its RSP.
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(3) Error Trade Policy
The Commission believes that the
proposed changes to the error trade rule
would reduce the costs and risks
associated with error trades and
promote swaps market integrity and
efficiency. When counterparties execute
a trade that is an error trade, the
counterparties bear the costs and risks
from being bound to terms to which
they did not intend to assent. The
proposed rule that requires error trades
be resolved in a fair, transparent, and
consistent manner would increase
confidence that error trades would be
corrected and that published swap data
is an accurate indication of market
supply and demand.
The proposed requirement that error
trades be resolved in a timely manner
would reduce the costs associated with
error trades, including associated
hedging costs. A counterparty may
hedge an executed trade: (i) Before it
learns that the trade may be erroneous,
(ii) after it learns the trade may be
erroneous, but before the SEF has
determined whether the trade is an error
trade, (iii) after an error has been
identified but before it has been
resolved, or (iv) after the SEF has
resolved the error. The potential cost of
each case likely depends on how
quickly the SEF resolves the error
because the longer a SEF takes to do so,
then the greater the chance the market
price of the trade and related hedge
trade will move. For example, if a trader
on a SEF enters into a hedge trade and
the SEF determines that the initial trade
is different from what the trader
believed, then the trader may have to
execute a new trade that hedges the
correct trade and unwind the initial
hedge trade. Doing so will be costly if
the market has moved and the price of
entering into the new hedge and
unwinding the old hedge has increased.
Similarly, a trader that waits to execute
a hedge trade until after the SEF has
resolved the error will likely face higher
costs the longer the SEF takes to resolve
the error. The proposed timeliness
requirement should result in faster error
resolution and lower the risk of costly
market moves.
The proposed requirement that SEFs
notify market participants that a swap
transaction is under review pursuant to
error trade rules and procedures, the
determination that the trade under
review is or is not an error trade, and
the resolution of any error trade review
should make markets more efficient. An
error trade misinforms market
participants when its price is different
than the price would be if the trade had
been executed non-erroneously. The
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notification requirement should allow
market participants to make better
informed decisions regarding supply
and demand.
associated with the extended reporting
deadline.
(4) Chief Compliance Officer
As discussed in the preamble, the
Commission believes that some of the
regulations implementing Core
Principle 15 may be unnecessarily
burdensome and inefficient. The
proposed regulations are intended to
address these issues.
The proposal to give the senior officer
the same authority as the board of
directors to oversee the CCO would
provide SEFs with greater opportunity
to structure the management and
oversight of the CCO based on the SEF’s
particular corporate structure, size, and
complexity. This could increase
efficiency and reduce costs.
Additionally, the quality of oversight of
the CCO could improve if the senior
officer is better positioned than the
board of directors to provide day-to-day
oversight of the CCO.
The proposal to permit the CCO to use
any means to identify noncompliance
issues is less prescriptive and should
also increase efficiencies. The proposed
amendment to § 37.1501(d) to refine the
scope of the required information in a
SEF’s ACR should make the ACR
process more efficient and reduce costs.
For example, the proposed removal of
§ 37.1501(e)(2)(i) and certain specific
content set forth under § 37.1501(e)(4)
should reduce the amount of time that
a CCO and his or her staff must spend
preparing the ACR. Proposed
§ 37.1501(d)(4), which would require
that SEFs focus on describing material
non-compliance matters, rather than
describing all compliance matters,
should streamline the ACR requirement
and provide more useful information to
the Commission. Additionally, the
proposed clarification under
§ 37.1501(e)(3) that the CCO must
submit an amended ACR to the SEF’s
board of directors or, in the absence of
a board of directors, the senior officer of
the SEF, should reduce the need for
extensive follow-up discussions.
Finally, the proposal to allow SEFs
more time to submit their ACRs should
reduce the time and resource burden on
the CCO and compliance department.
This additional time should allow SEFs
to fully complete their ACRs and meet
their other end-of-year reporting
obligations, such as the fourth quarter
financial report. However, the
Commission understands that those
SEFs that already may rely on
Commission staff no-action relief for an
extra 30 days to complete the ACR may
have availed themselves of the benefits
(i) Equity Interest Transfer
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(5) Recordkeeping, Reporting, and
Information-Sharing
The Commission notes that an
indirect transfer of a SEF’s equity
interest raises similar concerns as a
direct transfer, notification of which is
currently required under the existing
requirement. Therefore, the Commission
believes that proposed § 37.5(c)(1)
would benefit market participants
because the Commission would have
the ability to more broadly identify and
assess situations where an indirect
equity interest transfer of a SEF could
potentially impact its operational ability
to comply with the SEF core principles
and the Commission’s regulations.
(ii) Confirmation and Trade Evidence
Record
The Commission believes that the
proposed ‘‘trade evidence record’’
approach in proposed § 37.6(b) should
benefit both SEFs and market
participants by decreasing the
administrative costs to execute an
uncleared swap on a SEF. Not only
would a SEF not be required to expend
time and resources to gather and
maintain all of the underlying
relationship documentation between all
possible counterparties on its facility,
but market participants would also not
be required to expend time and
resources in gathering and submitting
this information to the SEF, including
any amendments or updates to that
documentation. Consistent with the
bilateral nature of the underlying
relationship documentation and current
market practice outside of SEFs,
counterparties to the transaction would
be better able to devise their own
confirmation documents by
supplementing the information
provided in the trade evidence record
with additional terms that they have
previously negotiated. Therefore, SEFs
and counterparties should benefit from
a documentation requirement that better
reflects the nature of uncleared swap
transactions. Moreover, the Commission
believes this trade evidence record may
encourage more uncleared swaps
trading on SEFs where these trades can
benefit from SEF oversight, and
ultimately would increase the financial
integrity of the swaps market. The
Commission notes that to the extent that
SEFs and market participants have
relied on the existing no-action relief
provided by Commission staff to avoid
these costs by incorporating those terms
by reference in a confirmation
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document, they have been availing
themselves of the benefits from these
reduced costs.
SEFs should also benefit from the
proposed requirement that they transmit
the confirmation document or the trade
evidence record ‘‘as soon as
technologically’’ practicable after
execution of the transaction rather than
at the same time as execution. In
particular, this approach should provide
an opportunity for a SEF to develop
protocols for transmitting this
documentation in a manner that is
adaptive to the type of execution
method that is utilized to execute a
transaction. Given the flexible methods
of execution that the Commission
proposes to allow for all swaps, this
practical approach to transmitting
documentation should not impede the
development of trading systems or
platforms. For example, a SEF that
offers non-automated execution
methods would not be required to
ensure that post-trade processing
protocols simultaneously transmit the
confirmation or trade evidence record at
the time of execution.
Further, SEFs and market participants
should benefit from allowing an
intermediary to receive a confirmation
document or trade evidence record on
behalf of the counterparties to the
transaction. This approach should be
more consistent with current market
practice, such that intermediaries
maintain the connectivity in trading on
the SEF. Given that intermediaries are
connected with and participating on the
SEFs, but are acting on behalf of the
counterparties, a SEF is able to transmit
the documentation related to a swap
transaction to the intermediary, who
would then transmit that information to
the ultimate counterparties.
(iii) Information-Sharing
The Commission believes that the
proposed amendment to informationsharing requirements would benefit
SEFs by providing a better opportunity
to utilize third-party entities to fulfill
their self-regulatory and reporting
responsibilities at a lower cost. The
proposed rule should increase the
number of RSPs and likely increase the
competition between these providers,
which should both lower costs and
improve the level of services offered.
The Commission anticipates that this
benefit would be greater for smaller
SEFs that otherwise would have
difficulty operating economically due to
the high fixed costs of some services.
(6) System Safeguards
The Commission has identified
several potential benefits from the
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proposed changes to the system
safeguards requirements. First, the
proposed annual Technology
Questionnaire filing requirement (in
proposed Exhibit Q) should help the
Commission maintain a current profile
of the SEF’s automated systems and be
consistent with the provisions of
existing § 37.1401(g)(4),1022 which
allows the Commission to request the
results from a SEF’s mandatory tests of
its automated systems and business
continuity-disaster recovery
capabilities. The Commission believes
that the proposed rule would reduce the
need for additional information and
document requests related to that
existing requirement.1023
Second, the Commission believes an
annually-updated Technology
Questionnaire could expedite Systems
Safeguards Examinations (‘‘SSE’’). For
example, it could reduce a SEF’s overall
compliance-related burdens for SSEs by
(i) reducing a SEF’s effort to respond to
SSE document requests by instead
allowing a SEF to provide updated
information and documents for sections
of Exhibit Q that have changed since the
last annual filing; and (ii) allowing SEFs
to respond to an SSE document request
by referencing Exhibit Q information
and documents to the extent that they
are still current, rather than
resubmitting such information and
documents. The Commission also notes
that an annual update to Exhibit Q,
which would be required concurrently
with submission of the CCO annual
compliance report, could provide
information and documents potentially
useful in preparing that annual report.
c. Costs
(1) SEF Trading Specialists
The Commission expects that SEFs
and/or SEF trading specialists would
incur additional costs to satisfy the
fitness requirement in proposed
§ 37.201(c)(2). The Commission expects
that SEFs would vet prospective SEF
trading specialists to ensure that they
are not subject to a statutory
disqualification. Such vetting may
include the completion by a prospective
1022 Existing § 37.1401(g) generally requires a SEF
to provide all other books and records requested by
Commission staff in connection with Commission
oversight of system safeguards pursuant to the Act
or Commission regulations, or in connection with
Commission maintenance of a current profile of the
SEF’s automated systems. 17 CFR 37.1401(g).
1023 The current profile of a SEF’s automated
systems is also supported by the provision of timely
advance notice of all material planned changes to
automated systems that may impact the reliability,
security, or adequate scalable capacity of such
systems, and of planned changes to the SEF’s
program of risk analysis and oversight, as required
by § 37.1401(f)(1)–(2). 17 CFR 37.1401(f)(1)–(2).
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SEF trading specialist of a questionnaire
regarding employment and criminal
history. Additionally, SEFs may
conduct criminal background checks
through third-party service providers to
ensure that SEF trading specialists are
not subject to a statutory
disqualification.
The costs of ensuring compliance
with proposed § 37.201(c)(2)(i) may be
mitigated where a SEF trading specialist
is separately registered with the
Commission in some other capacity
(e.g., as an associated person), in which
case a SEF may reasonably rely on the
person’s registration status as evidence
that the person is not subject to a
statutory disqualification or that the
person falls within the exception set
forth in proposed § 37.201(c)(2)(ii)(A).
In cases where a SEF relies on the
exception in proposed
§ 37.201(c)(2)(ii)(B), the SEF (or the SEF
trading specialist) would bear an
additional cost of obtaining the required
notice from an RFA.
The expected costs associated with
the proficiency requirement in proposed
§ 37.201(c)(3)(i) would include the cost
to a SEF of determining if a SEF trading
specialist is sufficiently proficient
(which can be accomplished by passing
the examination, once it is available)
and, if necessary, providing training to
ensure that a SEF trading specialist
possesses the requisite proficiency. In
some cases, the cost of determining
proficiency may be minimal; for
example where the SEF trading
specialist has an employment history
that reflects the requisite knowledge and
experience.
The expected costs associated with
the proficiency examination
requirement in proposed
§ 37.201(c)(3)(ii) would include a fee
imposed by the RFA. This fee would
likely be designed to, at a minimum,
offset the costs of developing and
administering the examination.
Additional costs may include study,
training, or other examination
preparation, borne by a SEF trading
specialist or by a SEF on behalf of the
SEF trading specialist. As discussed
above, once an examination for swaps
proficiency is made available,
compliance by a SEF with the
examination requirement in proposed
§ 37.201(c)(3)(ii) would constitute
compliance with the general proficiency
requirement in proposed
§ 37.201(c)(3)(i). Thus, the cost
associated with complying with
proposed § 37.201(c)(3)(i) would be
mitigated once an RFA-administered
examination is made available.
As discussed in the proposed
amendments to the guidance to Core
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Principle 2 in Appendix B, each SEF
would have broad discretion in
developing and implementing its ethics
training program under proposed
§ 37.201(c)(4). Given this discretion, the
costs to SEFs to comply with the ethics
training requirement may vary widely
from SEF to SEF. Furthermore, the
training needs of a SEF may vary
according to the size, number of SEF
trading specialists, and the level of their
expertise and responsibilities within a
SEF.
While the Commission believes that
the requirements in proposed
§§ 37.201(c)(5)–(6) would impose
additional costs on SEFs, the
Commission anticipates that the costs
would vary from SEF to SEF. A SEF
may utilize its existing compliance staff
or may opt to add compliance staff in
order to enforce its standards of conduct
for SEF trading specialists and to meet
the SEF’s obligation to diligently
supervise SEF trading specialists.
Additional costs associated with these
proposed requirements may include the
costs of developing standards of
conduct and policies and procedures
designed to ensure that SEF trading
specialists are diligently supervised.
(2) Rule Compliance and Enforcement
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(i) Definition of ‘‘Market Participant’’
By effectively moving clients of asset
managers out of the category of market
participant, the proposal potentially
reduces SEFs’ ability to monitor the
positions of these clients, although SEFs
would still be able to monitor the
trading of the asset managers.1024
Hence, the cost of the proposed change
may be a reduction in the ability of SEFs
to detect abusive practices to the extent
that clients of asset managers are able to
engage in such practices. However,
these swap users, who typically give up
their trading discretion, appear to be the
least likely to engage in manipulative
practices. For example, when a client
gives complete trading discretion to an
asset manager, the specifics of the asset
manager’s trading typically occurs
without particular knowledge of the
client—that is, they do not know the
investment, whether any swap traded is
occurring on a SEF, or even the identity
of the SEF. Importantly, the asset
1024 The proposed definition of ‘‘market
participant’’ includes any person who accesses a
SEF through direct access provided by a SEF;
through access or functionality provided by a thirdparty; or through directing an intermediary, such as
an asset manager, that accesses a swap execution
facility on behalf of such person to trade on its
behalf. A person who does not access a SEF in any
of these ways, such as a client who does not direct
the asset manager to trade on its behalf, would not
be a market participant under the proposed
definition. See proposed § 37.2(b).
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managers who conduct trading on the
SEF for the client remain subject to the
SEF’s record retention and other
requirements. Hence, to the extent that
an asset manager for a client is engaging
in abusive trading practices on a SEF, a
SEF’s ability to investigate and prevent
those practices should not be
diminished.
(ii) Audit Trail and Surveillance
Program
Without conducting automated
surveillance on orders entered by voice
or certain other electronic
communications, such as instant
messaging and email, SEFs may have a
reduced ability to identify potential
misconduct involving voice orders.
However, the Commission recognizes
that since SEFs currently do not have a
cost-effective solution for performing
such automated surveillance, the
proposed rules do not provide lesser
protections to market participants and
the public. Regarding the requirement to
capture post-trade allocation
information, the Commission
understands that SEFs currently cannot
capture this information. As a result of
capturing less audit trail data under the
proposal, there may be possible costs in
the form of reduced protections to
market participants and the public.
However, the Commission does not
believe that the proposed rule is likely
to meaningfully reduce protections to
market participants and the public as
compared to the current rules.
The Commission proposes to replace
the audit trail enforcement requirement
with the requirement to perform audit
trail reconstructions.1025 Since SEFs are
currently required to reconstruct a
sample of orders and trades under the
voice audit trail surveillance program,
the Commission does not anticipate that
any SEFs subject to this program will
incur any additional costs associated
with performing audit trail
reconstructions under proposed
§ 37.205(c). For SEFs that electronically
capture audit trail data and do not have
a voice component, the incremental cost
of reconstructing trades should not be
material, as their automated trade
surveillance systems should already be
capable of such reconstructions under
§ 37.203(d).
1025 The Commission also notes that some of the
new costs associated with the reconstruction
program requirement under proposed § 37.205(c)
are offset by the statutory mandate in Core Principle
4 that currently requires a SEF to have methods for
conducting comprehensive and accurate trade
reconstructions.
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(iii) Compliance and Disciplinary
Programs
The Commission is mindful that the
proposed elimination of the 12-month
requirement for completing
investigations under § 37.203(f)(2) could
lead to delays in completing
disciplinary actions. However, the
Commission notes that SEFs remain
responsible for completing
investigations in a ‘‘timely manner
taking into account the facts and
circumstances of the investigation.’’ In
addition, while many SEFs are likely to
benefit from the proposed changes
described above related to the
disciplinary process, there may be
accompanying costs. For example, a
SEF’s compliance staff may incur
additional costs taking on the added
responsibilities previously performed by
a disciplinary panel.
The proposed changes to § 37.206 also
permit SEFs to establish a disciplinary
process that may provide respondents
fewer procedural protections than are
required under the current rules.
However, the Commission notes that the
guidance to Core Principle 2 in
Appendix B states that a SEF’s rules
relating to disciplinary panel
procedures should be fair, equitable,
and publicly available. Competition and
customer demand should ensure that
SEFs maintain suitable disciplinary
programs with sufficient protections.
(iv) Regulatory Service Provider
New RSPs may incur start-up costs
associated with developing an
automated trade surveillance system
and establishing and maintaining
sufficient compliance staff. However,
the Commission would expect these
costs to decrease once the RSP has
established its program and as it gains
experience providing regulatory
services. RSPs may realize further
reductions in these costs as they gain
economies of scale by offering their
services to multiple SEFs.
Eliminating the requirement that a
SEF hold regular meetings and conduct
periodic reviews of its RSP may lead to
varying degrees of communication
between a SEF and its RSP, but the
Commission believes that most SEFs
would seek to maintain regular
communication with their RSPs, given
that SEFs remain ultimately responsible
for the performance of any regulatory
services received, for compliance with
their obligations under the Act and
Commission regulations, and for the
RSPs’ performance on their behalf.
(3) Error Trade Policy
The Commission anticipates that SEFs
would incur costs to establish and
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maintain rules and procedures that
facilitate the resolution of error trades.
As noted in the preamble, the proposed
rule is intended to reflect error trade
policies that generally exist among SEFs
so many SEFs should have policies that
are at least partially compliant with the
proposed rule and would not have to
incur the full costs discussed below.
The Commission understands that SEFs
implemented these policies as an
appropriate means to address error
trades or to satisfy a condition set forth
in no-action relief provided by
Commission staff.
Proposed § 37.203(e)(2) would require
that some SEFs incur the costs
associated with establishing and
maintaining rules and procedures that
facilitate resolution of purported errors
in a fair, transparent, consistent, and
timely manner. Existing § 37.203(e)
requires only that a SEF have the
authority to resolve errors when
necessary to mitigate certain market
disrupting events. SEFs that do not
currently have error trade policies, or
whose policies are not compliant with
proposed § 37.203(e)(2), would incur
one-time costs to develop a compliant
policy and ongoing costs to implement
such policy.
To comply with the proposed
§ 37.203(e)(3) requirement that SEFs
notify market participants of (i) any
swap transaction that is under review
pursuant to the SEF’s error trade rules
and procedures; (ii) a determination that
the trade under review is or is not an
error trade; and (iii) the resolution of
any error trade, including any trade
term adjustment or cancellation, some
SEFs would have to incur costs to
establish a means of communicating
such information to market participants.
The Commission believes that many
SEFs would send notifications
electronically to their market
participants. All SEFs have the ability to
communicate electronically with market
participants. However, some SEFs may
not be able to send electronic
notifications ‘‘as soon as practicable’’
and could have to obtain and implement
software to do so. SEFs would also incur
costs each time a notification is sent.
The Commission believes that the
ongoing cost would be minimal if the
notification was sent electronically
using a partially automated software
system. However, some SEFs may send
notifications to their market participants
by other means.
The Commission does not believe the
proposed error trade policy is likely to
increase the risk that counterparties act
carelessly and make more errors. As
noted above, market participants may
incur significant costs when they enter
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into error trades if they need to unwind
hedge trades and execute new hedge
trades. The Commission believes that
these costs encourage market
participants to implement best practices
to avoid errors. The Commission also
does not believe that the error trade
policy is likely to increase the risk that
counterparties attempt to use error
trades to manipulate the market by
entering into off-market transactions
and then cancelling the trades after the
market has moved. Since § 37.203(e)
already requires that SEFs correct error
trades, the proposed rule should not
improve a market manipulation
scheme’s chances of success.
(4) Chief Compliance Officer
The proposed change to § 37.1501(b)
to authorize the senior officer to oversee
the CCO, could impair the
independence of the CCO, and as a
result the CCO’s oversight of the SEF.
However, the Commission believes that
this risk is mitigated by the
Commission’s review of annual ACRs
and examination programs.
The proposed amendments would
eliminate requirements that the CCO
identify noncompliance matters using
only certain specified detection
methods, design procedures that detect
and resolve all possible noncompliance
issues, and eliminate all potential
conflicts of interest. These requirements
would be replaced by more flexible
standards, which could potentially
allow for some impairment of a CCO’s
oversight of the SEF in some
circumstances. However, the
Commission believes that the resulting
costs (in the form of potential adverse
consequences) would not be material
because the proposed changes would
now focus on material aspects of the
compliance program, e.g., material
breaches and material conflicts of
interest. The Commission believes that
the proposal acknowledges that the
focus should be placed on material
compliance issues rather than all
compliance issues.
The proposed change to § 37.1501(e)
to reduce the information required in an
ACR could make it more difficult for the
Commission to assess a SEF’s
compliance and self-regulatory
programs. However, the Commission
does not anticipate that these changes
would materially impact the
Commission’s assessment as it already
receives or has access to such
information from other sources. For
example, the Commission approves a
SEF’s compliance staffing and structure
as part of the SEF’s registration or rule
submission, and annual updates provide
minimal additional information, at best.
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In addition, SEFs report finalized
disciplinary actions to the NFA,1026 and
the Commission could access this
information through its oversight of the
NFA.
Finally, the proposal to give SEFs
more time to submit their ACRs could
delay the Commission in recognizing
and addressing a SEF compliance issue.
However, the Commission anticipates
that such risk is mitigated to the extent
that SEFs provide ACRs on the timeline
set forth in the proposed rules. The
Commission’s experience with these
SEFs has not indicated that this delayed
reporting has adversely impacted its
ability to recognize and address
compliance issues in a timely manner.
(5) Recordkeeping, Reporting, and
Information-Sharing
(i) Equity Interest Transfer
The proposed additional requirement
to notify the Commission of an indirect
change in ownership would increase
costs to a SEF, who would be required
to provide notice in these instances. As
part of that notification, a SEF may
incur costs that are similar to those
incurred when providing a notice of a
direct change, including providing
details of the proposed transaction and
how the transaction would not
adversely impact its ability to comply
with the SEF core principles and the
Commission’s regulation, responding to
any requests for supporting
documentation from the Commission,
and updating any ongoing changes to
the transaction.1027
(ii) Confirmation and Trade Evidence
Record
With respect to uncleared swaps, the
proposed ‘‘trade evidence record’’
approach in proposed § 37.6(b) could
reduce the financial integrity of
transactions on SEFs compared to the
current rule. There could be a greater
risk of misunderstanding between the
counterparties if they do not provide all
the terms of a transaction at the time of
execution. Even when parties reference
agreements, confusion could arise from
1026 See § 9.11 (stating that whenever an exchange
decision pursuant to which a disciplinary action or
access denial action is to be imposed has become
final, the exchange must, within thirty days
thereafter, provide written notice of such action to
the person against whom the action was taken and
notice to the National Futures Association). 17 CFR
9.11.
1027 The Commission previously identified the
types of information that a SEF should provide as
part of its notification, including (i) relevant
agreement(s); (ii) associated changes to relevant
corporate documents; (iii) a chart outlining any new
ownership or corporate or organization structure, if
available; and (iv) a brief description of the purpose
and any impact of the equity interest transfer. SEF
Core Principles Final Rule at 33490.
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issues such as multiple versions of the
agreement with the same labeling or
missing sections. However, the
Commission does not expect that this
risk will materially reduce the integrity
of the swaps market. The Commission
notes that these agreements are usually
relationship terms between
counterparties that govern all trading in
uncleared swaps and do not concern the
terms of specific transactions. The
Commission expects that, since it
should generally be less extensive, the
change should result in no increased
costs.
The Commission also notes that to the
extent that a SEF elects to not issue a
confirmation document that includes or
incorporates all of the terms of an
uncleared swap transaction (including
the trade evidence record), the
counterparties to the swap may be
subject to other Commission regulations
that impose those burdens, and
therefore, increased costs. For example,
where one of the counterparties to an
uncleared swap transaction is a swap
dealer or major swap participant,
§ 23.501 requires that the swap dealer or
major swap participant issue a
confirmation for the transaction as soon
as technologically practicable.1028 The
Commission, however, believes that
such costs are likely to be mitigated by
the reduced cost burdens § 37.6(b)
otherwise currently imposes upon
counterparties to an uncleared swap.
(iii) Information-Sharing
The Commission recognizes that
permitting SEFs to share information
with any third party to fulfill its selfregulatory obligations under proposed
§ 37.504 may increase the risk that the
SEF’s market participant information is
misappropriated. These third party
entities are not necessarily registered
with the Commission and may lack the
document security and compliance
knowledge, to adequately protect market
participant information. However, the
Commission notes that a SEF would
remain responsible for maintaining the
security of this information, and would
oversee their service providers to ensure
compliance, to the extent feasible.
Furthermore, the Commission intends to
continue to review SEFs’ operations to
ensure ongoing compliance (including
the compliance of third-party service
providers).
(6) System Safeguards
SEFs are currently required to file a
Technology Questionnaire under
existing Exhibit V to Form SEF for
registration as a SEF. SEFs are likely to
1028 17
CFR 23.501(a).
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incur additional costs associated with
annually updating this Questionnaire in
proposed Exhibit Q under proposed
§ 37.1401(g). The Commission believes,
however, that this cost may be minimal,
as the Technology Questionnaire
pertains to the SEF’s operations and is
information that a SEF should know for
purposes of its compliance with Core
Principle 14 and the Commission
regulations. Further, the Commission
believes that maintaining an annually
updated Exhibit Q would limit SSE
document requests and the effort
required to respond to these requests
and ad-hoc Commission system
safeguards-related requests under
proposed § 37.1401(h).
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
The Commission believes that the
proposed amendments to the existing
SEF requirements related to compliance
and self-regulatory responsibilities are
likely to increase professionalism in the
swaps market, further promote an
orderly trading environment and market
integrity, and better enable the
Commission to protect market
participants and the public.
First, several of the requirements
should help the Commission to
determine whether a SEF’s operations
are compliant with the Act and the
Commission’s regulations. For example,
requiring a SEF to additionally provide
notice of any transaction resulting in the
transfer of indirect ownership of fifty
percent or more of the SEF’s equity
interest under § 37.5(c)(1) would
broaden the Commission’s ability to
review changes in ownership that may
affect the SEF’s operations. Accordingly,
the Commission should be better able to
assess whether such changes would
adversely impact the SEF’s operations
or its ability to comply with the core
principles or Commission’s regulations,
which are intended in part to protect
market participants.
The Commission’s proposed
amendments to the ACR requirements
under proposed § 37.1501(d) should
also better enable the Commission to
assess the effectiveness of a SEF’s
compliance or self-regulatory programs.
The proposed amendments, among
other things, would remove some of the
existing content requirements that are
duplicative and unnecessary, but
require the ACR to include a description
and self-assessment of the SEF’s written
policies. Removing information
requirements, e.g., requirements to
review all Commission regulations
applicable to a SEF and to identify the
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62073
written policies and procedures enacted
to foster compliance, may reduce the
amount of information available to the
Commission in an ACR to assess a SEF’s
compliance. However, the Commission
has considered that, based on its
experience with the existing
requirements, this information may not
enhance the usefulness of the ACR.
Therefore, the Commission does not
believe that the proposed amendments
would negatively impact its ability to
assess the SEF, which is intended, in
part, to protect market participants.
The proposed requirement that a SEF
annually update its response to the
Questionnaire should facilitate the
Commission’s oversight of a SEF’s
systems safeguard program, and in turn,
benefit the swaps markets by promoting
more robust automated systems and
enhanced cybersecurity. This should
decrease the likelihood of disruptions
and market-wide closures, systems
compliance issues, and systems
intrusions. The receipt of an annuallyupdated response to Exhibit Q should
further the protection of market
participants and the public by helping
to ensure that automated systems are
available, reliable and secure; adequate
in scalable capacity; and effectively
overseen.
Second, the proposed requirements
under § 37.201(c) should protect market
participants and the public by
mandating that SEF trading specialists
meet fitness and proficiency standards,
undergo periodic ethics training, and be
subject to standards of conduct and
diligent supervision by SEFs. The
Commission expects that the proposed
requirements should reduce abusive and
fraudulent conduct and increase the
professionalism of, and fair dealing by,
SEF trading specialists who facilitate
trading between SEF market
participants. Furthermore, the proposed
requirements should promote
compliance with legal and regulatory
obligations and SEF rules that are aimed
at protecting market participants. These
improvements may be attenuated if the
costs of meeting the new standards
reduce the number of SEF trading
specialists.
Third, in addition to promoting the
Commission’s ability to assess a SEF’s
compliance with the Act and
Commission regulations, some of the
requirements should protect market
participants and the public by
improving a SEF’s ability to detect
potential rule violations. For example,
the proposed amendments to
§ 37.203(f)(2) and § 37.206(b) would
permit a SEF to determine the
timeframe within which to complete an
investigation and how to administer its
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disciplinary program, respectively. A
SEF would be better able to prioritize its
completion of investigations and
disciplinary cases that have a greater
impact on the SEF’s markets, its market
participants, and the public. These
benefits may be reduced if SEFs
excessively delay investigations or do
not prioritize appropriately.
Furthermore, proposed § 37.204(b)
should permit a SEF’s RSP to make
substantive decisions, which would
allow an RSP to take action more
promptly to protect the SEF’s markets,
market participants, and the public
against misconduct, with a reduced risk
of delay that could be incurred if the
SEF was required to take action. There
may be a risk of erroneous decisions or
inappropriate delays by the RSP,
however. By shifting existing
§ 37.205(c)’s focus from audit trail
enforcement to audit trail
reconstruction, proposed § 37.205(c)
should enable a SEF to better detect
inaccurate or incomplete audit trail data
that could potentially impair the SEF’s
ability to conduct effective surveillance.
As a whole, the Commission believes
that the requirements as amended
should continue to allow a SEF to better
protect its markets, market participants,
and the public by providing it with
greater discretion to carry out these selfregulatory responsibilities.
The proposed changes to the existing
audit trail requirements may reduce the
scope of information that would be
captured in a SEF’s audit trail, but the
Commission believes that these changes
are not likely to materially affect the
protection of market participants and
the public. For example, the
Commission proposes to eliminate the
requirement that a SEF capture postexecution allocation information. The
Commission notes that this information
has generally not been captured because
SEFs have operated under no-action
relief, which was provided by
Commission staff due to the general
inability of SEFs to access this
information. Thus, elimination of the
requirement should not have a material
effect.
The Commission believes that certain
proposed amendments to current
requirements reflect existing market
realities, which preclude SEFs from
complying with some of these
requirements. In particular, the proposal
would (i) move the requirement that
audit trail data be sufficient to
reconstruct indications of interest,
requests for quotes, orders and trades, to
the guidance to Core Principle 2 in
Appendix B; and (ii) eliminate the
requirement under existing
§ 37.205(b)(2) that a SEF’s electronic
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history database include all indications
of interest, requests for quotes, orders,
and trades entered into a SEF’s trading
system or platform. Further, the
proposed regulations would no longer
require a SEF that offers a voice-based
trading system or platform to maintain
regular voice audit trail surveillance
programs to reconstruct and review
voice trades for possible trading
violations. Notwithstanding the
regulatory requirements in this area, the
Commission emphasizes that SEF Core
Principle 2 and its requirements remain
and a SEF must still capture all audit
trail data related to each of its offered
execution methods that is necessary to
reconstruct all trading on its facility,
detect and investigate customer and
market abuses, and take disciplinary
action.
Fourth, the proposed requirements
should protect market participants by
promoting the integrity of the
transactions executed on the SEF. For
example, proposed § 37.203(e)—which
would require a SEF to adopt policies to
address and resolve error trades on its
facility—should help to ensure that
SEFs promptly address error trades to
facilitate fair and equitable treatment
between market participants on the SEF.
To the extent that market participants
better understand how a SEF addresses
error trades and its approach for
resolving such errors, these market
participants should have more
confidence in transacting on the SEF.
Furthermore, the proposal should lead
to SEFs adopting more consistent
approaches to addressing trading errors,
which should better protect market
participants from basing their trading on
erroneous information provided in
market data feeds. Additionally, the
proposal should lead to market
participants receiving more effective
notice of potential and resolved errors,
which should minimize the market
harm from price misinformation, which
can lead to price distortion and
inefficiency in the market, and
indirectly impact the public. The extent
of these improvements may depend on
the quality of error trade policies
adopted by SEFs and the effectiveness
of their implementation.
Fifth, the proposed requirements
should continue to promote the legal
certainty of transactions executed on the
SEF. Proposed § 37.6(b)(1)(ii), which
would require a SEF to provide the
counterparties to an uncleared swap
transaction with a ‘‘trade evidence
record’’ that memorializes the terms of
the swap transaction agreed upon
between the counterparties on the SEF,
specifies that such documentation must
be legally binding and memorialize the
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terms of the transaction. The
Commission notes that this approach
differs from the existing no-action relief
provided by Commission staff, under
which SEFs have incorporated terms by
reference in a confirmation for an
uncleared swap that have been
previously established via privatelynegotiated underlying agreements.
While the proposed requirement would
limit the scope of terms and conditions
that must be included in SEF-issued
documentation for uncleared swaps, the
Commission believes that this approach
is not likely to diminish the protection
of market participants. The trade
evidence record would continue to
serve as evidence of a legally-binding
swap transaction between the
counterparties, who would still have the
ability to supplement the record with
additional terms that they had already
previously agreed upon.
The protection of market participants
and the public may be adversely
affected to the extent that risks noted in
the discussion of the costs of the
proposed amendments occur. For
example, increased flexibility in the
implementation of compliance programs
may lead to a reduction of their
effectiveness in some circumstances.
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
The Commission believes that the
proposed amendments to the SEF
requirements listed above should
further promote efficiency,
competitiveness, and financial integrity
of the swaps markets.
Requiring a SEF to adopt error trade
policies under proposed § 37.203(e)
should also promote efficiency and
financial integrity on a SEF’s markets.
Although many SEFs currently maintain
error trade policies as noted, the
proposed rule should help to establish
a more consistent and transparent
approach to addressing and resolving
error trades that should benefit market
participants, including those that may
rely on trading data derived from the
SEF’s trading activity. Accordingly,
requiring SEFs to provide notification of
potential errors and a pending review
should mitigate the potential for
subsequent trading based on an
erroneous transaction that could create
market distortions interfering with
efficient and competitive markets. The
requirement should encourage
efficiency by minimizing the risk that
the SEF’s pricing information does not
reflect existing market conditions,
thereby increasing market participants’
confidence to participate on the SEF’s
facility. The extent of these
improvements may depend on the
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quality of error trade policies adopted
by SEFs, and the effectiveness of their
implementation.
The proposed amendments under
Core Principle 2 would generally allow
a SEF greater discretion to tailor its
compliance program to identify and
address rule violations among its
markets and market participants. The
Commission believes that proposed
§ 37.203(f) and § 37.206 may improve a
SEF’s operational efficiency, and
thereby the efficiency and integrity of its
markets, by allowing a SEF to determine
how to complete an investigation and
take disciplinary action to address
misconduct more efficiently. Further,
proposed § 37.204(b), which would
allow a SEF’s RSP more leeway to make
substantive decisions related to a SEF’s
compliance program, should also
improve the efficiency and integrity of
a SEF’s operations by allowing the RSP
to take action with less delay once it
identifies misconduct among market
participants. These efficiency gains may
be reduced by inappropriate decisions
made by RSPs. Additionally, the
Commission believes that the audit trail
reconstruction requirement under
proposed § 37.205(c) should improve a
SEF’s ability to detect potential rule
violations, and may thereby enhance the
overall integrity of its markets.
The requirements in proposed
§§ 37.201(c)(2)–(3) should enhance
efficiency, competitiveness, and
financial integrity of swap markets by
helping to ensure that SEF trading
specialists, who are responsible for
facilitating orderly, efficient, and fair
trading on SEFs, have better fitness and
proficiency to do so. The requirements
pertaining to ethics training and SEF
standards of conduct in proposed
§§ 37.201(c)(4)–(5) should better ensure
that SEF trading specialists are more
aware of applicable regulatory
obligations and SEF rules aimed at
maintaining efficiency, competiveness,
and market integrity. These gains may
not be as extensive if the costs of
meeting these standards reduce the
number of SEF trading specialists. The
proposed supervision requirement
under § 37.201(c)(6) should increase
compliance by SEF trading specialists
with its obligations.
The Commission believes that related
amendments proposed under Core
Principle 15 should also promote
efficiency and integrity of a SEF’s
market by allowing a more streamlined
compliance approach that does not
require the board of directors to assume
primary oversight responsibility for the
CCO. This proposed approach should in
many circumstances permit the CCO to
more efficiently make changes to the
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regulatory program in response to
potential trading violations, which
should aid in protecting the financial
integrity of the market. Furthermore, the
proposal’s focus of the CCO’s duties on
reasonably designed procedures to
address noncompliance issues and
material conflicts of interest should
improve the CCO’s efficiency by
specifying that this is the appropriate
standard. This increased efficiency
should permit CCOs to better allocate
resources to focus on detecting and
deterring material rule violations, which
otherwise may harm the market’s
efficiency, competitiveness, and
integrity.
(3) Price Discovery
The Commission believes that the
proposed amendments related to
compliance and self-regulatory
responsibilities should protect the price
discovery functions provided by a SEF’s
trading system or platform. For
example, the proposed amendments
under Core Principle 2, which the
Commission believes would allow a SEF
to develop the most efficient approach
to identify and address rule violations
based on its markets and market
participants, should help to facilitate
orderly trading and promote integrity in
the market. Price discovery may be
impaired, however, if SEFs are less
successful in addressing rule violations
or have difficulty in maintaining orderly
trading under the framework of the
proposed rules. By promoting market
integrity and orderly trading—
particularly through identifying and
resolving abusive trading practices in an
efficient manner—the Commission
believes that a SEF’s trading system or
platform should be able to serve as a
more robust mechanism for price
discovery.
To the extent that SEF trading
specialists facilitate the trading of swaps
transactions, they may be active
participants in the price discovery
process. The proposed fitness,
proficiency, and ethics rules would help
ensure that SEF trading specialists
perform these tasks ethically and
competently, which should contribute
to the smooth functioning of the price
discovery process.
The Commission believes that
requiring SEFs to adopt and maintain a
formal error trade policy under
proposed § 37.203(e) should similarly
promote the SEF’s ability to facilitate
price discovery. The error trade policy
should protect the price discovery
process on the SEF’s facility, and
promote confidence in the prices market
participants use to hedge risk. This may
depend on the quality of the policy and
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the effectiveness of its implementation.
If a SEF does not promptly address an
error trade, market participants may
mistakenly rely on inaccurate pricing
information.
(4) Sound Risk Management Practices
The Commission believes that the
proposed amendments related to
compliance and self-regulatory
responsibilities should promote sound
risk management practices. The gains in
this regard may depend on the quality
and effective implementation of the
policies and practices that SEFs would
adopt under the proposed amendments.
The Commission notes that proposed
§ 37.203(e) is intended to encourage
SEFs to implement and maintain error
trade policies that reduce operational
risks for market participants, and are
therefore sound risk management
policies. This proposed rule should
reduce the harm to a market participant
when it enters into an error trade, and
reduce harm to the market generally by
decreasing the risk of reliance on
pricing information from an error trade.
(5) Other Public Interest Considerations
The Commission has not identified
any effects of the proposed rules
identified above on other public interest
considerations.
Request for Comment
The Commission requests comment
on all aspects of the consideration of the
costs and benefits of the provisions
related to Compliance and SRO
Responsibilities.
6. Design and Monitoring of Swaps
a. Overview
(1) Swaps Not Readily Susceptible to
Manipulation
The Commission proposes to revise
the guidance relating to how a SEF
should demonstrate that a new swap
contract is not readily susceptible to
manipulation under § 37.301. The
Commission proposes to adopt rules
that would create an Appendix C to part
37 (and update the cross reference
under § 37.301) and make conforming
changes to the guidance found in
Appendix B. The proposed revision to
the guidance to Core Principle 3 in
Appendix B would eliminate the
explanatory guidance, which the
Commission is proposing to address in
the proposed guidance to Appendix C to
part 37 and replace the existing
Appendix B guidance’s cross reference
to sections of Appendix C to part 38
with a general reference to Appendix C
to part 37. The guidance in Appendix C
to part 38 partly focuses on futures
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products, which is not applicable in
part 37. The proposed guidance is
intended to clarify a SEF’s obligations
pursuant to Core Principle 3, and
specifically addresses only swap
contracts.
(2) Monitoring of Trading and Trade
Processing
The proposed changes to the
regulations implementing Core
Principle 4 are intended to establish
more practical trade monitoring
requirements. First, the Commission
proposes to amend existing
§ 37.401(c) 1029 to require that a SEF
conduct real-time market monitoring of
‘‘trading activity’’ only on its own
facility and in order to identify
disorderly trading, any market or system
anomalies, and instances or threats of
manipulation, price distortion, and
disruption. Second, the Commission
proposes to amend existing
§ 37.401(a) 1030 to specify that a SEF has
discretion to determine when (in place
of the current requirement that it do so
on an ‘‘ongoing basis’’) to collect and
evaluate market participant’s trading
activity beyond its market, i.e., as
necessary to detect and prevent
manipulation, price distortion, and,
where possible, disruptions of the
physical-delivery or cash-settlement
processes. Third, the Commission
proposes to eliminate the § 37.403(a)
requirement that SEFs monitor the
‘‘pricing’’ of the reference price used to
determine cash flows or settlement.
Fourth, with regards to the § 37.404(b)
requirement that a SEF require its
market participants to keep records of
their trading, the Commission proposes
to eliminate the current information
maintenance and collection exemption
that permits SEFs to limit the
application of the requirement for
market participants to keep and provide
records of their activity to only those
market participants that conduct
‘‘substantial’’ trading on the SEF as set
forth in the guidance to Core Principle
4 in Appendix B. Fifth, the Commission
proposes to amend § 37.405 to state that
a SEF must have risk control
mechanisms to prevent and reduce
market disruptions as well as price
distortions only on its own facility,
rather than on and off facility.
In addition to these substantive
changes, the Commission proposes a
number of clarifying and streamlining
changes that would not result in any
new costs or benefits and are not
discussed below. The Commission
proposes to partially incorporate
1029 This
1030 This
requirement is in proposed § 37.401(a).
requirement is in proposed § 37.401(b).
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existing § 37.203(e), which requires that
a SEF conduct real-time market
monitoring, into § 37.401(a),1031 and to
consolidate the trade reconstruction
requirements under § 37.401(d) and
§ 37.406 into proposed § 37.401(d). The
Commission proposes clarifying
amendments to § 37.402 and § 37.403,
regarding SEF monitoring obligations
with respect to physical-delivery and
cash-settled swaps, which would not
impose new obligations.
b. Benefits
(1) Swaps Not Readily Susceptible to
Manipulation
The Commission believes that SEFs
should benefit from the swap focused
discussion in proposed Appendix C to
part 37. Similar to Appendix C to part
38, the guidance outlined in proposed
Appendix C to part 37 would set forth
information that should be provided to
the Commission for new products and
rule amendments under § 37.301, based
on best practices developed over the
past three decades by the Commission
and other regulators. This guidance
should provide greater efficiency for
SEFs so that they do not have to try to
apply to swaps products the futuresrelated provisions in Appendix C to part
38. The guidance would also likely
reduce the time and costs that SEFs
would incur in providing the
appropriate information and should
mitigate the need for extensive followup discussions with the Commission. In
addition, it should reduce the amount of
time it takes Commission staff to
analyze whether a new product or rule
amendment is in compliance with the
CEA.
Furthermore, the proposed Appendix
C to part 37 should not diminish the
current benefits from the implementing
regulations for Core Principle 3. The
proposed Appendix C to part 37 should
continue to aid SEFs to list contracts
that are not readily susceptible to
manipulation and should contribute to
integrity and stability of the marketplace
by giving traders more confidence that
the prices associated with swaps reflect
the true supply of and demand for the
underlying commodities or financial
instruments.
1031 The Commission notes that existing
§ 37.203(e) specifies that a SEF must conduct realtime market monitoring of all trading activity on its
system(s) or platform(s) to identify ‘‘disorderly
trading and any market or system anomalies.’’ As
discussed above, the Commission is proposing to
eliminate this provision and establish these
requirements under § 37.401(a) to streamline the
existing regulations.
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(2) Monitoring of Trading and Trade
Processing
The Commission acknowledges that
trading abuses may take place across
trading platforms and markets.
However, the Commission understands
that the requirement that a SEF monitor
the trading activity of its market
participants, whether or not the activity
occurs on the SEF’s own platform, has
in practice been highly costly and
burdensome, and in some instances
these costs and burdens effectively
preclude compliance. Moreover,
requiring every SEF to monitor trading
on every other regulated trading facility
is redundant and therefore provides
little incremental benefit.
The Commission believes that the
proposed regulations should
substantially reduce these very high
monitoring costs for SEFs with
relatively little impact on the benefits of
the regulation, as discussed above.
Under the proposed regulations, a SEF
would not have to monitor trading
activity in real-time beyond its facility
or the pricing of reference prices for
cash-settled swaps, and would not have
to collect and evaluate its market
participants trading activity on an
ongoing basis—only as needed to detect
and prevent abusive trading practices.
Accordingly, this should save SEF
resources.
Proposed § 37.401(a) and, for cashsettled swaps, the removal of existing
§ 37.403(a),1032 would limit certain
monitoring obligations to a SEF’s
facility, and should significantly reduce
the hours that a SEF’s employees and
officers must spend reviewing both the
SEF’s market participants’ trading
activity off of its facility and also market
data (including the pricing information
as required under § 37.403(a)) from
other exchanges, index providers, and
over-the-counter (‘‘OTC’’) trading. SEFs
would not have to pay third party
exchanges and providers for this market
data and trading information because a
SEF would no longer have to monitor
trading beyond its facility (although it
would still have to collect and evaluate
market participant’s trading data as
needed per § 37.401(b)). As a practical
matter, SEFs would also not have to
establish and implement protocols to
reformat third party data for import and
use with the SEF’s internal systems.
While existing SEFs have already
incurred cost to establish protocols to
import third party data, there would be
1032 The Commission notes that the proposed
elimination of § 37.403(a) only creates a cost
savings for a SEF’s monitoring of cash-settled swap
products.
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some savings for new SEFs because they
would not have to develop protocols.
Furthermore, SEFs generally would
no longer have to implement or
maintain these protocols to import third
party data. Consistent with these
changes, proposed § 37.405 would
require a SEF to maintain risk control
mechanisms to prevent and reduce the
potential risk of price distortions and
market disruptions on its facility. A SEF
would no longer have to incur costs to
monitor other trading facilities and OTC
trading for purposes of its risk controls.
As noted above, since these other
trading facilities also have risk control
mechanisms, the benefits of requiring
SEFs to monitor other trading facilities
may be incremental.
Additionally, under proposed
§ 37.401(b), a SEF would only be
required to collect and evaluate data on
its market participant’s activity that
occurs away from the SEF to the extent
that doing so is necessary to detect and
prevent abusive trading practices. The
cost for SEFs to collect market data
should decrease because SEFs would no
longer collect information on an
ongoing basis. To the extent that SEFs
were requesting that market participants
provide trading data, market
participants should also incur fewer
costs. Furthermore, SEFs would no
longer have to obtain trading data from
third parties since all market
participants would be required to
provide trading data upon request under
§ 37.404(b), including those market
participants that a SEF currently may
not require to provide trading activity
information to the SEF.1033 These
market participants that currently do
not collect or provide trading data
would incur some additional costs to
provide such information. Overall, SEFs
should be required to spend less money
importing and analyzing its market
participants’ off-SEF trading, and
market participants should incur less
cost in exporting this data.
Consistent with these changes,
proposed § 37.405 would require a SEF
to maintain risk control mechanisms to
prevent and reduce the potential risk of
price distortions and market disruptions
only on its facility. A SEF would no
longer have to monitor or coordinate its
risk controls with other SEFs and
activity on the OTC market.
1033 Section 37.404(b) and the associated
guidance to Core Principle 4 in Appendix B permits
a SEF to limit the application of the requirement for
market participants to keep and provide records of
their activity in the index or instrument used as a
reference price, the underlying commodity, and
related derivatives markets, to only those market
participants that conduct substantial trading on its
facility. 17 CFR part 37 app. B.
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Notwithstanding these potential
savings due to proposed §§ 37.401(a)–
(b), § 37.405, and removal of existing
§ 37.403(a), the Commission
understands that most SEFs have (in
light of the infeasibility of compliance
as discussed above) interpreted the
existing regulations to be less
demanding than as described in the
preamble to the part 37 SEF final rule,
and, in practice, have implemented
monitoring programs and risk controls
that primarily focus on their respective
facility. These SEFs may not realize a
meaningful reduction in costs because
they already have implemented many of
these more limited monitoring programs
and risk controls.
c. Costs
(1) Swaps Not Readily Susceptible to
Manipulation
Compliance with the guidance in
proposed Appendix C to part 37 should
not impose any additional costs on SEFs
or the market generally. SEFs submitting
products for the Commission’s
certification under § 37.301 could incur
some costs applying the guidance if the
proposed Appendix C to part 37
prompted a SEF to increase the
information that it provided when
submitting a new swap product.
However, the requested information set
forth in proposed Appendix C to part 37
is intended to reflect the Commission’s
prior expectations. For example, the
proposed Appendix C to part 37
includes a specific section for options
on swap contracts that Appendix C to
part 38 does not address. This newly
created section is intended to be
consistent with previous Commission
expectations regarding contract design
and transparency of option contract
terms. The Commission currently
requires that a SEF’s product
submission specify in an objective
manner the following material optionspecific terms of a swap (in addition to
appropriately designing and sufficiently
specifying the underlying swap’s terms):
(i) Exercise method; (ii) exercise
procedure; (iii) strike price provisions;
(iv) automatic exercise provisions; (v)
contract size; (vi) option expiration and
last trading day; and (vii) option type
and trading convention. SEFs have
provided these option-specific terms in
their submissions for options on swap
contracts. The Commission does not
expect SEFs to incur any additional
costs because of the guidance.
(2) Monitoring of Trading and Trade
Processing
The proposed changes to the
implementing regulations under Core
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Principle 4 could increase the chance
that a SEF does not promptly identify
abusive trading practices that occur
away from its facility, but this risk is
mitigated because every transaction
occurring on a regulated platform such
as a SEF or DCM would still be subject
to monitoring. The narrowing of a SEF’s
monitoring obligations under § 37.401(a)
may potentially cause the SEF to not
identify an abusive trading practice
occurring on another exchange or OTC
market, possibly in coordination with
trading on the SEF’s facility.
As a mitigating factor, the
Commission believes that a SEF should
benefit from its monitoring staff
focusing more on trading activity on its
facilities and the SEF’s obligation to
collect and evaluate its market
participants’ trading activity off of the
SEF. This refocusing of the monitoring
staff’s attention should better enable a
SEF to more quickly identify and
address abusive trading practices on its
facility.
The removal of SEFs’ monitoring
obligations under § 37.403(a) may
potentially cause a SEF to not identify
an abusive trading practice occurring on
a cash-settled swap’s underlier, possibly
in coordination with trading of the cashsettled swap on the SEF’s facility. In
practice, the Commission believes that
the additional risk of a SEF failing to
promptly identify abusive trading due to
this proposed regulation is minimal
because SEFs typically cannot access
third parties’ price-forming information,
and SEFs would be challenged to
analyze this third party information for
abusive activities. Consequently, the
Commission does not anticipate that
removing this requirement will
materially impact SEFs current
monitoring practices or
effectiveness.1034
The reduction in trading information
that SEFs have to analyze under
proposed § 37.401(b) could limit a SEF’s
ability to identify an abusive trading
practice occurring on another SEF or a
DCM or OTC, possibly in coordination
with trading on the SEF’s facility.
However, the Commission believes that
under the proposed regulation, SEFs
would still have the means to collect
market participants’ trading information
and, in unusual situations when a SEF
would benefit from additional
information to identify abusive trading
practices, the SEF would be able to
request this information. Moreover, the
1034 The Commission notes that SEFs would
continue to be obligated to monitor the continued
appropriateness of the index or instrument and take
appropriate actions where there is a threat of
manipulation, price distortion, or market disruption
pursuant to proposed § 37.403(b).
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other SEFs and DCMs would be
required to monitor for abusive
practices on their own facilities. Thus,
requiring SEFs to monitor trading on
other regulated trading facilities is
redundant. The Commission believes
that SEFs would be more efficient and
effective if they were required only to
ask for this information when needed.
The proposed changes to the risk
control mechanisms under § 37.405
could increase the chance that abusive
trading practices go unchecked. A SEF
would no longer have to monitor or
coordinate its risk controls with other
SEFs and OTC trading, and a market
participant may be able to attempt to
engage in an abusive trading practice
across exchanges and OTC due to this
lack of coordination. The Commission
believes that this risk is largely
mitigated because every SEF and DCM
would be required to have these
mechanisms on their own facilities, and
therefore the incremental detriment
from removing this requirement should
be minimal. The Commission believes
that potential costs resulting from
removing the requirement that SEFs
monitor or have risk controls related to
the OTC market are unlikely to be
significant, since such monitoring and
risk controls are not practicable. The
OTC market is not required by the CEA
or the Commission’s regulations to have
risk controls and it is not clear that risk
controls in the OTC market are feasible.
The Commission notes that in light of
the Commission’s proposed
interpretation of the trade execution
requirement, more swaps are likely to be
traded on-SEF and thus subject to
monitoring and risk controls. Moreover,
SEFs would continue to have the ability
to investigate and address abusive
trading practices that are implemented
across multiple trading facilities, and to
request information on a market
participant’s trading activity.
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d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
The proposed guidance in Appendix
C to part 37 and the monitoring
requirements in proposed §§ 37.401–403
should not materially diminish a SEF’s
ability to protect market participants
and the public. The proposed guidance
in Appendix C to part 37 and the
proposed amendments to §§ 37.402–403
are intended to provide additional
clarity for SEFs to help ensure that a
contract is not readily susceptible to
manipulation, and to help ensure that
SEFs are able to adequately collect
information on market activity,
including special considerations for
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physical-delivery contracts and cashsettled contracts. Proposed §§ 37.402–
403 would require SEFs to take specific
actions to address threats of
manipulation, price distortion, or
market disruption, and proposed
§ 37.405 would continue to require risk
controls to prevent and reduce the
potential risk of price distortions and
market disruptions on the SEF.
The Commission does not believe that
narrowing a SEF’s monitoring obligation
under proposed § 37.401(a) to trading
activity on its facility, requiring a SEF
to collect market participants’ off
facility trading information only when
necessary to detect abusive trading
activity per proposed § 37.401(b),
eliminating the SEF’s monitoring of the
price formation information for
underlying indexes currently set forth
under § 37.403(a), or altering the risk
control mechanisms under § 37.405
would meaningfully increase the risk
that abusive trading practices go
undetected. While there is a risk that
abusive trading can lead to market
disruptions and create distorted prices
or systemic risks that could harm the
economy and the public, the SEF’s
requirement to monitor its facility per
§ 37.401(a) and to collect additional
trading information from market
participants as necessary per § 37.401(b)
should mitigate this risk. As a group,
these rules should continue to protect
market participants by helping to
prevent price manipulation and trading
abuses, as the proposed rules are
designed to protect the public by
creating an environment that fosters
prices that reflect actual market
conditions.
(2) Efficiency, Competitiveness, and
Financial Integrity of the Markets
The proposed guidance in Appendix
C to part 37 is intended to provide more
tailored guidance, based on best
practices for swaps, regarding what a
SEF should consider when developing a
swap or amending the terms and
conditions of an existing swap. This
tailored guidance should help the
contracts listed by SEFs, as a whole, to
be more reflective of the underlying
cash market, thus providing for more
efficient hedging of commercial risk.
Furthermore, proposed §§ 37.401–403
should require SEFs to continue to
detect and promptly address violations
and market anomalies, and ensure that
prohibited activities do not distort the
swap market’s prices. Therefore, the
proposed modifications to SEF
monitoring requirements should not
materially diminish market confidence
or reduce the market’s ability to operate
efficiently. Additionally, proposed
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§ 37.405 should continue to deter rule
violations by establishing conditions
under which trading is paused or
halted.
(3) Price Discovery
The Commission does not believe that
the proposed rules would materially
diminish a SEF’s ability to implement
an effective monitoring system of its
facility to detect rule violations.
Manipulation or other market
disruptions interfere with the price
discovery process by artificially
distorting prices and preventing those
prices from properly reflecting the
fundamental forces of supply and
demand. Although there is some risk, as
discussed above, that modifications to
the SEF’s monitoring obligations may
cause a SEF to not identify price
manipulation, the Commission believes
this risk is not material. These rules
would continue to require that SEFs
detect, and where possible prevent,
such market mispricing, and detect
disconnects between swaps and their
related market prices, e.g., between cash
market prices and the prices of related
futures and swaps. These rules should
continue to promote confidence in the
SEF’s price discovery process and
market participants’ use of swaps to
hedge risk.
(4) Sound Risk Management Practices
By following the best practices
outlined in the proposed guidance in
Appendix C to part 37 and the
requirements of proposed §§ 37.402–
403, a SEF should be able to minimize
the susceptibility of a swap to
manipulation or price distortion at the
time it is developing the contract’s
terms and conditions. Performing this
work early on should enable a SEF to
minimize risks to its clearinghouse and
to market participants. Sound risk
management practices rely upon
execution of hedge strategies at market
prices that are free of manipulation or
other disruptions. These rules are
designed to facilitate hedging at prices
free of distortions that may be
preventable by adequate controls.
Furthermore, proposed §§ 37.401–403
should continue to aid SEFs in
deterring, detecting, and addressing
operational risks posed by abusive
trading practices or trading activities.
These proposed rules are designed to
limit the potential losses and costs to
SEFs and market participants and
promote sound risk management
practices.
(5) Other Public Interest Considerations
The Commission has not identified
any effects that these rules will have on
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other public interest considerations
other than those enumerated above.
Request for Comment
The Commission requests comment
on all aspects of the consideration of the
costs and benefits of the provisions
related to the Design and Monitoring of
Swaps.
7. Financial Integrity of Transactions
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a. Overview
In order to promote financial integrity
of transactions, the Commission is
proposing changes with respect to
certain straight-through processing
obligations under Core Principle 7 for
SEFs and its implementing regulations
and under § 39.12(b)(7) for derivatives
clearing organizations (‘‘DCO’’). The
Commission will discuss these changes
together in this section since these
provisions interact to form the basis of
the Commission’s straight-through
processing obligations for SEFs and
DCOs.1035
Proposed § 37.701 would require a
SEF to have an independent clearing
agreement with each registered DCO or
exempt DCO to which the SEF routes
swaps for clearing, including in those
instances where a SEF, pursuant to a
service agreement with a third-party
service provider, routes swaps through
the SEF’s third-party service provider to
a DCO that maintains its own agreement
with the third-party service provider,
but not with the SEF.
Proposed § 37.702(b)(1) would require
SEFs to coordinate with registered DCOs
to develop rules and procedures that
facilitate the ‘‘prompt, efficient, and
accurate’’ processing and routing of
swap transactions in accordance with
§ 39.12(b)(7)(i)(A).1036 The Commission
proposes to explicitly interpret the
‘‘prompt, efficient, and accurate’’
standard to establish a qualitative
approach for swaps subject to manual
post-execution affirmation to be routed
to and received by the relevant DCO via
a third-party affirmation hub that would
account for existing market practices
and technology, as well as current
market conditions at the time of
execution. The Commission notes that
1035 For example, the Commission promulgated
§ 37.702(b) and § 39.12(b)(7) along with other
Commission regulations related to straight-through
processing in the same Commission rulemaking.
See Customer Clearing Documentation, Timing of
Acceptance for Clearing, and Clearing Member Risk
Management, 77 FR 21278 (Apr. 9, 2012) (‘‘Timing
of Acceptance for Clearing Final Rule’’).
1036 See Section XII.B.—§ 37.702—General
Financial Integrity. The proposal would renumber
§ 37.702(b)(2) to § 37.702(b)(1), delete existing
§ 37.702(b)(1), and amend the ‘‘prompt and
efficient’’ standard to ‘‘prompt, efficient, and
accurate’’ (emphasis added).
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this proposed interpretation is in
contrast to the Divisions’ view
discussed in the 2013 Staff STP
Guidance, in which the Divisions
interpreted the ‘‘prompt and efficient’’
standard in existing § 37.702(b)(2) to
mean that swaps subject to manual postexecution affirmation via a third-party
affirmation hub should be routed to and
received by the relevant DCO in no
more than ten minutes after
execution.1037
Proposed §§ 37.702(b)(2)–(3),
respectively, would mandate that SEFs
(i) require their market participants to
identify a clearing member in advance
for each counterparty on an order-byorder basis and (ii) facilitate preexecution screening by each clearing
FCM in accordance with the
requirements of § 1.73 on an order-byorder basis. The Commission notes that
this is consistent with the Divisions’
view in the 2013 Staff STP Guidance
that such requirements are corollary to
a SEF’s obligation to facilitate ‘‘prompt
and efficient’’ transaction
processing.1038 Further, the Commission
notes that pre-execution credit
screening has become a fundamental
component of the swaps clearing
infrastructure as SEFs that list Required
Transactions 1039 for trading or offer
clearing for Permitted Transactions 1040
generally have already established these
functionalities, at least in part, to
comply with the Commission’s
regulations, to be consistent with the
Divisions’ views expressed in the 2013
1037 The Commission understands that several
aspects of straight-through processing requirements
are rendered through the 2013 Staff STP Guidance
and the 2015 Staff Supplementary Letter. The
Commission also understands that certain aspects
of the guidance may be unclear when read in
conjunction with existing regulations. Therefore,
the Commission seeks to provide greater clarity and
certainty under the proposed framework with
respect to the straight-through processing
requirements for SEFs and DCOs through the
proposed clarifications and amendments described
herein.
1038 See 2013 Staff STP Guidance at 3. The
Commission further notes that it stated in the
Timing of Acceptance for Clearing Final Rule, that
the ‘‘parties would need to have clearing
arrangement in place with clearing members in
advance of execution’’ and that ‘‘[i]n cases where
more than once DCO offered clearing services, the
parties also would need to specify in advance
where the trade should be sent for clearing.’’
Timing of Acceptance for Clearing Final Rule at
21284.
1039 17 CFR 37.9(a)(1) (defining a Required
Transaction as any transaction involving a swap
that is subject to the trade execution requirement
in section 2(h)(8) of the Act).
1040 17 CFR 37.9(c) (defining a Permitted
Transaction as any transaction not involving a swap
that is subject to the trade execution requirement
in section 2(h)(8) of the Act).
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Staff STP Guidance, or to adhere to
existing industry practices.1041
The Commission proposes to
streamline the applicable straightthrough processing provisions for
registered DCOs by consolidating the
existing requirements under
§§ 39.12(b)(7)(ii)–(iii) into proposed
§ 39.12(b)(7)(ii) and would delete
existing § 39.12(b)(7)(iii). Specifically,
proposed § 39.12(b)(7)(ii) would
establish a single AQATP standard that
applies to all ‘‘agreements, contracts,
and transactions’’ (emphasis added)
regardless of whether a trade is (1)
executed competitively or
noncompetitively; (2) executed on, off,
or pursuant to the rules of a DCM; 1042
or (3) a swap, futures contract, or option
on a futures contract; and (4) would
apply after submission to the DCO (i.e.,
once the transaction is received by the
DCO) rather than after execution in all
circumstances.
In contrast, existing §§ 39.12(b)(7)(ii)–
(iii) establish different standards that
apply based on a transaction’s
characteristics. Existing § 39.12(b)(7)(ii)
applies to (i) any contract, including
futures, options on futures, and swaps,
that is (ii) executed competitively, (iii)
on or subject to the rules of a SEF or
DCM, and (iv) the AQATP period
applies after the trade’s execution on the
SEF or DCM (emphasis added). Existing
§ 39.12(b)(7)(iii) applies to any (i) swap
(but not other products) that either is (ii)
executed noncompetitively on or subject
to the rules of a SEF or DCM or (iii) not
executed on or subject to the rules of a
SEF or DCM, and (iv) the AQATP period
applies after submission to the DCO
(emphasis added). Moreover, consistent
with the views expressed by the
Divisions in the 2013 Staff STP
Guidance, the Commission proposes
that registered DCOs must continue to
accept or reject trades within ten
seconds after submission under
proposed § 39.12(b)(7)(ii)’s AQATP
standard.
The Commission would also make
several non-substantive amendments.
First, to conform the changes
throughout the part 37 proposal, all
references under §§ 37.702–703 to
1041 In the 2013 Staff STP Guidance, the Divisions
believed that pre-trade credit checks would make
rejection from clearing for credit reasons a rare
event. See 2013 Staff STP Guidance at 5. The
Commission notes that the proposed amendments
to § 37.702(b) are generally consistent with the
Divisions’ views articulated in the 2013 Staff STP
Guidance.
1042 The Commission notes that it is proposing to
eliminate the ‘‘pursuant to the rules’’ language,
given the change to the block trade definition. See
supra Section XXII.A.—§ 43.2—Definition—Block
Trade; § 37.203(a)—Elimination of Block Trade
Exception to Pre-Arranged Trading.
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‘‘member’’ would be changed to ‘‘market
participant.’’
Second, existing § 37.702(b)(2)
requires SEFs to develop rules and
procedures to facilitate the ‘‘prompt and
efficient transaction processing’’ of
swap transactions to the applicable
DCO. To conform this requirement to
existing § 39.12(b)(7)(i)(A), which
requires each registered DCO to
coordinate with a SEF or DCM to
facilitate the ‘‘prompt, efficient, and
accurate’’ processing of swaps for
clearing, the Commission proposes to
add the term ‘‘accurate’’ to the existing
‘‘prompt and efficient’’ standard for
SEFs under § 37.702(b)(2).1043 Proposed
§ 37.702(b)(1) would also apply to the
‘‘routing’’ of swap transactions; while
the Commission believes that
‘‘processing’’ as used in existing
§ 37.702(b)(2) also encompasses the
routing of swaps from a SEF to a DCO,
the Commission proposes to explicitly
include ‘‘routing’’ in the regulatory text
for avoidance of doubt.1044 As a result,
existing § 37.702(b)(1), which required a
SEF to have the ‘‘capacity to route
transactions’’ to a DCO, would be
deleted as unnecessary due to new
proposed § 37.702(b)(1). As a
conforming change to proposed
§ 37.702(b)(1), the Commission also
proposes to add the term ‘‘routing’’ to
§ 39.12(b)(7)(i)(A). The Commission also
proposes to specify under § 37.702(b)(1)
that a SEF’s obligation to coordinate
with DCOs should be in accordance
with DCOs’ obligations under existing
§ 39.12(b)(7)(i)(A).1045
Third, proposed § 37.702 would
clarify that a SEF’s obligations under
§ 37.702 apply only to registered DCOs,
as opposed to exempt DCOs.
Fourth, proposed § 37.702(b) would
specify that its requirements apply only
to those transactions routed through a
SEF to a registered DCO for clearing.
The Commission believes that this
change is helpful to clarify that
§ 37.702(b)’s requirements do not apply
1043 The Commission proposes to renumber
§ 37.702(b)(2) to § 37.702(b)(1).
1044 Existing § 37.702(b)(1) requires SEFs to have
the capacity to route transactions to the DCO in a
manner acceptable to the DCO for purposes of
clearing. Since proposed § 37.702(b)(3) would
specify that SEFs must also work with DCOs to
route transactions, existing § 37.702(b)(1) would
become superfluous and would be deleted.
1045 Existing § 37.702(b)(2) requires SEFs to work
with each DCO in accordance with the
requirements of § 39.12(b)(7). The Commission’s
proposal would more specifically reference
§ 39.12(b)(7)(i)(A) (emphasis added), which
establishes a corresponding obligation on DCOs to
work with SEFs to develop rules to facilitate the
‘‘prompt, efficient, and accurate processing’’ of
transactions in order to avoid any confusion with
the application of the AQATP standard under
existing §§ 39.12(b)(7)(ii)–(iii).
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to those SEFs that do not facilitate the
clearing of swaps executed on the SEF.
Fifth, proposed § 39.12(b)(7) would
apply to all ‘‘agreements, contracts, and
transactions,’’ rather than ‘‘transactions’’
as currently provided, in order to
conform with the statutory definition of
‘‘DCO’’ in section 1a(15) of the Act and
general scope of product eligibility
under § 39.12(b)(1) and would make
conforming changes in proposed
§§ 39.12(b)(7)(i)–(ii).
b. Benefits
Proposed § 37.701 is intended to
interact with the other proposed
changes in Core Principle 7 and
§ 39.12(b)(7) to strengthen the straightthrough processing and routing of swaps
from SEFs to DCOs, and increase market
integrity. The Commission believes
proposed § 37.701(b)’s requirement that
a SEF have a direct clearing agreement
with each DCO to which the SEF
submits swaps for clearing would
improve a SEF’s ability to establish
rules and procedures that better
coordinate with a DCO’s clearance and
settlement processes to foster greater
financial integrity of swaps sent to the
DCO for clearing. Such an agreement
also would instill more confidence in
the ability of swap clearing through the
SEF, as under the proposal the SEF
should have the appropriate processes
to facilitate swaps clearing. Further, the
terms established in a direct clearing
agreement between the SEF and DCO
should help the SEF and DCO resolve
any problems that arise at the DCO that
could diminish the SEF’s ability to
submit transactions for clearing.
The Commission believes that
adopting proposed §§ 37.702(b)(2)–(3)
would strengthen the straight-through
processing and routing of swaps from
SEFs to DCOs, and increase financial
integrity of transactions by ensuring a
consistent and timely clearing process.
Specifically, proposed §§ 37.702(b)(2)–
(3) should benefit transaction
processing, routing, and clearing by
codifying the straight-through
processing requirement that SEFs must
ensure that trades are efficiently routed
to DCOs, reducing the time between
execution and clearing. However, to the
extent counterparties already comply
with proposed §§ 37.702(b)(2)–(3) as a
result of standard industry practices or
as a result of adopting the Divisions’
view discussed in the 2013 Staff STP
Guidance, these benefits may already
have been realized.1046
1046 As discussed above, in the 2013 Staff STP
Guidance, the Divisions previously discussed their
view that the straight-through processing
requirements under § 37.702(b) require SEFs to
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The Commission believes that its
proposed qualitative interpretation of
the ‘‘prompt, efficient, and accurate’’
standard in proposed § 37.702(b)(1),
rather than a static bright-line standard
such as the ten-minute standard
discussed by the Divisions in the 2015
Supplementary Staff Letter, would
benefit the marketplace by establishing
a standard that is conducive to the
broader array of swaps that would be
subject to the expanded trade execution
requirement, as well as the additional
executed methods that would be
permitted under the Commission’s
proposal.
The Commission’s proposed
qualitative interpretation of the
‘‘prompt, efficient, and accurate’’
standard should also help ensure that
SEFs have time to use third-party
affirmation hubs for all swap trades
instead of merely those trades that can
be routed through the affirmation hub
for submission to the DCO within the
prescribed time limit. The Commission
believes that permitting the use of
affirmation hubs benefits the
marketplace in certain situations by
providing an opportunity for
counterparties to identify and correct
potential error trades prior to routing
these trades to a DCO for clearing,
thereby reducing the number of error
trades.
The Commission believes that
streamlining and creating a single
AQATP standard would benefit DCOs,
SEFs, and clearing FCMs. The current
bifurcation of the AQATP standard
requires a DCO to ascertain the
characteristics of a trade to determine
whether the DCO’s obligation to accept
or reject a trade subject to AQATP
begins after (1) the trade’s execution for
a trade that is executed competitively on
a SEF or DCM (and therefore subject to
§ 39.12(b)(7)(ii)), or (2) the trade’s
submission to the DCO for a trade that
was either executed non-competitively
or on or subject to the rules of a SEF or
DCM or executed bilaterally (and
therefore subject to § 39.12(b)(7)(iii)).
The Commission’s proposal to
streamline the AQATP standard should
simplify the AQATP standard for DCOs,
which in turn may lead to even more
efficient trade processing, routing, and
clearing since these extra steps are being
removed from the straight-through
processing requirements.
c. Costs
Proposed § 37.701 would require
those SEFs that do not currently have a
direct clearing agreement with a DCO to
have pre-execution credit screening in certain
instances. Id. at 3.
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clear swaps executed on the SEF to
enter into such an agreement with an
applicable DCO. This requirement could
add a marginal cost related to reviewing
and entering into such an agreement
with the SEF’s DCO.
With respect to the Commission’s
proposed qualitative interpretation of
the ‘‘prompt, efficient, and accurate’’
standard in proposed § 37.702(b)(1), the
Commission believes that the proposed
qualitative standard for swaps routed
via third-party affirmation hubs could
reduce the financial integrity of the
trades facilitated by the SEF as
compared to the alternative of
establishing a bright-line static deadline,
such as the ten-minute timeframe
discussed by the Divisions in the 2015
Supplementary Staff Letter. As a result,
a SEF could argue that it complies with
the Commission’s qualitative
interpretation of the ‘‘prompt, efficient,
and accurate’’ standard even though the
swap could have been processed and
routed more quickly if the Commission
would have established a bright-line
standard, e.g., the ten-minute timeframe
articulated in the 2015 Supplementary
Staff Letter.
However, the Commission believes
this potential cost would be mitigated if,
as the Commission expects will occur,
market and technological developments
enable processing and routing through
third-party affirmation hubs to occur at
increasingly shorter time intervals. The
Commission also believes that there is
an inherent incentive to confirm all
trades in a timely manner, as a
counterparty to the trade that has
entered a trade in its front office system
and is trading on that information needs
to ensure that trade is accurate,
otherwise, it may be managing its
portfolio with inaccurate information.
Further, the Commission has set forth
its expectation that under its proposed
qualitative standard, transactions that
can be reasonably affirmed on a fully
automatic basis after execution should
be affirmed in that manner.1047 In such
cases, the Commission believes that
‘‘prompt, efficient, and accurate’’
processing and routing would occur in
a much shorter time frame, e.g., less
than the ten-minute time frame
discussed in the 2015 Supplementary
Staff Letter. Accordingly, the
Commission would continue to monitor
the post-trade affirmation timeframe and
industry developments with respect to
swap processing and routing to require
that SEFs and DCOs comply with their
1047 The Commission notes that this statement is
consistent with the views of the Divisions in the
2015 Supplementary Staff Letter. Id. at 3.
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applicable straight-through processing
requirements.
Proposed § 37.702(b)(2) would require
each market participant to identify a
clearing FCM in advance of each trade
for each counterparty. The Commission
notes that market participants must
already identify a clearing FCM, and so
does not believe that the proposed
requirement will impose a material cost
since it would specify only that a
market participant must identify its
clearing FCM before the trade rather
than after. Similarly, proposed
§ 37.702(b)(3) would require SEFs to
provide pre-execution credit screening,
which could impose a cost on some
SEFs to establish a means of
communicating with an FCM. While
proposed §§ 37.702(b)(2)–(3) could
impose costs by requiring SEFs to
update their systems to facilitate these
requirements, the Commission believes
that SEFs generally already have
established these functionalities as
established market practices. Moreover,
existing § 1.73 requires a clearing FCM
to implement pre-execution risk
controls. Consequently, the Commission
believes that most SEFs already comply
with proposed § 37.702(b)(3) since
clearing FCMs otherwise would
unlikely be able to comply with their
§ 1.73 obligations. Accordingly, costs
imposed by proposed §§ 37.702(b)(2)–
(3) likely have already been realized.1048
The Commission believes that the
proposed consolidation of the AQATP
standard would not impose any new
cost on DCOs since the Commission is
merely clarifying an AQATP standard in
existing § 39.12(b)(7)(ii) to more
accurately reflect when a DCO’s AQATP
obligation begins. The proposed tensecond AQATP standard could impose
new costs by requiring DCOs to
establish the ability to accept or reject
trades for clearing within ten seconds.
However, the Commission does not
believe that the proposed interpretation
of the AQATP standard would impose
any material costs because it conforms
to the industry standard and 99 percent
of all trades are accepted or rejected
from clearing within ten seconds or
less.1049 The proposed ten-second
interpretation of the AQATP standard
could dis-incentivize the development
of an even quicker industry AQATP
standard, resulting in the opportunity
cost of the development of more
1048 The Divisions’ view in the 2013 Staff STP
Guidance already stipulated that SEFs should adopt
the practices that the Commission has proposed
under §§ 37.702(b)(2)–(3). As a result, to the extent
that SEFs have followed the Divisions’
interpretation in the 2013 Staff STP Guidance, such
costs already have been realized.
1049 See 2015 Supplementary Staff Letter at 5.
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62081
efficient and faster straight-through
processing. On the other hand, the tensecond standard could be too
prescriptive, compared to the qualitative
approach the Commission is taking with
respect to the ‘‘prompt, efficient, and
accurate’’ standard in the context of
manual affirmation hubs, and certain
execution methods such as voice
execution, that may have a relatively
higher error rate compared to other
execution methods such as electronic
trading, could reasonably require more
than ten seconds under the AQATP
standard. This issue could be
exacerbated by new or innovative
execution methods along with
potentially new and complex swaps that
the Commission anticipates may
become more common on SEFs and
DCMs under its proposed framework
and that otherwise could benefit from
more than ten seconds under the
AQATP standard.
d. Section 15(a) Factors
(1) Protection of Market Participants and
the Public
The Commission’s proposal on the
financial integrity of transactions and
straight-through processing obligations
should benefit market participants and
the public by helping to ensure greater
transparency and consistency of
straight-through processing, which the
Commission expects would result in
market participants and the public
having a better understanding of the
relevant market structure. In turn, this
could enable market participants and
the public to make more informed
choices and more readily identify and
understand possible risks. The proposal
would adopt and codify certain straightthrough processing standards—rather
than relying on industry practice or staff
guidance—related to the processing and
routing of swaps by SEFs, i.e., the
‘‘prompt, efficient, and accurate’’
standard and the continued use of
manual affirmation hubs and the
clearing or rejection of trades by
registered DCOs, i.e., the ten-second
AQATP standard. These requirements
should help market participants and the
public obtain greater transparency of
market structure and potential risks
related to timely trade processing and
clearing. Similarly, although the
Commission believes that its proposal is
consistent with existing industry
practices, by adopting and codifying
these straight-through processing
standards, the proposal should better
protect market participants and the
public by helping to ensure that FCMs,
SEFs, DCMs, and DCOs adhere to the
applicable straight-through processing
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standards. As a result, the proposal
would help ensure that market
participants and the public continue to
receive the related straight-through
processing benefits.
(2) Efficiency, Competitiveness, and
Financial Integrity of Markets
The AQATP standard reflects the
Commission’s belief that acceptance or
rejection for clearing in close to real
time is crucial for the efficient operation
of trading venues, and the Commission’s
proposal is intended to reinforce SEFs’
and DCOs’ mutual obligation to work
with one another to ensure the prompt,
efficient, and accurate processing and
routing of swaps from SEFs to DCOs. In
turn, this should promote market
efficiency and the financial integrity of
transactions by requiring these market
participants to work together to process,
route, and ultimately clear swap
transactions as appropriate.
In recognizing that some trading
venues may not be fully automated or
may offer execution methods that either
are not fully automated or that have a
relatively higher error rate, such as
voice execution, the Commission’s
proposal would explicitly permit the
use of third-party affirmation hubs
pursuant to proposed § 37.702(b) to
assist counterparties in identifying and
fixing any errors before routing to a
DCO. Identifying errors before trades are
cleared should enhance the financial
integrity of markets by helping to ensure
that cleared transactions reflect
counterparties’ expectations and thereby
avoid costs associated with fixing any
cleared error trades. However, the
absence of a prescribed timeframe to
confirm transactions may result in
delayed resolution of trade errors.
Clarifying that a DCO must accept or
reject a trade after submission to the
DCO, i.e., when the DCO receives the
transaction, subject to the ten-second
AQATP standard should facilitate a
regulatory framework in which DCOs
have access to reasonably available
technology to provide their clearing
customers with competitive and
efficient timeframes to accurately accept
or reject trades for clearing. The
Commission’s AQATP standard for
DCOs’ compliance will allow—and
require—the timeframe for straightthrough processing to continue to adapt
with technological advancements and
other cleared product developments.
Proposed § 37.702(b) and the
Commission’s related interpretation
should promote efficiency by
incorporating the use of third-party
affirmation platforms, which provide an
opportunity to identify error trades prior
to clearing, pursuant to the ‘‘prompt,
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efficient, and accurate’’ standards.
Similarly, proposed § 37.702(b) should
promote financial integrity by reducing
instances in which a DCO inadvertently
clears an error trade, which may also
possibly be reported to an SDR that
would publish such trades to the public
pursuant to the real-time reporting
requirements under part 43 of the
Commission’s regulations. However, the
Commission also recognizes that to the
extent that market participants have
adopted these practices, such as preexecution screening by FCMs, these
benefits may already have been realized.
(3) Price Discovery
The Commission does not believe the
proposed changes will have a significant
effect on price discovery. To the extent
that the Commission’s proposal is
conducive to permitting new execution
methods (i.e., by establishing a
qualitative standard for third-party
manual affirmation hubs), the
Commission believes that these changes
could improve price discovery. On the
other hand, the absence of a prescribed
timeframe to process and route
transactions to a DCO may result in
trades taking longer to clear than they
otherwise would have with a prescribed
timeframe, which may affect price
discovery. However, as noted above, the
Commission believes that the proposed
standard is consistent with industry
practice.
(4) Sound Risk Management Practices
The AQATP standard reflects the
Commission’s belief that acceptance or
rejection for clearing in close to real
time is crucial for effective risk
management. The Commission believes
that prudent risk management dictates
that once a trade has been submitted to
a clearing FCM or a DCO, the clearing
FCM or DCO must accept or reject it as
quickly as possible. The Commission’s
proposal would promote sound risk
management practices by ensuring that
all intended-to-be-cleared swaps are
subject to straight-through processing on
a SEF and that all trades submitted to
a DCO are subject to a consistent
AQATP standard.
(5) Other Public Interest Considerations
The Commission has not identified
any other public interest considerations
relevant to the proposal on financial
integrity and straight-through
processing obligations.
Request for Comment
The Commission requests comment
on all aspects of the consideration of the
costs and benefits of the proposal
related to the financial integrity of
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transactions and straight-through
processing obligations.
8. Financial Resources
a. Overview
The proposal would generally adopt
Commission staff ‘‘Financial Resources
Guidance,’’ 1050 with certain changes, as
part of the proposed acceptable
practices to Core Principle 13 in
Appendix B to part 37 to provide
additional guidance for SEFs when
determining their financial obligations
under proposed § 37.1301 and
§ 37.1303, including what costs a SEF
may or may not include in its projected
operating cost calculations.
Proposed § 37.1301(a) would require a
SEF to maintain financial resources in
an amount adequate to cover only those
projected operating costs necessary to
enable the SEF to comply with its core
principle obligations under section 5h
of the Act and any applicable
Commission regulation for a one-year
period, calculated on an ongoing basis.
In contrast, existing § 37.1301(a)
requires a SEF to maintain sufficient
financial resources to cover all of its
operations for a one-year period,
calculated on an ongoing basis,
regardless of whether such operating
costs are necessary for the SEF to
comply with its core principle or other
applicable Commission regulations. The
Commission would consolidate
§ 37.1301(c) with § 37.1301(a) and
accordingly delete § 37.1301(c).
Proposed § 37.1301(b) would permit a
SEF to file a consolidated financial
report if the SEF also operates as a DCO.
Pursuant to existing § 37.1303, a SEF
currently has reasonable discretion to
determine its financial obligations
under § 37.1301.1051 The Commission
would adopt Acceptable Practices to
further clarify the costs that a SEF may
or may not exclude in its reasonable
discretion when determining its
projected operating costs under
§ 37.1301(a). The proposed Acceptable
Practices would generally be based
1050 CFTC Letter No. 17–25 Division of Market
Oversight Guidance on Calculating Projected
Operating Costs by Designated Contract Markets
and Swap Execution Facilities (Apr. 28, 2017).
1051 Section 37.1303 provides that a SEF has
reasonable discretion in determining the
methodology used to compute its projected
operating costs in order to determine the amount
needed to meet its requirements under § 37.1301.
Because the liquidity requirement in existing
§ 37.1305 is based upon a SEF’s financial
requirement under § 37.1301, the SEF’s application
of its reasonable discretion also implicitly
determines its liquidity obligation under § 37.1305.
The Commission proposes to renumber § 37.1303 to
§ 37.1304. Other than renumbering the provision
and other conforming changes, such as including a
reference to wind-down costs, the Commission is
not proposing substantive changes to the provision.
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upon the Financial Resources Guidance
in which staff discussed the scope of a
SEF’s reasonable discretion for
determining its obligations under
§ 37.1301 and § 37.1303. Specifically,
the Financial Resources Guidance
provides that a SEF may reasonably
exclude from its projected operating
costs certain expenses, including (1)
costs attributable solely to sales,
marketing, business development, or
recruitment; 1052 (2) compensation and
related taxes and benefits for SEF
employees whose functions are not
necessary to meet the SEF’s regulatory
responsibilities; 1053 (3) costs for
acquiring and defending patents and
trademarks for SEF products and related
intellectual property; (4) magazine,
newspaper, and online periodical
subscription fees; (5) tax preparation
and audit fees; (6) to the extent not
covered by item (2) above, the variable
commissions that a voice-based SEF
may pay to its employee-brokers,
calculated as a percentage of transaction
revenue generated by the voice-based
SEF; and (7) any non-cash costs,
including depreciation and
amortization. The Commission similarly
would incorporate this list with certain
conforming changes into the proposed
Acceptable Practices as costs that the
Commission believes may be reasonable
for a SEF to exclude from its projected
operating cost calculations.1054 In
addition to these enumerated items, the
proposed Acceptable Practices
additionally would provide that as long
as a SEF offers more than one bona fide
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1052 The
costs listed in this item (1) also include
costs for travel, entertainment, events and
conferences to the extent that such costs are not
necessary.
1053 For example, if a SEF requires a certain
number of voice brokers to run its voice/hybrid
platform but hires additional voice brokers to
provide superior customer service, the SEF would
only need to include the minimum number of voice
brokers to run its voice-based or voice-assisted
platform based on its current business volume, and
taking into account any projected increase or
decrease in business volume, in its projected
operating cost calculations.
1054 In order to conform to the Commission’s
proposed change to § 37.1301(a), the Commission
proposes to slightly alter the wording of item (2) to
provide that a SEF may exclude the costs of a SEF’s
employees are not necessary to comply with the
core principles set forth in § 5h of the Act and any
applicable Commission regulations. (emphasis
added). Similarly, the Financial Resources
Guidance provides that a reasonable calculation of
projected operating expenses must include all
expenses necessary for a SEF to discharge its
responsibilities as a SEF in compliance with the
CEA, the Commission’s regulations, and the SEF’s
rulebooks, which is consistent with existing
§ 37.1301(a). However, in order to conform with
proposed § 37.1301(a), the proposed acceptable
practices would instead provide that a SEF must
include all expenses necessary for the SEF ‘‘to
comply’’ with the core principles and any
applicable Commission regulations.
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execution method, it may be a
reasonable use of a SEF’s discretion
under proposed § 37.1304 to include the
costs of only one of its bona fide
execution methods in its projected
operating costs calculations, while
excluding the costs associated with its
other execution methods.1055
Further, based on the Financial
Resources Guidance, the proposed
Acceptable Practices would clarify that
in order to determine its obligations
under proposed § 37.1301(a), a SEF may
pro-rate, but not exclude, certain
expenses in calculating projected
operating costs.1056 In pro-rating any of
these expenses, however, a SEF would
need to document, identify, and justify
is decision to pro-rate such expenses.
Proposed § 37.1303 would require a
SEF to maintain liquid assets in an
amount equal to the greater of (i) threemonths’ projected operating costs
necessary to enable the SEF to comply
with its core principle and applicable
Commission regulations and (ii) the
SEF’s projected wind-down costs. In
contrast, a SEF currently must maintain
sufficient liquid assets to cover sixmonths’ projected operating costs.1057
As discussed above, the Commission
proposes to adopt the Acceptable
Practices to further clarify the costs that
a SEF, based on its reasonable
discretion, may or may not exclude from
its projected operating costs when
determining its financial obligations
under proposed § 37.1303.
Since SEFs currently are not required
to provide GAAP-compliant financial
submissions, proposed § 37.1306(a)
would require a SEF’s quarterly
financial submissions to conform to
GAAP, or in the case of a non-U.S.
domiciled SEF that is not otherwise
1055 For example, if a SEF offers both an Order
Book and RFQ System, the SEF would be permitted
to include the costs related to only one of the
execution methods it offers (e.g., if a SEF includes
in its projected operating costs the costs associated
with its Order Book, it may exclude the costs
related to its RFQ System, or vice-versa). A bona
fide method would refer to a method actually used
by SEF participants and not established by a SEF
on a pro forma basis for the purpose of complying
with—or evading—the financial resources
requirement. In contrast, under the current
Financial Resources Guidance and Commission
regulations, a SEF’s projected operating costs
generally must include all offered execution
methods.
1056 For example, a SEF would be permitted to
pro-rate expenses that are shared with affiliates,
e.g., the costs of administrative staff or seconded
employees that a SEF shares with affiliates. Further,
a SEF would also be permitted to pro-rate expenses
that are attributable in part to activities that are not
required to comply with the SEF core principles,
e.g., costs of a SEF’s office space to the extent it also
houses personnel whose costs may be excludable
under items (1) or (2).
1057 The proposal would renumber § 37.1305 to
§ 37.1303.
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62083
required to prepare GAAP-compliant
statements, to prepare its statements in
accordance with either the International
Financial Reporting Standards issued by
the International Accounting Standards
Board, or a comparable international
standard that the Commission may
accept in its discretion. Proposed
§ 37.1306(c) would provide that a SEF’s
quarterly financial statements must
explicitly (i) identify all the SEF’s
expenses without any exclusions, (ii)
identify all expenses and corresponding
amounts that the SEF excluded or prorated when it determined its projected
operating costs, (iii) explain why the
SEF excluded or pro-rated any
expenses, and (iv) identify and explain
all costs necessary to wind down the
SEF’s operations. Section 37.1306(c)(1)
currently requires SEFs to provide
‘‘[s]ufficient documentation’’ explaining
how the SEF determined its financial
resources obligations, and the
Commission believes that the items
specified in proposed § 37.1306(c)
constitute such sufficient
documentation and are already being
provided by compliant SEFs. Proposed
§ 37.1306(d) would extend the deadline
for a SEF’s fourth quarter financial
statement from sixty to ninety days after
the end of such fiscal quarter to conform
to the extended deadline for a SEF’s
annual compliance report. Proposed
§ 37.1306(e) would require a SEF to
provide notice no later than forty-eight
hours after it knows or reasonably
should know it no longer meets its
financial resources obligations.
b. Benefits
Proposed § 37.1301(a) is expected to
reduce the total financial assets that
most SEFs must maintain since a SEF
would be required to maintain sufficient
resources to cover only its operations
necessary to comply with its core
principle obligations and applicable
Commission regulations rather than all
of its operating costs as currently
provided in existing § 37.1301(a). With
respect to proposed § 37.1301(a), the
proposed Acceptable Practices would
provide further guidance regarding the
scope of a SEF’s reasonable discretion
when determining the SEF’s financial
requirements under § 37.1301(a) to
exclude certain expenses from its
projected operating cost calculations,
thereby reducing the amount of total
financial assets that a SEF must
maintain under proposed § 37.1301(a).
To the extent that the proposed
Acceptable Practices generally adopt the
staff’s existing Financial Resources
Guidance, SEFs may also already have
realized the benefits associated with
reduced financial resources
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requirements. However, in addition to
the expenses enumerated in the
Financial Resources Guidance, the
proposed Acceptable Practices also
would clarify that when determining its
financial obligations under § 37.1301(a),
as long as a SEF includes the costs of
one bona fide execution method, a SEF
could reasonably exclude from its
projected operating costs the expenses
associated with its other execution
methods.1058 As a result, the
Commission anticipates that a SEF’s
projected operating costs related to a
SEF’s execution platforms would
generally not be significantly more than
the least costly bona fide execution
method offered by the SEF, which the
Commission notes could be in the
millions of dollars for certain SEFs.1059
Proposed § 37.1301(b) could result in
a marginal cost reduction since an entity
would no longer be required to submit
a separate financial submission for its
affiliated SEF and DCO. However, the
Commission believes that this would be
a de minimis reduction.
Proposed § 37.1303’s liquidity
requirement would significantly reduce
the amount of liquid financial assets
that must be maintained by most SEFs.
Currently, a SEF must maintain liquid
financial assets equal to six-months’
projected operating costs, while
proposed § 37.1303 would require most
SEFs to hold three-months’ projected
operating costs. As a result, proposed
§ 37.1303 generally would reduce the
liquidity requirement for most SEFs by
50 percent.1060 Similar to the discussion
above under proposed § 37.1301(a), the
proposed Acceptable Practices would
broaden the reasonable discretion that a
1058 For example, if a SEF offers both an Order
Book and RFQ System, the SEF would be permitted
to include the costs related to only one of the
execution methods it offers (e.g., if a SEF includes
in its projected operating costs the costs associated
with its Order Book, it may exclude the costs
related to its RFQ System, or vice-versa). A bona
fide method would refer to a method actually used
by SEF participants and not established by a SEF
on a pro forma basis for the purpose of complying
with—or evading—the financial resources
requirement.
1059 The Commission anticipates that SEFs that
offer execution methods that are more costly for a
SEF to maintain, such as voice-based or voiceassisted execution methods, are likely to see the
greatest relative reduction in projected operating
costs.
1060 The Commission notes that the current
liquidity requirement in existing § 37.1305 as well
as proposed § 37.1303 permits a SEF to acquire a
‘‘committed line of credit’’ to satisfy the liquidity
requirement. However, the Commission notes that
most SEFs satisfy this requirement through
maintaining liquid assets rather than obtaining a
line of credit. Accordingly, as a practical matter, the
Commission expects proposed § 37.1303 to reduce
the amount of liquid assets that a SEF must
maintain. Moreover, the Commission notes that
there would be additional associated costs if a SEF
were to obtain a committed line of credit.
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SEF has under proposed § 37.1304 for
computing its projected operating costs
to exclude certain expenses from its
projected three-months’ operating cost
calculations, thereby reducing the
amount of total financial assets that a
SEF must maintain under proposed
§ 37.1303.1061 In addition, a SEF
currently must maintain liquid assets
equal to six-months’ operating costs
even if the SEF’s actual wind-down
costs are greater. For certain SEFs with
wind-down costs that exceed sixmonths’ operating costs, proposed
§ 37.1303 would augment market
integrity for such SEFs by requiring
them to maintain additional liquid
assets to cover their wind-down costs,
even if the SEF’s wind-down would
exceed six-months, but in no event
would a SEF be permitted to maintain
less than three-months’ operating costs.
The Commission believes that the
proposal provides a SEF with greater
flexibility in terms of establishing its
financial resources. This, in turn, may
lead to greater efficiencies in terms of
financing and capital allocation and
investment. However, the Commission
acknowledges, as discussed below, this
flexibility may increase the level of
financial risk at the SEF.
Proposed §§ 37.1306(a) and (c) would
benefit transparency and augment the
Commission’s oversight by requiring
SEFs to provide standardized, GAAPcompliant financial submissions that
explicitly identify any cost a SEF has
excluded or pro-rated in determining its
projected operating costs. In its
experience conducting ongoing SEF
oversight, Commission staff has devoted
additional effort to obtain appropriate
clarity and sufficient documentation
from SEFs. Therefore, the Commission
believes that clarifying the minimum
documentation that a SEF must provide
would mitigate the time and resources
required both by staff in conducting its
oversight and by SEFs in responding to
staff’s requests for additional
information. Proposed § 37.1306(e)
would benefit market integrity by
ensuring that the Commission is aware
of any non-compliance forty-eight hours
after the SEF knows or reasonably
should know that it fails to satisfy its
financial resources obligations rather
than when the SEF submits its quarterly
financial statement under § 37.1306(a),
increasing the Commission’s ability to
promptly respond.
1061 This assumes that a SEF’s projected winddown costs are less than the SEF’s three-months’
projected operating costs; otherwise, proposed
§ 37.1303 would require the SEF to maintain liquid
financial resources in an amount equal to its winddown costs.
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c. Costs
Proposed § 37.1301(a) would reduce
the amount of financial resources that a
SEF must maintain to an amount that
would enable the SEF to comply with
its core principle obligations and
applicable Commission regulations for a
one-year period, calculated on an
ongoing basis, rather than in an amount
necessary to cover all of the SEF’s
operations as required under existing
§ 37.1301(a). The proposed Acceptable
Practices further would clarify the costs
that a SEF may exclude when
determining its obligations under
proposed § 37.1301(a). As a result,
proposed § 37.1301(a) as contemplated
in the proposed Acceptable Practices
likely would induce SEFs to reduce the
current level of total financial resources
that they maintain under § 37.1301. In
turn, this could decrease market
participants’ confidence and could harm
a SEF’s stability during adverse market
conditions because the SEF may not
have adequate financial resources to
cover its costs. However, the
Commission believes that the potential
harm to a SEF’s financial stability and
to the market is minimal since proposed
§ 37.1301(a) addresses only the amount
of a SEF’s total financial assets, which
includes illiquid assets, rather than
focusing only on a SEF’s liquid assets.
The Commission notes that illiquid
assets are less important compared to
the amount of liquid financial assets
that a SEF must maintain under
proposed § 37.1303 since it is more
difficult for a SEF to timely liquidate its
illiquid assets to cover its operating
costs, especially during periods of
market instability. Accordingly, the
Commission believes a SEF’s liquid
financial assets, which the Commission
addresses in proposed § 37.1303 below,
is more important for sustaining a SEF’s
financial health and continuing
operations.
Proposed § 37.1303 could require
some SEFs to maintain additional liquid
financial assets, compared to the current
liquidity requirement, where a SEF’s
wind-down costs exceed six-months’
operating costs. However, as explained
above under the discussion of benefits,
the Commission believes that most SEFs
would not have wind-down costs that
exceed six-months’ operating costs.
Accordingly, proposed § 37.1303 should
not increase the liquidity requirement
for most SEFs.
Proposed § 37.1304 would require a
SEF to incur an additional marginal cost
to calculate its wind-down costs, in
addition to its projected operating costs
as currently required, in order to
determine its financial resources
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obligations under § 37.1301 and
§ 37.1303. The Commission estimates
that this proposed change would impose
an initial, minimal, one-time cost for
each SEF related to determining the
length of time and associated costs
associated with an orderly wind down.
Proposed § 37.1306 would impose
greater costs on a SEF. Specifically,
proposed § 37.1306(a) would require a
SEF to submit GAAP-compliant
quarterly reports. Because GAAPcompliant financial statements generally
require additional effort compared to
non-GAAP compliance financial
statements, the Commission estimates
that the proposed change would
increase annual costs for each SEF to
create GAAP-compliance financial
report. However, the Commission does
not believe that proposed § 37.1306(c)
would increase costs. Under existing
§ 37.1306(c), a SEF must provide
sufficient documentation explaining the
methodology it used to compute its
financial resources requirements;
accordingly, proposed § 37.1306(c) is
merely clarifying the type of
information that is already required.1062
Similarly, the Commission does not
believe that proposed § 37.1306(e)
would increase costs since a SEF
currently is required to maintain
continuous compliance with its
financial resources obligations. By
requiring a SEF to notify the
Commission within 48 hours of noncompliance, rather than informing the
Commission through a SEF’s quarterly
financial submission, proposed
§ 37.1306(e) could impose a de minimis
cost to prepare a notice from a noncompliant SEF.
d. Section 15(a) Factors
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(1) Protection of Market Participants and
the Public
The Commission previously noted
that the financial resources
requirements protect market
participants and the public by
establishing uniform standards and a
system of Commission oversight that
ensures that trading occurs on a
financially stable facility, which in turn,
mitigates the risk of market disruptions,
financial losses, and system problems
that could arise from a SEF’s failure to
maintain adequate financial
resources.1063 In the event that a SEF
must wind down its operations,
proposed § 37.1303 would explicitly
require a SEF to maintain sufficient
liquid financial resources to conduct an
orderly wind-down of its operations, or
1062 See
1063 See
§ 37.1306(c).
Core Principles Final Rule at 33580.
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three-months’ operating costs if greater
than the SEF’s wind-down costs.1064
The Commission believes that the
proposed SEF financial requirements
are better calibrated to the inherent risks
of a SEF, which should not diminish the
financial integrity of the SEF, but
should result in greater efficiencies.
Moreover, a SEF would be required to
provide notice under proposed
§ 37.1306(e) no later than forty-eight
hours after it knows or reasonably
should have known that it no longer
satisfies its financial resources
obligations, ensuring that the
Commission can take prompt action to
protect market participants and the
public. In contrast, the Commission
currently is notified of non-compliance
in a SEF’s quarterly financial
statements. Lastly, a SEF would be
required to submit GAAP-compliant
quarterly financial submissions under
proposed § 37.1306(c) that explicitly
identify the costs a SEF has excluded or
pro-rated in determining its projected
operating costs. As a result, the
Commission would more easily be able
to compare SEFs’ financial health and
take pro-active steps to protect market
participants and the public if the
Commission identifies a SEF with weak
financial health or the development of
negative financial trends among SEFs
that could endanger the market
participants or the public.
(2) Efficiency, Competitiveness, and
Financial Integrity of the Markets
Proposed § 37.1301(a) and § 37.1303,
as further clarified through the proposed
Acceptable Practices, together should
benefit market efficiency by reducing
capital costs since SEFs would no
longer be required to maintain an
excessive amount of financial resources.
Accordingly, a SEF should be able to
more efficiently allocate its financial
resources, which in turn should
encourage market growth and
innovation. For example, as noted
above, in the case of proposed
§ 37.1303, the Commission expects that
most SEFs would need to hold
approximately 50 percent less liquid
financial assets as reserve capital to
cover operating costs. The current
financial resources requirements disincentivize a SEF by imposing higher
capital requirements if the SEF wishes
to offer new or experimental technology,
execution methods, or related products
1064 As the Commission previously noted, a SEF
that has sufficient amounts of liquid financial
resources would be better positioned to close out
trading in a manner not disruptive to market
participants or to members of the public who rely
on SEF prices. See Core Principles Final Rule at
33580.
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62085
and services—especially if such
business lines, products, or services are
not expected to be immediately
profitable or would have low margins.
The existing regulations may
discourage a SEF from offering more
capital intensive activities, such as
execution methods that involve human
brokers compared to fully electronic
trading that are less capital intensive.
Accordingly, the Commission believes
that the proposed capital resources
requirements would be more neutral
with respect to a SEF’s chosen
technology and business model, and
therefore should encourage a greater
variety of execution methods and
related services and products in the
market place.
Reducing capital costs would promote
the entry of new entrants into the
market by reducing start-up costs and
initial capital requirements, thereby
further encouraging competition and
innovation. The increase in competition
and innovation could depend on the
extent to which potential new entrants
respond to this encouragement.
Proposed § 37.1306(e) should improve
the financial integrity of markets by
requiring a SEF to notify the
Commission within 48 hours after it
knows or reasonably should have
known that it no longer satisfies its
financial resources obligations, ensuring
that the Commission can take prompt
action to protect market integrity.
Lastly, proposed § 37.1306(c) would
improve SEF financial submissions by
requiring GAAP-compliant statements
as well as clarifying that a SEF must
explicitly identify any costs that it has
exclude or pro-rated in determining its
projected operating costs. These changes
should improve the Commission’s
ability to conduct its oversight
responsibilities to protect market
integrity.
(3) Price Discovery
The Commission has not identified
any effects of the proposed rules
identified above on price discovery.
(4) Sound Risk Management Practices
By establishing specific standards
with respect to how SEFs should assess
and monitor the adequacy of their
financial resources, the financial
resources rules should promote sound
risk management practices by SEFs. As
noted above, proposed § 37.1303 would
require a SEF to identify its wind-down
costs and associated timing and ensure
that it has sufficient liquid assets to
maintain an orderly wind down.
Similarly, proposed § 37.1306(c) would
require a SEF to explain the basis of its
determination for its estimate of its
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wind-down costs and timing. Proposed
§ 37.1307(e) would require a SEF to
notify the Commission no later than 48
hours after it knows or reasonably
should have known that it no longer
satisfies its financial resources
obligations. As a result, a SEF would be
required to ensure that it maintains the
necessary procedures to identify, and to
notify the Commission of, any noncompliance.
(5) Other Public Interest Considerations
The Commission has not identified
any effects that these rules will have on
other public interest considerations
other than those enumerated above.
Request for Comment
The Commission requests comment
on all aspects of the consideration of the
costs and benefits of the provisions
related to SEF financial resources.
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D. Antitrust Considerations
CEA section 15(b) requires the
Commission to ‘‘take into consideration
the public interest to be protected by the
antitrust laws and endeavor to take the
least anticompetitive means of
achieving the purposes of this Act, in
issuing any order or adopting any
Commission rule or regulation
(including any exemption under section
4(c) or 4c(b)), or in requiring or
approving any bylaw, rule, or regulation
of a contract market or registered futures
association established pursuant to
section 17 of this Act.’’ 1065
The Commission believes that the
public interest to be protected by the
antitrust laws is generally to protect
competition. The Commission requests
comment on whether the proposal
implicates any other specific public
interest to be protected by the antitrust
laws.
The Commission has considered the
proposal to determine whether it is
anticompetitive and does not anticipate
that the proposal, viewed in its entirety,
will have material anticompetitive
effects or result in anticompetitive
behavior. As described in detail in the
preamble above, the proposal is
expected to generally provide greater
flexibility and competition in
connection with swap trading on SEFs
largely as a result of the proposed
approach that would permit SEFs to
offer a variety of innovative execution
methods rather than being limited to
specific, mandated execution methods.
The Commission believes that such
innovation is expected to promote
greater competition between SEFs in
1065 7
U.S.C. 19(b).
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order to attract additional trading and
market participation.
The Commission also believes that
achieving the SEF statutory goals of
promoting trading on SEFs and pretrade price transparency requires both
(i) increasing the number of swaps that
are subject to the trade execution
requirement; and (ii) concurrently
providing flexibility of execution
methods. The Commission believes that
requiring market participants to conduct
a larger portion of their swaps trading
on SEFs would, among other things,
foster additional competition among a
more concentrated number of market
participants resulting in increased
market efficiency and decreased
transaction costs.
The Commission also notes that the
proposal would enhance the available
third party regulatory service providers
that a SEF could hire to perform a
variety of regulatory functions required
of SEFs under the Act and Commission
regulations. Specifically, as noted in the
preamble, the Commission has proposed
to expand the scope of entities that may
provide regulatory services under
§ 37.204(a) to include any nonregistered entity approved by the
Commission. This proposed change is
expected to potentially increase
competition among existing and
potential regulatory service providers
and, thereby, reduce operating costs for
SEFs, and mitigate barriers to entry for
new SEFs.
Although the Commission does not
anticipate that the proposal, viewed in
its entirety, will have material
anticompetitive effects or result in
anticompetitive behavior, the
Commission encourages comments on
any aspect of the proposal that may be
inconsistent with the antitrust laws or
anticompetitive in nature. For example,
the impartial access requirements
proposed under § 37.202(a) would not
require an all-to-all market as
envisioned by the current SEF rules,
and therefore may inhibit the ability of
certain market participants to access
certain trading markets and liquidity
pools. The Commission notes, however,
that the current SEF market structure
and participation patterns already have
generally developed along these
traditional lines, absent the proposed
access criteria. The Commission
underscores that its proposed changes to
the impartial access requirements would
require a SEF to allow access to
prospective participants who are able to
meet the SEF’s participation criteria. As
discussed in this proposal, although the
Commission believes that this approach
should prevent potential
anticompetitive harms, it may still
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provide potential barriers to access.1066
The Commission requests comment on
whether and in what circumstances
adopting the proposed rule could be
anticompetitive.
Further, the Commission has
preliminarily determined that the
proposal serves the regulatory goals set
forth in CEA section 5h(e) to promote
trading on SEFs and pre-trade
transparency in the swaps market. In
addition, the Commission also
preliminary believes that the proposal
serves the general regulatory purpose in
CEA section 3(b) to ‘‘promote
responsible innovation and fair
competition among boards of trade,
other markets and market
participants.’’ 1067
Although the Commission has not
identified any less anticompetitive
means to effectuate the purposes of CEA
sections 5h(e) and 3(b) in connection
with the SEF regulatory framework,
nonetheless, the Commission requests
comment on whether there are other
less anticompetitive means of achieving
the relevant purposes of the Act. The
Commission notes that it is not required
to follow the least anticompetitive
course of action.
List of Subjects
17 CFR Part 9
Administrative practice and
procedure, Commodity exchanges,
Commodity futures, Reporting and
recordkeeping requirements.
17 CFR Part 36
Designated contract markets,
Registered entities, Swap execution
facilities, Swaps, Trade execution
requirement.
17 CFR Part 37
Commodity futures, Registered
entities, Registration application,
Reporting and recordkeeping
requirements, Swap execution facilities,
Swaps.
17 CFR Part 38
Commodity futures, Designated
contract markets, Registered entities,
Reporting and recordkeeping
1066 The Commission previously applied the
impartial access requirement to ISVs on the basis
that such types of vendors would provide various
benefits to the market and market participants. SEF
Core Principles Final Rule at 33,508 n.423.
However, based on the Commission’s experience
and notwithstanding the existing impartial access
requirement, ISVs have not established a significant
level of participation on SEFs, nor have they
achieved a broad level of adoption among market
participants, absent the proposed access criteria.
See supra VII.A.1.a.—§ 37.202(a)(1)—Impartial
Access Criteria.
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requirements, Swaps, Trade execution
requirement.
17 CFR Part 39
Consumer protection, Derivatives
clearing organizations, Reporting and
recordkeeping requirements, Risk
management, Straight-through
processing, Swaps.
17 CFR Part 43
Block trades, Consumer protection,
Reporting and recordkeeping
requirements, Swaps.
For the reasons stated in the
preamble, the Commodity Futures
Trading Commission proposes to amend
17 CFR chapter I as follows:
PART 9—RULES RELATING TO
REVIEW OF EXCHANGE
DISCIPLINARY, ACCESS DENIAL OR
OTHER ADVERSE ACTIONS
1. The authority citation for part 9
continues to read as follows:
■
Authority: 7 U.S.C. 1a, 2, 6b–1, 6c, 7, 7a–
2, 7b–3, 8, 9, 9a, 12, 12a, 12c, 13b, 16a, 18,
19, and 21.
2. Amend § 9.1 by:
a. Redesignating paragraph (c) as
paragraph (d);
■ b. Redesignating paragraph (b)(4) as
paragraph (c);
■ c. Revising paragraphs (b)(2), (b)(3),
and newly redesignated paragraph (c).
The revisions read as follows:
■
■
§ 9.1
Scope of rules.
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*
*
*
*
*
(b) * * *
(2) Except as provided in §§ 9.11(a),
(b)(3)(i) through (v), (c), 9.12(a), and
9.13 (concerning the notice, effective
date and publication of a disciplinary or
access denial action), any summary
action permitted under the rules of the
swap execution facility imposing a
minor penalty for the violation of rules
relating to recordkeeping or reporting,
or permitted under Core Principle 13,
paragraph (a)(6) in appendix B to part
38 of this chapter imposing a minor
penalty for the violation of exchange
rules relating to decorum or attire, or
relating to the timely submission of
accurate records required for clearing or
verifying each day’s transactions or
other similar activities; and
(3) Any exchange action arising from
a claim, grievance, or dispute involving
cash market transactions which are not
a part of, or directly connected with,
any transaction for the purchase, sale,
delivery or exercise of a commodity for
future delivery, a commodity option, or
a swap.
(c) The Commission will, upon its
own motion or upon motion filed
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pursuant to § 9.21(b), promptly notify
the appellant and the exchange that it
will not accept the notice of appeal or
petition for stay of matters specified in
paragraph (b) of this section. The
determination to decline to accept a
notice of appeal will be without
prejudice to the appellant’s right to seek
alternate forms of relief that may be
available in any other forum.
■ 3. In § 9.2, revise paragraph (k) to read
as follows:
§ 9.2
Definitions.
*
*
*
*
*
(k) Summary action means a
disciplinary action resulting in the
imposition of a penalty on a person for
violation of rules of the exchange
permitted under the rules of the swap
execution facility for impeding the
progress of a hearing; Core Principle 13,
paragraph (a)(4) in appendix B to part
38 of this chapter (penalty for impeding
progress of hearing); Core Principle 2,
paragraph (a)(8) in appendix B to part
37 of this chapter (emergency
disciplinary actions); Core Principle 13,
paragraph (a)(7) in appendix B to part
38 of this chapter (emergency
disciplinary actions); the rules of the
swap execution facility for summary
fines for violations of rules regarding
recordkeeping or reporting; or Core
Principle 13, paragraph (a)(6) in
appendix B to part 38 of this chapter
(summary fines for violations of rules
regarding timely submission of records,
decorum, or other similar activities).
■ 4. In § 9.11, revise paragraph (b)(2) to
read as follows:
§ 9.11 Form, contents and delivery of
notice of disciplinary or access denial
action.
*
*
*
*
*
(b) * * *
(2) The written notice of a
disciplinary action or access denial
action provided to the person against
whom the action was taken by a swap
execution facility must be a copy of a
written decision which includes the
items listed in paragraphs (b)(3)(i)
through (vi) of this section.
*
*
*
*
*
■ 5. In § 9.12, revise paragraphs (a)(1)
through (3) to read as follows:
§ 9.12 Effective date of disciplinary or
access denial action.
(a) * * *
(1) As permitted by Core Principle 2,
paragraph (a)(8) in appendix B to part
37 of this chapter (emergency
disciplinary actions) or Core Principle
13, paragraph (a)(7) in appendix B to
part 38 of this chapter (emergency
disciplinary actions), the exchange
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62087
reasonably believes, and so states in its
written decision, that immediate action
is necessary to protect the best interests
of the marketplace;
(2) As permitted by the rules of the
swap execution facility or Core
Principle 13, paragraph (a)(4) in
appendix B to part 38 of this chapter
(hearings), the exchange determines,
and so states in its written decision, that
the actions of a person who is within
the exchange’s jurisdiction has impeded
the progress of a disciplinary hearing;
(3) As permitted by the rules of the
swap execution facility for
recordkeeping or reporting violations or
Core Principle 13, paragraph (a)(6) in
appendix B to part 38 of this chapter
(summary fines for violations of rules
regarding timely submission of records,
decorum, or other similar activities), the
exchange determines that a person has
violated exchange rules relating to
decorum or attire, or timely submission
of accurate records required for clearing
or verifying each day’s transactions or
other similar activities; or
*
*
*
*
*
■ 6. In § 9.24, revise paragraph (a)(2) to
read as follows:
§ 9.24
Petition for stay pending review.
(a) * * *
(2) Within ten days after a notice of
summary action has been delivered in
accordance with § 9.12(b) to a person
who is the subject of a summary action
permitted by Core Principle 2,
paragraph (a)(8) in appendix B to part
37 of this chapter (emergency
disciplinary actions) or Core Principle
13, paragraph (a)(7) in appendix B to
part 38 of this chapter (emergency
disciplinary actions), that person may
petition the Commission to stay the
effectiveness of the summary action
pending completion of the exchange
proceeding.
*
*
*
*
*
■ 7. Add part 36 to read as follows:
PART 36—TRADE EXECUTION
REQUIREMENT
Sec.
36.1
36.2
Trade execution requirement.
Registry of registered entities listing
swaps subject to the trade execution
requirement.
36.3 Trade execution requirement
compliance schedule.
Appendix A to Part 36—Form TER
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a–
2, 7b–3, 2a2, and 21, as amended by Titles
VII and VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Public
Law 111–203, 124 Stat. 1376 (2010).
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Trade execution requirement.
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(a) Except as provided in this section,
counterparties shall execute a
transaction involving a swap subject to
the clearing requirement of section
2(h)(1) of the Act on a designated
contract market, a swap execution
facility, or a swap execution facility that
is exempt from registration under
section 5h(g) of the Act, that lists the
swap for trading.
(b) Paragraph (a) of this section does
not apply to a swap transaction that is
listed only by a swap execution facility
that is exempt from registration under
section 5h(g) of the Act.
(c) Paragraph (a) of this section does
not apply to a swap transaction for
which the clearing exception under
section 2(h)(7) of the Act or the
exceptions or exemptions under part 50
of this chapter have been elected, and
the associated requirements met.
(d) Paragraph (a) of this section does
not apply to a swap transaction that is
executed as a component of a package
transaction that includes a component
transaction that is the issuance of a
bond in a primary market.
(1) For purposes of this paragraph (d),
a package transaction consists of two or
more component transactions executed
between two or more counterparties
where:
(i) Execution of each component
transaction is contingent upon the
execution of all other components
transactions; and
(ii) The component transactions are
priced or quoted together as one
economic transaction with simultaneous
or near simultaneous execution of all
components.
(2) [Reserved]
(e) Paragraph (a) of this section does
not apply to a swap transaction that is
executed between counterparties that
have eligible affiliate counterparty
status pursuant to § 50.52(a) of this
chapter even if the eligible affiliate
counterparties clear the swap
transaction.
forth in appendix A to this part for each
swap, or any group, category, type or
class of swaps that it lists for trading
and is subject to or becomes subject to
the clearing requirement of section
2(h)(1) of the Act, as follows:
(1) For any swap, or any group,
category, type or class of swaps subject
to the clearing requirement of section
2(h)(1) of the Act, to be listed for
trading, a designated contract market or
a swap execution facility shall submit a
complete Form TER or amend its Form
TER concurrently with the submission
of a product listing pursuant to § 40.2 or
§ 40.3 of this chapter;
(2) For any swap, or any group,
category, type or class of swaps
currently listed for trading and subject
to the clearing requirement of section
2(h)(1) of the Act, a designated contract
market or a swap execution facility shall
submit a complete Form TER ten
business days prior to the effective date
of this rule in the Federal Register; or
(3) For any swap, or any group,
category, type or class of swaps that a
designated contract market or a swap
execution facility lists for trading that
subsequent to listing is determined to
become subject to the clearing
requirement of section 2(h)(1) of the
Act, the designated contract market or
the swap execution facility shall submit
a complete Form TER or amend its Form
TER ten business days prior to the
effective date of the same swap, or same
group, category, type or class of swaps
becoming subject to the clearing
requirement.
(c) Required posting. A designated
contract market and a swap execution
facility shall publicly post the most
recent version of its Form TER on its
website pursuant to the timeline in
paragraph (b) of this section. If any
information reported on Form TER, or
in any amendment thereto, is or
becomes inaccurate for any reason, the
designated contract market or the swap
execution facility shall promptly file an
amendment on Form TER updating such
information.
§ 36.2 Registry of registered entities listing
swaps subject to the trade execution
requirement.
§ 36.3 Trade execution requirement
compliance schedule.
(a) Registry. The Commission shall
publish and maintain on its website a
list that specifies the swaps that are
subject to the trade execution
requirement under section 2(h)(8) of the
Act as set forth in § 36.1 and the
designated contract markets and swap
execution facilities where such swaps
are listed for trading.
(b) Required filing. A designated
contract market or swap execution
facility shall file electronically to the
Commission a complete Form TER set
(a) Definitions. For the purposes of
this section:
Category 1 entity means a swap
dealer; a security-based swap dealer; a
major swap participant; or a major
security-based swap participant.
Category 2 entity means a commodity
pool; a private fund as defined in
section 202(a) of the Investment
Advisers Act of 1940; or a person
predominantly engaged in activities that
are in the business of banking, or in
activities that are financial in nature as
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defined in section 4(k) of the Bank
Holding Company Act of 1956.
(b) For swaps subject to the
requirements of section 2(h)(8) of the
Act prior to the effective date of this
rule, counterparties must continue to
comply with the requirements of section
2(h)(8) of the Act.
(c) Schedule for compliance. Upon
the effective date of this rule, the
following schedule for compliance with
the trade execution requirement under
section 2(h)(8) of the Act as set forth in
§ 36.1 shall apply with respect to swaps
that on the effective date of this rule in
the Federal Register become subject to
the requirements of section 2(h)(8) of
the Act:
(1) Category 1 entities. A Category 1
entity must comply with the
requirements of section 2(h)(8) of the
Act as set forth in § 36.1 no later than
ninety (90) days from the effective date
of this rule in the Federal Register when
it executes a swap transaction with
another Category 1 entity or a nonCategory 1 entity that voluntarily seeks
to execute the swap on a swap
execution facility, designated contract
market, or swap execution facility that
is exempt from registration under
section 5h(g) of the Act.
(2) Category 2 entities. A Category 2
entity must comply with the
requirements of section 2(h)(8) of the
Act as set forth in § 36.1 no later than
one hundred and eighty (180) days from
the effective date of this rule in the
Federal Register when it executes a
swap transaction with another Category
2 entity, a Category 1 entity, or other
counterparties that voluntarily seek to
execute the swap on a swap execution
facility, designated contract market, or
swap execution facility that is exempt
from registration under section 5h(g) of
the Act.
(3) Other counterparties. All other
counterparties must comply with the
requirements of section 2(h)(8) of the
Act as set forth in § 36.1 no later than
two hundred and seventy (270) days
from the effective date of this rule in the
Federal Register.
(d) Nothing in this rule shall be
construed to prohibit any person from
voluntarily complying with the
requirements of section 2(h)(8) of the
Act as set forth in § 36.1 sooner than
required under the implementation
schedule provided under paragraph (c)
of this section.
(e) Future compliance schedules.
After the effective date of this rule and
upon the issuance of additional clearing
requirement determinations under
section 2(h)(2) of the Act that a swap, or
any group, category, type or class of
swaps is required to be cleared, the
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Commission shall determine the
appropriate schedule for compliance
with the trade execution requirement
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under section 2(h)(8) of the Act as set
forth in § 36.1 for that swap, group,
category, type or class of swap.
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62089
Appendix A to Part 36—Form TER
BILLING CODE 6351–01–P
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62090
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
COMMODITY FUTURES TRADING COMMISSION
FORMTER
LISTED SWAPS SUBJECT TO THE TRADE EXECUTION REQUIREMENT
INSTRUCTIONS
Intentional misstatements or omissions of material fact may constitute federal
criminal violations (7 U.S.C. 13 and 18 U.S.C. 1001).
DEFINITIONS
Unless the context requires otherwise, all terms used in this Form TER have the same
meaning as in the Commodity Exchange Act, as amended ("CEA" or "Act"), and in the
General Rules and Regulations of the Commodity Futures Trading Commission
("Commission") thereunder (17 CFR chapter I).
GENERAL INSTRUCTIONS
1. This Form TER, which includes instructions, is to be filed with the Commission by
a designated contract market ("DCM") or swap execution facility ("SEF") for a
swap or a group, category, type, or class of swaps, that is subject to or that
becomes subject to the clearing requirement of section 2(h)(l) of the Act that the
DCM or SEF lists for trading.
2. Individuals' names, except the executing signature, shall be given in full (Last
Name, First Name, Middle Name).
3. Signatures on all copies of the Form TER filed with the Commission can be
executed electronically. If this Form TER is filed by a corporation, it shall be
signed in the name of the corporation by a principal officer duly authorized; if
filed by a limited liability company, it shall be signed in the name of the limited
liability company by a manager or member duly authorized to sign on the limited
liability company's behalf; if filed by a partnership, it shall be signed in the name
of the partnership by a general partner duly authorized; if filed by an
unincorporated organization or association which is not a partnership, it shall be
signed in the name of such organization or association by the managing agent,
i.e., a duly authorized person who directs or manages or who participates in the
directing or managing of its affairs.
5. The Commission may determine that additional information is required from the
DCM or SEF in order to process its filing. A Form TER that is not prepared
and executed in compliance with applicable requirements and instructions
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4. If any item is inapplicable, indicate by "none," "not applicable," or "N/A," as
appropriate.
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62091
may be returned as not acceptable for filing. Acceptance of this Form TER,
however, shall not constitute a finding that the Form TER has been filed as
required or that the information submitted is true, current, or complete.
6. The information submitted on this Form TER will be published and maintained on
the Commission's website and be available for inspection by any interested
person.
AMENDMENTS
1. When filing this Form TER for purposes of amending a prior filing pursuant to
§ 36.2 of the Commission's regulations (17 CFR 36.2), a DCM or SEF must file a
complete form that is marked to show changes as applicable.
2. Amendments shall be signed on behalf of the DCM or SEF by a duly authorized
representative.
WHERE TO FILE
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This Form TER must be filed electronically with the Secretary of the Commission in the
manner specified by the Commission.
62092
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
COMMODITY FUTURES TRADING COMMISSION
FORMTER
LISTED SWAPS SUBJECT TO THE TRADE EXECUTION REQUIREMENT
Registered Entity Identifier Code (optional):
Organization:
Filing as a:
D
D
DCM
SEF
If this is an INITIAL filing of Form TER, complete in full and check here.
If this is an AMENDMENT to a previously filed Form TER, complete in full, list
all items that are amended and check here.
SIGNATURES
The DCM or SEF has duly caused this Form TER or amendment to be signed on its
behalf by the undersigned, hereunto duly authorized, this __ day of _ _ _ __
20_. The undersigned represents hereby that all information contained herein is
true, current, and complete. It is understood that all required items are considered
integral parts of this Form TER and that the submission of any amendment represents
that all unamended items remain true, current, and complete as previously filed.
Name ofDCM or SEF
Signature of Duly Authorized Person
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Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
62093
GENERAL INFORMATION- EXHIBIT INSTRUCTIONS
1. The following Exhibit(s) must be filed with the Commission for each swap, or any
group, category, type, or class of swaps that the DCM or SEF lists for trading that
is subject to the clearing requirement under section 2(h)(l) of the Act as set forth
in§ 50.4 of the Commission's regulations (17 CFR 50.4).
2. An Exhibit must be labeled and include the information as specified in this Form
TER. The following tables are the required template and must be reproduced for
each contract listing, as appropriate.
EXHIBIT A-1- INTEREST RATES
1. Attach as Exhibit A-1, the interest rate contracts the DCM or SEF lists for trading
that are subject to the clearing requirement
Product Class/Specification
Currency
Floating Rate Index
Stated Termination Date
Ran~e
Optionality
Dual Currencies
Conditional Notional Amounts
EXHIBIT A-2- CREDIT
2. Attach as Exhibit A-2, the credit contracts the DCM or SEF lists for trading that
are subject to the clearing requirement.
Product Class/Specification
Reference Entities
Region
Indices
Tenor
Tranched
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Applicable Series
62094
■
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
Subpart H—Financial Integrity of
Transactions
37.700 Core Principle 7—Financial integrity
of transactions.
37.701 Required clearing.
37.702 General financial integrity.
37.703 Monitoring for financial soundness.
8. Revise part 37 to read as follows:
PART 37—SWAP EXECUTION
FACILITIES
Subpart A—General Provisions
Sec.
37.1
37.2
37.3
Scope.
Applicable provisions and definitions.
Requirements and procedures for
registration.
37.4 Procedures for implementing rules.
37.5 Provision of information relating to a
swap execution facility.
37.6 Enforceability.
37.7 Boards of trade operating both a
designated contract market and a swap
execution facility.
Subpart B—Compliance With Core
Principles
37.100 Core Principle 1—Compliance with
core principles.
37.101 [Reserved]
Subpart C—Compliance With Rules
37.200 Core Principle 2—Compliance with
rules.
37.201 Requirements for swap execution
facility execution methods.
37.202 Access requirements.
37.203 Rule enforcement program.
37.204 Regulatory services provided by a
third party.
37.205 Audit trail.
37.206 Disciplinary procedures and
sanctions.
Subpart D—Swaps Not Readily Susceptible
to Manipulation
37.300 Core Principle 3—Swaps not readily
susceptible to manipulation.
37.301 General requirements.
Subpart E—Monitoring of Trading and
Trade Processing
37.400 Core Principle 4—Monitoring of
trading and trade processing.
37.401 General requirements.
37.402 Additional requirements for
physical-delivery swaps.
37.403 Additional requirements for cashsettled swaps.
37.404 Ability to obtain information.
37.405 Risk controls for trading.
37.406 Regulatory service provider.
37.407 Additional sources for compliance.
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Subpart F—Ability To Obtain Information
37.500 Core Principle 5—Ability to obtain
information.
37.501 Establish and enforce rules.
37.502 Provide information to the
Commission.
37.503 Information-sharing.
37.504 Prohibited use of data collected for
regulatory purposes.
37.600 Core Principle 6—Position limits or
accountability.
37.601 [Reserved].
20:44 Nov 29, 2018
Subpart J—Timely Publication of Trading
Information
37.900 Core Principle 9—Timely
publication of trading information.
37.901 General requirements.
Subpart K—Recordkeeping and Reporting
37.1000 Core Principle 10—Recordkeeping
and reporting.
37.1001 Recordkeeping.
Subpart L—Antitrust Considerations
37.1100 Core Principle 11—Antitrust
considerations.
37.1101 Additional sources for compliance.
Subpart M—Conflicts of Interest
37.1200 Core Principle 12—Conflicts of
interest.
37.1201 [Reserved].
Subpart N—Financial Resources
37.1300 Core Principle 13—Financial
resources.
37.1301 General requirements.
37.1302 Types of financial resources.
37.1303 Liquidity of financial resources.
37.1304 Computation of costs to meet
financial resources requirement.
37.1305 Valuation of financial resources.
37.1306 Reporting to the Commission.
37.1307 Delegation of authority.
Subpart O—System Safeguards
37.1400 Core Principle 14—System
safeguards.
37.1401 Requirements.
Subpart P—Designation of Chief
Compliance Officer
37.1500 Core Principle 15—Designation of
chief compliance officer.
37.1501 Chief compliance officer.
Appendix A to Part 37—Form SEF
Appendix B to Part 37—Guidance on, and
Acceptable Practices in, Compliance
With Core Principles
Appendix C to Part 37—Demonstration of
Compliance That a Swap Contract Is Not
Readily Susceptible to Manipulation
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a–
2, 7b–3 and 12a, as amended by Titles VII
and VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Public
Law 111–203, 124 Stat. 1376 (2010).
Subpart A—General Provisions
§ 37.1
Subpart G—Position Limits or
Accountability
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Subpart I—Emergency Authority
37.800 Core Principle 8—Emergency
authority.
37.801 Additional sources for compliance.
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Scope.
The provisions of this part shall apply
to every swap execution facility that is
registered or is applying to become
registered as a swap execution facility
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under section 5h of the Commodity
Exchange Act (‘‘the Act’’).
§ 37.2 Applicable provisions and
definitions.
(a) Applicable provisions. A swap
execution facility shall comply with the
requirements of this part and all other
applicable Commission regulations,
including § 1.60 of this chapter and any
related definitions and cross-referenced
sections.
(b) Definitions. For the purposes of
this part, market participant means any
person who accesses a swap execution
facility in the following manner:
(1) Through direct access provided by
a swap execution facility;
(2) Through access or functionality
provided by a third-party; or
(3) Through directing an intermediary
that accesses a swap execution facility
on behalf of such person to trade on its
behalf.
§ 37.3 Requirements and procedures for
registration.
(a) Requirements for registration. Any
person operating a facility that offers a
trading system or platform in which
more than one market participant has
the ability to execute or trade any swap,
regardless of whether such swap is
subject to the trade execution
requirement under section 2(h)(8) of the
Act as set forth in § 36.1 of this chapter,
with more than one other market
participant on the system or platform
shall register the facility as a swap
execution facility under this part or as
a designated contract market under part
38 of this chapter.
(b) Procedures for registration—(1)
Application for registration. An
applicant requesting registration as a
swap execution facility shall:
(i) File electronically a complete Form
SEF as set forth in appendix A to this
part, or any successor forms, and all
information and documentation
described in such forms with the
Secretary of the Commission in the form
and manner specified by the
Commission;
(ii) Provide to the Commission, upon
the Commission’s request, any
additional information and
documentation necessary to review an
application; and
(iii) Obtain a legal entity identifier
code for the purpose of identifying the
swap execution facility pursuant to part
45 of this chapter.
(2) Request for confidential treatment.
(i) An applicant requesting registration
as a swap execution facility shall
identify with particularity any
information in the application that will
be subject to a request for confidential
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treatment pursuant to § 145.9 of this
chapter.
(ii) Section 40.8 of this chapter sets
forth those sections of the application
that will be made publicly available,
notwithstanding a request for
confidential treatment pursuant to
§ 145.9 of this chapter.
(3) Amendment of application for
registration. An applicant amending a
pending application for registration as a
swap execution facility shall file an
amended Form SEF electronically with
the Secretary of the Commission in the
manner specified by the Commission.
(4) Effect of incomplete application. If
an application is incomplete pursuant to
paragraph (b)(1) of this section, the
Commission shall notify the applicant
that its application will not be deemed
to have been submitted for purposes of
the Commission’s review.
(5) Commission review period. The
Commission shall review an application
for registration as a swap execution
facility pursuant to the 180-day
timeframe and procedures specified in
section 6(a) of the Act.
(6) Commission determination. (i) The
Commission shall issue an order
granting registration upon a
Commission determination, in its own
discretion, that the applicant has
demonstrated compliance with the Act
and the Commission’s regulations
applicable to swap execution facilities.
If deemed appropriate, the Commission
may issue an order granting registration
subject to conditions.
(ii) The Commission may issue an
order denying registration upon a
Commission determination, in its own
discretion, that the applicant has not
demonstrated compliance with the Act
and the Commission’s regulations
applicable to swap execution facilities.
(c) Amendment of an order of
registration. (1) A swap execution
facility requesting an amendment to an
order of registration shall electronically
file such request with the Secretary of
the Commission in the form and manner
specified by the Commission.
(2) A swap execution facility shall
provide to the Commission, upon the
Commission’s request, any additional
information and documentation
necessary to review a request to amend
an order of registration.
(3) The Commission shall issue an
amended order of registration upon a
Commission determination, in its own
discretion, that the swap execution
facility would maintain compliance
with the Act and the Commission’s
regulations upon amendment to the
order. If deemed appropriate, the
Commission may issue an amended
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order of registration subject to
conditions.
(4) The Commission may decline to
issue an amended order based upon a
Commission determination, in its own
discretion, that the SEF would not
continue to maintain compliance with
the Act and the Commission’s
regulations upon amendment to the
order.
(d) Reinstatement of dormant
registration. A dormant swap execution
facility as defined in § 40.1 of this
chapter may reinstate its registration
under the procedures of paragraph (b) of
this section. The applicant may rely
upon previously submitted materials if
such materials accurately describe the
dormant swap execution facility’s
conditions at the time that it applies for
reinstatement of its registration.
(e) Request for transfer of registration.
(1) A swap execution facility seeking to
transfer its registration from its current
legal entity to a new legal entity as a
result of a corporate change shall file a
request for approval to transfer such
registration with the Secretary of the
Commission in the form and manner
specified by the Commission.
(2) Timeline for filing a request for
transfer of registration. A swap
execution facility shall file a request for
transfer of registration as soon as
practicable prior to the anticipated
corporate change.
(3) Required information. The request
for transfer of registration shall include
the following:
(i) The underlying documentation that
governs the corporate change;
(ii) A description of the corporate
change, including the reason for the
change and its impact on the swap
execution facility, including its
governance and operations, and its
impact on the rights and obligations of
market participants;
(iii) A discussion of the transferee’s
ability to comply with the Act,
including the core principles applicable
to swap execution facilities, and the
Commission’s regulations thereunder;
(iv) The governing documents
adopted by the transferee, including a
copy of any constitution, articles or
certificate of incorporation,
organization, formation, or association
with all amendments thereto,
partnership or limited liability
agreements, and any existing bylaws,
operating agreement, or rules or
instruments corresponding thereto;
(v) The transferee’s rules marked to
show changes from the current rules of
the swap execution facility;
(vi) A representation by the transferee
that it:
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(A) Will be the surviving entity and
successor-in-interest to the transferor
swap execution facility and will retain
and assume the assets and liabilities of
the transferor, except if otherwise
indicated in the request;
(B) Will assume responsibility for
complying with all applicable
provisions of the Act and the
Commission’s regulations promulgated
thereunder, including all self-regulatory
responsibilities except if otherwise
indicated in the request; and
(C) Will notify market participants of
all changes to the transferor’s rulebook
prior to the transfer, including those
changes that may affect the rights and
obligations of market participants, and
will further notify market participants of
the concurrent transfer of the
registration to the transferee upon
Commission approval and issuance of
an order permitting this transfer.
(4) Commission determination. Upon
review of a request for transfer of
registration, the Commission, as soon as
practicable, shall issue an order either
approving or denying the request.
(f) Request for withdrawal of
application for registration. An
applicant for registration as a swap
execution facility may withdraw its
application submitted pursuant to
paragraph (b) of this section by filing a
withdrawal request electronically with
the Secretary of the Commission.
Withdrawal of an application for
registration shall not affect any action
taken or to be taken by the Commission
based upon actions, activities, or events
occurring during the time that the
application was pending with the
Commission.
(g) Request for vacation of
registration. A swap execution facility
may request that its registration be
vacated under section 7 of the Act by
filing a vacation request electronically
with the Secretary of the Commission.
Vacation of registration shall not affect
any action taken or to be taken by the
Commission based upon actions,
activities, or events occurring during the
time that the swap execution facility
was registered by the Commission.
(h) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, to the Director of the
Division of Market Oversight or such
other employee or employees as the
Director may designate from time to
time, upon consultation with the
General Counsel or the General
Counsel’s delegate, authority to notify
an applicant seeking registration that its
application is incomplete and that it
will not be deemed to have been
submitted for purposes of the
Commission’s review, and to notify an
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applicant seeking registration under
section 6(a) of the Act that its
application is materially incomplete and
the running of the 180-day period is
stayed. The Director may submit to the
Commission for its consideration any
matter that has been delegated in this
paragraph. Nothing in this paragraph
prohibits the Commission, at its
election, from exercising the authority
delegated in this paragraph.
§ 37.4
Procedures for implementing rules.
(a) Any rule, except for swap product
terms and conditions, submitted as part
of a swap execution facility’s
application for registration shall be
considered for approval by the
Commission at the time the Commission
issues the swap execution facility’s
order of registration.
(b) Any rule, except for swap product
terms and conditions, submitted as part
of an application to reinstate the
registration of a dormant swap
execution facility, as defined in § 40.1 of
this chapter, shall be considered for
approval by the Commission at the time
the Commission approves the dormant
swap execution facility’s reinstatement
of registration.
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§ 37.5 Provision of information relating to
a swap execution facility.
(a) Request for information. Upon the
Commission’s request, a swap execution
facility shall file with the Commission
information related to its business as a
swap execution facility in the form and
manner and within the time period as
the Commission specifies in its request.
(b) Demonstration of compliance.
Upon the Commission’s request, a swap
execution facility shall file with the
Commission a written demonstration,
containing supporting data, information,
and documents that it is in compliance
with its obligations under the Act and
the Commission’s regulations as the
Commission specifies in its request. The
swap execution facility shall file such
written demonstration in the form and
manner and within the time period as
the Commission specifies in its request.
(c) Equity interest transfer—(1) Equity
interest transfer notification. A swap
execution facility shall file with the
Commission a notification of each
transaction involving the direct or
indirect transfer of fifty percent or more
of the equity interest in the swap
execution facility. The Commission
may, upon receiving such notification,
request that the swap execution facility
provide supporting documentation of
the transaction.
(2) Timing of notification. The equity
interest transfer notice described in
paragraph (c)(1) of this section shall be
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filed electronically with the Secretary of
the Commission at its Washington, DC
headquarters at submissions@cftc.gov
and the Division of Market Oversight at
DMOSubmissions@cftc.gov, at the
earliest possible time but in no event
later than the open of business ten
business days following the date upon
which a firm obligation is made to
transfer, directly or indirectly, fifty
percent or more of the equity interest in
the swap execution facility.
(3) Certification. Upon a transfer,
whether directly or indirectly, of an
equity interest of fifty percent or more
in a swap execution facility, the swap
execution facility shall file
electronically with the Secretary of the
Commission at its Washington, DC
headquarters at submissions@cftc.gov
and the Division of Market Oversight at
DMOSubmissions@cftc.gov, a
certification that the swap execution
facility meets all of the requirements of
section 5h of the Act and the
Commission regulations adopted
thereunder, no later than two business
days following the date on which the
equity interest of fifty percent or more
was acquired.
(d) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, the authority set forth
in this section to the Director of the
Division of Market Oversight or such
other employee or employees as the
Director may designate from time to
time. The Director may submit to the
Commission for its consideration any
matter that has been delegated in this
paragraph. Nothing in this paragraph
prohibits the Commission, at its
election, from exercising the authority
delegated in this paragraph.
§ 37.6
Enforceability.
(a) Enforceability of transactions. A
swap transaction executed on a swap
execution facility shall not be void,
voidable, subject to rescission,
otherwise invalidated, or rendered
unenforceable as a result of:
(1) A violation by the swap execution
facility of the provisions of section 5h
of the Act or this part;
(2) Any Commission proceeding to
alter or supplement a rule, term, or
condition under section 8a(7) of the Act
or to declare an emergency under
section 8a(9) of the Act; or
(3) Any other proceeding the effect of
which is to:
(i) Alter or supplement a specific term
or condition or trading rule or
procedure; or
(ii) Require a swap execution facility
to adopt a specific term or condition,
trading rule or procedure, or to take or
refrain from taking a specific action.
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(b) Swap documentation—(1) Legally
binding documentation—(i) Cleared
swaps. (A) A swap execution facility
shall provide a confirmation document
to each counterparty to a cleared swap
transaction that is executed on the swap
execution facility.
(B) Confirmation document means a
legally binding written documentation
(electronic or otherwise) that
memorializes the agreement to all terms
of a swap transaction and legally
supersedes any previous agreement
(electronic or otherwise) that relates to
the swap transaction between the
counterparties.
(ii) Uncleared swaps. (A) A swap
execution facility shall provide a trade
evidence record to each counterparty to
an uncleared swap transaction that is
executed on the swap execution facility.
(B) Trade evidence record means a
legally binding written documentation
(electronic or otherwise) that
memorializes the terms of a swap
transaction agreed upon by the
counterparties and legally supersedes
any conflicting term in any previous
agreement (electronic or otherwise) that
relates to the swap transaction between
the counterparties.
(2) Requirements for swap
documentation. (i) A swap execution
facility shall issue the confirmation
document or trade evidence record to
the counterparties as soon as
technologically practicable after the
execution of the swap transaction on the
swap execution facility.
(ii) Specific customer identifiers for
accounts included in bunched orders
involving swap transactions need not be
included in a confirmation document or
a trade evidence record provided by a
swap execution facility if the applicable
requirements of § 1.35(b)(5) of this
chapter are met.
(iii) The swap execution facility may
issue the confirmation document or
trade evidence record to the person
acting as an intermediary on behalf of
the counterparty to the swap
transaction. The swap execution facility
shall establish and enforce rules that
require such intermediary to send the
confirmation document or trade
evidence record to the respective
counterparty as soon as technologically
practicable upon receipt of the
confirmation document or trade
evidence record from the swap
execution facility.
§ 37.7 Boards of trade operating both a
designated contract market and a swap
execution facility.
(a) An entity that intends to operate
both a designated contract market and a
swap execution facility shall separately
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register the two entities pursuant to the
designated contract market designation
procedures set forth in part 38 of this
chapter and the swap execution facility
registration procedures set forth in this
part.
(b) A board of trade, as defined in
section 1a(6) of the Act, that operates
both a designated contract market and a
swap execution facility and that uses
the same electronic trade execution
system for executing and trading swaps
on the designated contract market and
on the swap execution facility shall
clearly identify to market participants
for each swap whether the execution or
trading of such swaps is taking place on
the designated contract market or on the
swap execution facility.
Subpart B—Compliance With Core
Principles
§ 37.100 Core Principle 1—Compliance
with core principles.
(a) In general. To be registered, and
maintain registration, as a swap
execution facility, the swap execution
facility shall comply with—
(1) The core principles described in
section 5h of the Act; and
(2) Any requirement that the
Commission may impose by rule or
regulation pursuant to section 8a(5) of
the Act.
(b) Reasonable discretion of a swap
execution facility. Unless otherwise
determined by the Commission by rule
or regulation, a swap execution facility
described in paragraph (a) of this
section shall have reasonable discretion
in establishing the manner in which the
swap execution facility complies with
the core principles described in section
5h of the Act.
§ 37.101
[Reserved]
Subpart C—Compliance With Rules
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§ 37.200 Core Principle 2—Compliance
with rules.
A swap execution facility shall:
(a) Establish and enforce compliance
with any rule of the swap execution
facility, including the terms and
conditions of the swaps traded or
processed on or through the swap
execution facility and any limitation on
access to the swap execution facility;
(b) Establish and enforce trading,
trade processing, and participation rules
that will deter abuses and have the
capacity to detect, investigate, and
enforce those rules, including means to
provide market participants with
impartial access to the market and to
capture information that may be used in
establishing whether rule violations
have occurred;
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(c) Establish rules governing the
operation of the facility, including rules
specifying trading procedures to be used
in entering and executing orders traded
or posted on the facility, including
block trades; and
(d) Provide by its rules that when a
swap dealer or major swap participant
enters into or facilitates a swap that is
subject to the mandatory clearing
requirement of section 2(h) of the Act,
the swap dealer or major swap
participant shall be responsible for
compliance with the mandatory trading
requirement under section 2(h)(8) of the
Act.
§ 37.201 Requirements for swap execution
facility execution methods.
(a) Required swap execution facility
rules. A swap execution facility shall
establish rules governing the operation
of the swap execution facility that
specify:
(1) The protocols and procedures for
trading and execution, including
entering, amending, cancelling, or
executing orders for each execution
method;
(2) The manner or circumstances in
which the swap execution facility may
exercise discretion in facilitating trading
and execution for each execution
method; and
(3) The sources and methodology for
generating any market pricing
information provided to facilitate
trading and execution for each
execution method.
(b) Pre-execution communications. A
swap execution facility shall establish
rules governing the operation of the
swap execution facility that specify a
prohibition on engaging in any
communications away from the swap
execution facility regarding any swap
subject to the trade execution
requirement of section 2(h)(8) of the Act
as set forth in § 36.1 of this chapter.
(1) Counterparties to a swap that is
subject to the trade execution
requirement of section 2(h)(8) of the Act
as set forth in § 36.1 of this chapter may
engage in communications away from
the swap execution facility if the swap
is executed as a component of a package
transaction that includes a component
transaction that is not subject to section
2(h)(8) of the Act as set forth in § 36.1
of this chapter. For purposes of this
paragraph (b)(1), a package transaction
consists of two or more component
transactions executed between two or
more counterparties where:
(i) Execution of each component
transaction is contingent upon the
execution of all other components
transactions; and
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62097
(ii) The component transactions are
each priced or quoted together as part of
one economic transaction with
simultaneous or near simultaneous
execution of all components.
(2) [Reserved]
(c) SEF trading specialist—(1)
Definition. For purposes of this part, the
term SEF trading specialist means any
natural person who, acting as an
employee (or in a similar capacity) of a
swap execution facility, facilitates the
trading or execution of swaps
transactions (other than in a ministerial
or clerical capacity), or who is
responsible for direct supervision of
such persons.
(2) Fitness. (i) No swap execution
facility shall permit a person who is
subject to a statutory disqualification
under sections 8a(2) or 8a(3) of the Act
to serve as a SEF trading specialist if the
swap execution facility knows, or in the
exercise of reasonable care should
know, of the statutory disqualification.
(ii) The prohibition set forth in
paragraph (c)(2)(i) of this section shall
not apply to:
(A) Any person listed as a principal
or registered with the Commission as an
associated person of a futures
commission merchant, retail foreign
exchange dealer, introducing broker,
commodity pool operator, commodity
trading advisor, or leverage transaction
merchant, or any person registered as a
floor broker or floor trader,
notwithstanding that such person is
subject to a disqualification from
registration under sections 8a(2) or 8a(3)
of the Act; or
(B) Any person otherwise subject to a
disqualification from registration under
sections 8a(2) or 8a(3) of the Act for
whom a registered futures association
provides a notice stating that, if the
person applied for registration with the
Commission as an associated person,
the registered futures association would
not deny the application on the basis of
the statutory disqualification.
(3) Proficiency requirements. (i) A
swap execution facility shall establish
and enforce standards and procedures to
ensure that its SEF trading specialists
have the proficiency and knowledge
necessary to:
(A) Fulfill their responsibilities to the
swap execution facility as SEF trading
specialists; and
(B) Comply with applicable
provisions of the Act, the Commission’s
regulations, and the rules of the swap
execution facility.
(ii) Qualification testing. A swap
execution facility shall require any
person serving as a SEF trading
specialist to demonstrate that:
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(A) Such person has taken and passed
any examination for swaps proficiency
developed and administered by a
registered futures association; and
(B) There is no continuous two-year
period subsequent to such person
passing a swaps proficiency
examination during which the person
has not served as a SEF trading
specialist.
(iii) Compliance with the qualification
testing requirements under paragraph
(c)(3)(ii) of this section shall constitute
compliance with the proficiency
requirements under paragraph (c)(3)(i)
of this section.
(4) Ethics training. A swap execution
facility shall establish and enforce
policies and procedures to ensure that
its SEF trading specialists receive ethics
training on a periodic basis.
(5) Standards of conduct. A swap
execution facility shall establish and
enforce policies and procedures that
require its SEF trading specialists in
dealing with market participants and
fulfilling their responsibilities to the
swap execution facility to satisfy
standards of conduct as established by
the swap execution facility.
(6) Duty to supervise. A swap
execution facility shall diligently
supervise the activities of its SEF
trading specialists in the facilitation of
trading and execution on the swap
execution facility.
(7) Additional sources for compliance.
A swap execution facility may refer to
the guidance and/or acceptable
practices in appendix B of this part to
demonstrate to the Commission
compliance with the requirements of
§ 37.201.
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§ 37.202
Access requirements.
(a) Impartial access to markets,
market services, and execution
methods. (1) A swap execution facility
shall establish rules specifying impartial
access criteria for its markets, market
services, and execution methods,
including any indicative quote screens
or any similar pricing data displays.
Such impartial access criteria shall be
transparent, fair, and nondiscriminatory and applied to all or
similarly situated market participants.
(2) A swap execution facility shall
establish fee structures and fee practices
that are fair and non-discriminatory to
market participants.
(b) Limitations on access. A swap
execution facility shall establish and
impartially enforce rules governing any
decision to deny, suspend, permanently
bar, or otherwise limit market
participants’ access to the swap
execution facility, including when such
decisions are made as part of a
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disciplinary or emergency action taken
by the swap execution facility. The
swap execution facility shall maintain
documentation of any decision to deny,
suspend, permanently bar, or otherwise
limit access of a market participant to
the swap execution facility.
(c) Eligibility. A swap execution
facility shall require its market
participants to provide the swap
execution facility with written
confirmation (electronic or otherwise) of
their status as eligible contract
participants, as defined by the Act and
Commission regulations, prior to
obtaining access.
(d) Jurisdiction. Prior to granting any
market participant access to its
facilities, a swap execution facility shall
require that the market participant
consent to its jurisdiction.
§ 37.203
Rule enforcement program.
(a) Abusive trading practices
prohibited. A swap execution facility
shall prohibit abusive trading practices
on its markets by market participants.
Swap execution facilities that permit
intermediation shall prohibit customerrelated abuses including, but not limited
to, trading ahead of customer orders,
trading against customer orders,
accommodation trading, and improper
cross trading. Specific trading practices
that shall be prohibited include frontrunning, wash trading, pre-arranged
trading, fraudulent trading, money
passes, and any other trading practices
that a swap execution facility deems to
be abusive. A swap execution facility
shall also prohibit any other
manipulative or disruptive trading
practices prohibited by the Act or by the
Commission pursuant to Commission
regulation.
(b) Authority to collect information. A
swap execution facility shall have the
authority to collect information required
to be kept by persons subject to the
swap execution facility’s recordkeeping
rules.
(c) Compliance staff and resources. A
swap execution facility shall establish
and maintain sufficient compliance staff
and resources to ensure that it can fulfill
its self-regulatory obligations under the
Act and Commission regulations.
(d) Automated trade surveillance
system. A swap execution facility shall
maintain an automated trade
surveillance system capable of detecting
and reconstructing potential trade
practice violations. Any trade executed
by voice or by entry into a swap
execution facility’s electronic trading
system or platform and any order
entered into an electronic trading
system or platform shall be loaded and
processed into the automated trade
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surveillance system no later than 24
hours after the completion of the trading
day on which such trade was executed
or such order was entered.
(e) Error trade policy—(1) Definition.
As used in this paragraph (e), the term
error trade means any swap transaction
executed on a swap execution facility
that contains an error in any term of the
swap transaction, including price, size,
or direction.
(2) A swap execution facility shall
establish and maintain rules and
procedures that facilitate the resolution
of error trades in a fair, transparent,
consistent, and timely manner. Such
rules and procedures shall:
(i) Provide the swap execution facility
with the authority to adjust trade terms
or cancel trades; and
(ii) Specify the rules and procedures
for market participants to notify the
swap execution facility of an error trade,
including any time limits for
notification.
(3) A swap execution facility shall, as
soon as practicable, provide notice to all
market participants of:
(i) Any swap transaction that is under
review by the swap execution facility
pursuant to error trade rules and
procedures;
(ii) Any determination by the swap
execution facility that a swap
transaction under review is or is not an
error trade; and
(iii) The resolution of any error trade,
including any trade term adjustment or
trade cancellation.
(4) The requirements of paragraph (e)
of this section shall not preclude the
swap execution facility from
establishing non-reviewable ranges.
(f) Investigations—(1) Procedures. A
swap execution facility shall establish
and maintain procedures that require its
compliance staff to conduct
investigations, including the
commencement of an investigation
upon the receipt of a request from
Commission staff or upon the discovery
or receipt of information by the swap
execution facility that indicates a
reasonable basis for finding that a
violation may have occurred or will
occur.
(2) Timeliness. Each investigation
shall be completed in a timely manner,
taking into account the facts and
circumstances of the investigation.
(3) Investigation reports. Compliance
staff shall prepare a written
investigation report to document the
conclusion of each investigation. The
investigation report shall include the
reason the investigation was initiated; a
summary of the complaint, if any; the
relevant facts; compliance staff’s
analysis and conclusions; and a
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recommendation as to whether
disciplinary action should be pursued.
(g) Additional sources for compliance.
A swap execution facility may refer to
the guidance and/or acceptable
practices in appendix B of this part to
demonstrate to the Commission
compliance with the requirements of
§ 37.203.
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§ 37.204 Regulatory services provided by
a third party.
(a) Use of regulatory service provider
permitted. A swap execution facility
may choose to contract with a registered
futures association or another registered
entity, as such terms are defined under
the Act, or any non-registered entity
(collectively, ‘‘regulatory service
providers’’), for the provision of services
to assist in complying with the Act and
Commission regulations thereunder, as
approved by the Commission. Any swap
execution facility that chooses to
contract with a regulatory service
provider shall ensure that such provider
has the capabilities and resources
necessary to provide timely and
effective regulatory services, including
adequate staff and automated
surveillance systems. A swap execution
facility shall at all times remain
responsible for the performance of any
regulatory services received, for
compliance with the swap execution
facility’s obligations under the Act and
Commission regulations, and for the
regulatory service provider’s
performance on its behalf.
(b) Duty to supervise regulatory
service provider. A swap execution
facility that elects to use the service of
a regulatory service provider shall retain
sufficient compliance staff and
resources to supervise the quality and
effectiveness of the regulatory services
provided on its behalf. A swap
execution facility shall determine the
necessary processes for a swap
execution facility to supervise such
provider. Such processes shall include,
at a minimum, the swap execution
facility’s involvement in all substantive
decisions, such as decisions involving:
(1) The adjustment or cancellation of
trades;
(2) Whether or not to issue
disciplinary charges; and
(3) Denials of access to the swap
execution facility for disciplinary
reasons. Such decisions shall be
documented as agreed upon by the swap
execution facility and its regulatory
service provider.
(c) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, to the Director of the
Division of Market Oversight or such
other employee or employees as the
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Director may designate from time to
time, the authority to approve any
regulatory service provider chosen by a
swap execution facility for the provision
of regulatory services. The Director may
submit to the Commission for its
consideration any matter that has been
delegated in this paragraph. Nothing in
this paragraph prohibits the
Commission, at its election, from
exercising the authority delegated in
this paragraph.
§ 37.205
Audit trail.
(a) Audit trail required. A swap
execution facility shall capture and
retain all audit trail data necessary to
reconstruct all trading on its facility,
detect and investigate customer and
market abuses, and take appropriate
disciplinary action. An acceptable audit
trail shall also permit the swap
execution facility to track a customer
order from the time of receipt through
execution on the swap execution
facility.
(b) Elements of an acceptable audit
trail program—(1) Original source
documents. A swap execution facility’s
audit trail shall include original source
documents. Original source documents
include unalterable, sequentiallyidentified records on which trade
execution information is originally
recorded, whether recorded manually or
electronically.
(2) Transaction history database. A
swap execution facility’s audit trail
program shall include an electronic
transaction history database. An
adequate transaction history database
includes a history of any trade executed
by voice or by entry into a swap
execution facility’s electronic trading
system or platform and any order
entered into its electronic trading
system or platform, including any order
modification and cancellation.
(3) Electronic analysis capability. A
swap execution facility’s audit trail
program shall include electronic
analysis capability with respect to all
audit trail data in the transaction history
database. Such electronic analysis
capability shall ensure that the swap
execution facility has the ability to
reconstruct any trade executed by voice
or by entry into a swap execution
facility’s electronic trading system or
platform and any order entered into its
electronic trading system or platform,
and identify possible trading violations
with respect to both customer and
market abuse.
(c) Audit trail reconstruction. A swap
execution facility shall establish a
program to verify its ability to
comprehensively and accurately
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reconstruct all trading on its facility in
a timely manner.
§ 37.206 Disciplinary procedures and
sanctions.
(a) Enforcement staff. A swap
execution facility shall establish and
maintain sufficient enforcement staff
and resources to effectively and
promptly enforce possible rule
violations within the disciplinary
jurisdiction of the swap execution
facility.
(b) Disciplinary program. A swap
execution facility shall establish a
disciplinary program to enforce its
rules. A swap execution facility shall
administer its disciplinary program
through one or more disciplinary panels
or its compliance staff. Notwithstanding
the requirements of § 37.2, if a swap
execution facility elects to administer its
disciplinary program through its
compliance staff, the requirements of
§ 1.64(c)(4) of this chapter shall not
apply to such compliance staff. Any
disciplinary panel or appellate panel
established by a swap execution facility
shall meet the composition
requirements of applicable Commission
regulations, and shall not include any
member of the swap execution facility’s
compliance staff or any person involved
in adjudicating any other stage of the
same proceeding.
(c) Warning letters and sanctions. (1)
All warning letters and sanctions
imposed by a swap execution facility or
its disciplinary panels shall be
commensurate with the violations
committed and shall be clearly
sufficient to deter recidivism or similar
violations by other market participants.
All such warning letters and sanctions
(including summary fines and sanctions
imposed pursuant to an accepted
settlement offer) shall take into account
the respondent’s disciplinary history. In
the event of demonstrated customer
harm, any sanction shall also include
full customer restitution, except where
the amount of restitution or to whom it
should be provided cannot be
reasonably determined.
(2) A swap execution facility’s
compliance staff or disciplinary panel
may not issue more than one warning
letter to the same individual found to
have committed the same rule violation
within a rolling twelve-month period,
except for rule violations related to
minor recordkeeping or reporting
infractions.
(d) Additional sources for
compliance. A swap execution facility
may refer to the guidance and/or
acceptable practices in appendix B of
this part to demonstrate to the
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Commission compliance with the
requirements of § 37.206.
Subpart D—Swaps Not Readily
Susceptible to Manipulation
§ 37.300 Core Principle 3—Swaps not
readily susceptible to manipulation.
The swap execution facility shall
permit trading only in swaps that are
not readily susceptible to manipulation.
§ 37.301
General requirements.
To demonstrate to the Commission
compliance with the requirements of
§ 37.300, a swap execution facility shall,
at the time it submits a new swap
contract in advance to the Commission
pursuant to part 40 of this chapter,
provide the applicable information as
set forth in appendix C to this part,
Demonstration of Compliance that a
Swap Contract is Not Readily
Susceptible to Manipulation.
Subpart E—Monitoring of Trading and
Trade Processing
§ 37.400 Core Principle 4—Monitoring of
trading and trade processing.
The swap execution facility shall:
(a) Establish and enforce rules or
terms and conditions defining, or
specifications detailing:
(1) Trading procedures to be used in
entering and executing orders traded on
or through the facilities of the swap
execution facility; and
(2) Procedures for trade processing of
swaps on or through the facilities of the
swap execution facility; and
(b) Monitor trading in swaps to
prevent manipulation, price distortion,
and disruptions of the delivery or cash
settlement process through surveillance,
compliance, and disciplinary practices
and procedures, including methods for
conducting real-time monitoring of
trading and comprehensive and accurate
trade reconstructions.
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§ 37.401
General requirements.
A swap execution facility shall:
(a) Conduct real-time market
monitoring of all trading activity on the
swap execution facility to identify
disorderly trading, any market or system
anomalies, and instances or threats of
manipulation, price distortion, and
disruption;
(b) Collect and evaluate data on its
market participants’ trading activity
away from its facility, including trading
in the index or instrument used as a
reference price, the underlying
commodity for its listed swaps, or in
related derivatives markets, as necessary
to detect and prevent manipulation,
price distortion, and, where possible,
disruptions of the physical-delivery or
cash-settlement processes;
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(c) Monitor and evaluate general
market data as necessary to detect and
prevent manipulative activity that
would result in the failure of the market
price to reflect the normal forces of
supply and demand; and
(d) Have the ability to
comprehensively and accurately
reconstruct all trading activity on its
facility for the purpose of detecting
instances or threats of manipulation,
price distortion, and disruptions.
§ 37.402 Additional requirements for
physical-delivery swaps.
listed swaps is being used to affect
prices on its market.
(b) A swap execution facility shall
have rules that require its market
participants to keep records of their
trading, including records of their
activity in the index or instrument used
as a reference price, the underlying
commodity, and related derivatives
markets, and make such records
available, upon request, to the swap
execution facility or, if applicable, to its
regulatory service provider, and the
Commission.
For a physical-delivery swap listed on
the swap execution facility, the swap
execution facility shall:
(a) Monitor the swap’s terms and
conditions as it relates to the underlying
commodity market by reviewing the
convergence between the swap’s price
and the price of the underlying
commodity and make a good-faith effort
to resolve conditions that are interfering
with convergence or notify the
Commission of such conditions; and
(b) Monitor the availability of the
supply of the commodity specified by
the delivery requirements of the swap
and make a good-faith effort to resolve
conditions that threaten the adequacy of
supplies or the delivery process or
notify the Commission of such
conditions.
§ 37.405
§ 37.403 Additional requirements for cashsettled swaps.
A swap execution facility may refer to
the guidance and/or acceptable
practices in appendix B of this part to
demonstrate to the Commission
compliance with the requirements of
§ 37.400.
(a) For cash-settled swaps listed on
the swap execution facility where the
reference price is formulated and
computed by the swap execution
facility, the swap execution facility shall
monitor the continued appropriateness
of its methodology for deriving that
price and take appropriate action,
including amending the methodology,
where there is a threat of manipulation,
price distortion, or market disruption.
(b) For cash-settled swaps listed on
the swap execution facility where the
reference price relies on a third-party
index or instrument, the swap execution
facility shall monitor the continued
appropriateness of the index or
instrument and take appropriate action,
including selecting an alternate index or
instrument for deriving the reference
price, where there is a threat of
manipulation, price distortion, or
market disruption.
§ 37.404
Ability to obtain information.
(a) A swap execution facility shall
maintain access to sufficient
information to assess whether trading in
swaps that it lists, in the index or
instrument used as a reference price, or
in the underlying commodity for its
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Risk controls for trading.
The swap execution facility shall
establish and maintain risk control
mechanisms to prevent and reduce the
potential risk of price distortions and
market disruptions on its facility,
including, but not limited to, market
restrictions that pause or halt trading
under market conditions prescribed by
the swap execution facility.
§ 37.406
Regulatory service provider.
A swap execution facility shall
comply with the regulations in this
subpart through a dedicated regulatory
department or by contracting with a
regulatory service provider pursuant to
§ 37.204.
§ 37.407 Additional sources for
compliance.
Subpart F—Ability To Obtain
Information
§ 37.500 Core Principle 5—Ability to obtain
information.
The swap execution facility shall:
(a) Establish and enforce rules that
will allow the facility to obtain any
necessary information to perform any of
the functions described in section 5h of
the Act;
(b) Provide the information to the
Commission on request; and
(c) Have the capacity to carry out such
international information-sharing
agreements as the Commission may
require.
§ 37.501
Establish and enforce rules.
A swap execution facility shall
establish and enforce rules that will
allow the swap execution facility to
have the ability and authority to obtain
sufficient information to allow it to fully
perform its operational, risk
management, governance, and
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for compliance with the limit set by the
Commission and the limit, if any, set by
the swap execution facility.
regulatory functions and any
requirements under this part.
§ 37.502 Provide information to the
Commission.
§ 37.601
A swap execution facility shall
provide information in its possession to
the Commission upon request, in a form
and manner that the Commission
approves.
§ 37.503
Information-sharing.
A swap execution facility shall share
information as required by the
Commission or as appropriate to fulfill
its self-regulatory and reporting
responsibilities. Appropriate
information-sharing agreements can be
established or the Commission can act
in conjunction with the swap execution
facility to carry out such information
sharing.
§ 37.504 Prohibited use of data collected
for regulatory purposes.
A swap execution facility shall not
use for business or marketing purposes,
nor permit such use of, any proprietary
data or personal information it collects
or receives, from or on behalf of any
person, for the purpose of fulfilling its
regulatory obligations; provided,
however, that a swap execution facility
may use or permit the use of such data
or information for business or marketing
purposes if the person from whom it
collects or receives such data or
information clearly consents to the use
of such data or information in such
manner. A swap execution facility shall
not condition access to its markets or
market services on a person’s consent to
the swap execution facility’s use of
proprietary data or personal information
for business or marketing purposes.
Subpart G—Position Limits or
Accountability
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§ 37.600 Core Principle 6—Position limits
or accountability.
(a) In general. To reduce the potential
threat of market manipulation or
congestion, especially during trading in
the delivery month, a swap execution
facility that is a trading facility shall
adopt for each of the contracts of the
facility, as is necessary and appropriate,
position limitations or position
accountability for speculators.
(b) Position limits. For any contract
that is subject to a position limitation
established by the Commission pursuant
to section 4a(a) of the Act, the swap
execution facility shall:
(1) Set its position limitation at a level
no higher than the Commission
limitation; and
(2) Monitor positions established on
or through the swap execution facility
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(3) By facilitating pre-execution
screening by each clearing futures
commission merchant in accordance
with the requirements of § 1.73 of this
chapter on an order-by-order basis.
Subpart H—Financial Integrity of
Transactions
§ 37.703 Monitoring for financial
soundness.
§ 37.700 Core Principle 7—Financial
integrity of transactions.
A swap execution facility shall
monitor its market participants to
ensure that they continue to qualify as
eligible contract participants as defined
in section 1a(18) of the Act.
The swap execution facility shall
establish and enforce rules and
procedures for ensuring the financial
integrity of swaps entered on or through
the facilities of the swap execution
facility, including the clearance and
settlement of the swaps pursuant to
section 2(h)(1) of the Act.
§ 37.701
Required clearing.
(a) Transactions executed on the swap
execution facility that are required to be
cleared under section 2(h)(1)(A) of the
Act or are voluntarily cleared by the
counterparties shall be cleared through
a Commission-registered derivatives
clearing organization, or a derivatives
clearing organization that the
Commission has determined is exempt
from registration.
(b) A swap execution facility shall
have an independent clearing agreement
with each Commission-registered
derivatives clearing organization, or
derivatives clearing organization that
the Commission has determined is
exempt from registration, to which the
swap execution facility submits a swap
for clearing.
§ 37.702
General financial integrity.
A swap execution facility shall
provide for the financial integrity of its
transactions:
(a) By establishing minimum financial
standards for its market participants,
which shall, at a minimum, require that
each market participant qualifies as an
eligible contract participant as defined
in section 1a(18) of the Act;
(b) For transactions routed through a
swap execution facility to a registered
derivatives clearing organization for
clearing:
(1) By coordinating with each
registered derivatives clearing
organization to which the swap
execution facility submits transactions
for clearing, in the development of rules
and procedures to facilitate prompt,
efficient, and accurate processing and
routing of transactions to registered
derivatives clearing organizations in
accordance with the requirements of
§ 39.12(b)(7)(i)(A) of this chapter;
(2) By requiring that each market
participant identify a clearing member
in advance for each counterparty on an
order-by-order basis; and
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Subpart I—Emergency Authority
§ 37.800 Core Principle 8—Emergency
authority.
The swap execution facility shall
adopt rules to provide for the exercise
of emergency authority, in consultation
or cooperation with the Commission, as
is necessary and appropriate, including
the authority to liquidate or transfer
open positions in any swap or to
suspend or curtail trading in a swap.
§ 37.801 Additional sources for
compliance.
A swap execution facility may refer to
the guidance and/or acceptable
practices in appendix B of this part to
demonstrate to the Commission
compliance with the requirements of
§ 37.800.
Subpart J—Timely Publication of
Trading Information
§ 37.900 Core Principle 9—Timely
publication of trading information.
(a) In general. The swap execution
facility shall make public timely
information on price, trading volume,
and other trading data on swaps to the
extent prescribed by the Commission.
(b) Capacity of swap execution
facility. The swap execution facility
shall be required to have the capacity to
electronically capture and transmit
trade information with respect to
transactions executed on the facility.
§ 37.901
General requirements.
With respect to swaps traded on or
through a swap execution facility, each
swap execution facility shall:
(a) Report specified swap data as
provided under parts 43 and 45 of this
chapter; and
(b) Meet the requirements of part 16
of this chapter.
Subpart K—Recordkeeping and
Reporting
§ 37.1000 Core Principle 10—
Recordkeeping and reporting.
(a) In general. A swap execution
facility shall:
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(1) Maintain records of all activities
relating to the business of the facility,
including a complete audit trail, in a
form and manner acceptable to the
Commission for a period of five years;
(2) Report to the Commission, in a
form and manner acceptable to the
Commission, such information as the
Commission determines to be necessary
or appropriate for the Commission to
perform the duties of the Commission
under the Act; and
(3) Keep any such records relating to
swaps defined in section 1a(47)(A)(v) of
the Act open to inspection and
examination by the Securities and
Exchange Commission.
(b) Requirements. The Commission
shall adopt data collection and reporting
requirements for swap execution
facilities that are comparable to
corresponding requirements for
derivatives clearing organizations and
swap data repositories.
§ 37.1001
Subpart L—Antitrust Considerations
§ 37.1100 Core Principle 11—Antitrust
considerations.
Unless necessary or appropriate to
achieve the purposes of the Act, the
swap execution facility shall not:
(a) Adopt any rules or take any
actions that result in any unreasonable
restraint of trade; or
(b) Impose any material
anticompetitive burden on trading or
clearing.
A swap execution facility may refer to
the guidance and/or acceptable
practices in appendix B of this part to
demonstrate to the Commission
compliance with the requirements of
§ 37.1100.
Subpart M—Conflicts of Interest
[Reserved]
Subpart N—Financial Resources
§ 37.1300 Core Principle 13—Financial
resources.
(a) In general. The swap execution
facility shall have adequate financial,
operational, and managerial resources to
discharge each responsibility of the
swap execution facility.
(b) Determination of resource
adequacy. The financial resources of a
swap execution facility shall be
considered to be adequate if the value
of the financial resources exceeds the
total amount that would enable the
swap execution facility to cover the
operating costs of the swap execution
facility for a one-year period, as
calculated on a rolling basis.
General requirements.
(a) A swap execution facility shall
maintain financial resources on an
ongoing basis that are adequate to
enable it to comply with the core
principles set forth in section 5h of the
Act and any applicable Commission
regulations. Financial resources shall be
considered adequate if their value
exceeds the total amount that would
enable the swap execution facility to
cover its projected operating costs
necessary for the swap execution facility
to comply with section 5h of the Act
and applicable Commission regulations
for a one-year period, as calculated on
a rolling basis pursuant to § 37.1304.
(b) An entity that operates as both a
swap execution facility and a
derivatives clearing organization shall
also comply with the financial resource
requirements of § 39.11 of this chapter.
In lieu of filing separate reports under
§ 37.1306(a) and § 39.11(f) of this
chapter, such an entity may file a single
report in accordance with § 39.11 of this
chapter.
§ 37.1302
§ 37.1101 Additional sources for
compliance.
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§ 37.1201
§ 37.1301
Recordkeeping.
A swap execution facility shall
maintain records of all activities relating
to the business of the facility, in a form
and manner acceptable to the
Commission, for a period of at least five
years. A swap execution facility shall
maintain such records, including a
complete audit trail for all swaps
executed on the swap execution facility,
investigatory files, and disciplinary
files, in accordance with the
requirements of § 1.31 and part 45 of
this chapter.
§ 37.1200
interest.
(b) Establish a process for resolving
the conflicts of interest.
Types of financial resources.
Financial resources available to
satisfy the requirements of § 37.1301
may include:
(a) The swap execution facility’s own
capital, meaning its assets minus its
liabilities calculated in accordance with
generally accepted accounting
principles in the United States; and
(b) Any other financial resource
deemed acceptable by the Commission.
Core Principle 12—Conflicts of
§ 37.1303
The swap execution facility shall:
(a) Establish and enforce rules to
minimize conflicts of interest in its
decision-making process; and
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Liquidity of financial resources.
The financial resources allocated by
the swap execution facility to meet the
ongoing requirements of § 37.1301 shall
include unencumbered, liquid financial
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assets (i.e., cash and/or highly liquid
securities) equal to at least the greater of
three months of projected operating
costs, as calculated on a rolling basis, or
the projected costs needed to wind
down the swap execution facility’s
operations, in each case as determined
under § 37.1304. If a swap execution
facility lacks sufficient unencumbered,
liquid financial assets to satisfy its
obligations under this section, the swap
execution facility may satisfy this
requirement by obtaining a committed
line of credit or similar facility in an
amount at least equal to such
deficiency.
§ 37.1304 Computation of costs to meet
financial resources requirement.
A swap execution facility shall each
fiscal quarter, make a reasonable
calculation of its projected operating
costs and wind-down costs in order to
determine its applicable obligations
under § 37.1301 and § 37.1303. The
swap execution facility shall have
reasonable discretion in determining the
methodologies used to compute such
amounts. The Commission may review
the methodologies and require changes
as appropriate.
§ 37.1305
Valuation of financial resources.
No less than each fiscal quarter, a
swap execution facility shall compute
the current market value of each
financial resource used to meet its
obligations under § 37.1301 and
§ 37.1303. Reductions in value to reflect
market and credit risk (‘‘haircuts’’) shall
be applied as appropriate.
§ 37.1306
Reporting to the Commission.
(a) Each fiscal quarter, or at any time
upon Commission request, a swap
execution facility shall provide a report
to the Commission that includes:
(1) The amount of financial resources
necessary to meet the requirements of
§ 37.1301 and § 37.1303, computed in
accordance with the requirements of
§ 37.1304, and the market value of each
available financial resource, computed
in accordance with the requirements of
§ 37.1305; and
(2) Financial statements, including
the balance sheet, income statement,
and statement of cash flows of the swap
execution facility.
(i) The financial statements shall be
prepared in accordance with generally
accepted accounting principles in the
United States, prepared in English, and
denominated in U.S. dollars.
(ii) The financial statements of a swap
execution facility that is not domiciled
in the United States, and is not
otherwise required to prepare financial
statements in accordance with generally
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accepted accounting principles in the
United States, may satisfy the
requirement in paragraph (a)(2)(i) of this
section if such financial statements are
prepared in accordance with either
International Financial Reporting
Standards issued by the International
Accounting Standards Board, or a
comparable international standard as
the Commission may otherwise accept
in its discretion.
(b) The calculations required by
paragraph (a) of this section shall be
made as of the last business day of the
swap execution facility’s applicable
fiscal quarter.
(c) With each report required under
paragraph (a) of this section, the swap
execution facility shall also provide the
Commission with sufficient
documentation explaining the
methodology used to compute its
financial requirements under § 37.1301
and § 37.1303. Such documentation
shall:
(1) Allow the Commission to reliably
determine, without additional requests
for information, that the swap execution
facility has made reasonable
calculations pursuant to § 37.1304; and
(2) Include, at a minimum:
(i) A total list of all expenses, without
any exclusion;
(ii) All expenses and the
corresponding amounts, if any, that the
swap execution facility excluded or prorated when determining its operating
costs, calculated on a rolling basis,
required under § 37.1301 and § 37.1303,
and the basis for any determination to
exclude or pro-rate any such expenses;
(iii) Documentation demonstrating the
existence of any committed line of
credit or similar facility relied upon for
the purpose of meeting the requirements
of § 37.1303 (e.g., copies of agreements
establishing or amending a credit
facility or similar facility); and
(iv) All costs that a swap execution
facility would incur to wind down the
swap execution facility’s operations, the
projected amount of time for any such
wind-down period, and the basis of its
determination for the estimation of its
costs and timing.
(d) The reports and supporting
documentation required by this section
shall be filed not later than 40 calendar
days after the end of the swap execution
facility’s first three fiscal quarters, and
not later than 90 calendar days after the
end of the swap execution facility’s
fourth fiscal quarter, or at such later
time as the Commission may permit, in
its discretion, upon request by the swap
execution facility.
(e) A swap execution facility shall
provide notice to the Commission no
later than 48 hours after it knows or
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reasonably should have known that it
no longer meets its obligations under
§ 37.1301 or § 37.1303.
§ 37.1307
Delegation of authority.
(a) The Commission hereby delegates,
until it orders otherwise, to the Director
of the Division of Market Oversight or
such other employee or employees as
the Director may designate from time to
time, authority to:
(1) Determine whether a particular
financial resource under § 37.1302 may
be used to satisfy the requirements of
§ 37.1301;
(2) Review and make changes to the
methodology used to compute projected
operating costs and wind-down costs
under § 37.1304 and the valuation of
financial resources under § 37.1305;
(3) Request reports, in addition to
those required in § 37.1306, or
additional documentation or
information under § 37.1306(a), (c), and
(e); and
(4) Grant an extension of time to file
fiscal quarter reports under § 37.1306(d).
(b) The Director may submit to the
Commission for its consideration any
matter that has been delegated in this
section. Nothing in this section
prohibits the Commission, at its
election, from exercising the authority
delegated in this section.
Subpart O—System Safeguards
§ 37.1400 Core Principle 14—System
safeguards.
The swap execution facility shall:
(a) Establish and maintain a program
of risk analysis and oversight to identify
and minimize sources of operational
risk, through the development of
appropriate controls and procedures,
and automated systems, that:
(1) Are reliable and secure; and
(2) Have adequate scalable capacity;
(b) Establish and maintain emergency
procedures, backup facilities, and a plan
for disaster recovery that allow for:
(1) The timely recovery and
resumption of operations; and
(2) The fulfillment of the
responsibilities and obligations of the
swap execution facility; and
(c) Periodically conduct tests to verify
that the backup resources of the swap
execution facility are sufficient to
ensure continued:
(1) Order processing and trade
matching;
(2) Price reporting;
(3) Market surveillance; and
(4) Maintenance of a comprehensive
and accurate audit trail.
§ 37.1401
Requirements.
(a) A swap execution facility’s
program of risk analysis and oversight
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with respect to its operations and
automated systems shall address each of
the following categories of risk analysis
and oversight:
(1) Enterprise risk management and
governance. This category includes, but
is not limited to: Assessment,
mitigation, and monitoring of security
and technology risk; security and
technology capital planning and
investment; board of directors and
management oversight of technology
and security; information technology
audit and controls assessments;
remediation of deficiencies; and any
other elements of enterprise risk
management and governance included
in generally accepted best practices;
(2) Information security. This category
includes, but is not limited to, controls
relating to: Access to systems and data
(including least privilege, separation of
duties, account monitoring and control);
user and device identification and
authentication; security awareness
training; audit log maintenance,
monitoring, and analysis; media
protection; personnel security and
screening; automated system and
communications protection (including
network port control, boundary
defenses, encryption); system and
information integrity (including
malware defenses, software integrity
monitoring); vulnerability management;
penetration testing; security incident
response and management; and any
other elements of information security
included in generally accepted best
practices;
(3) Business continuity-disaster
recovery planning and resources. This
category includes, but is not limited to:
Regular, periodic testing and review of
business continuity-disaster recovery
capabilities, the controls and
capabilities described in paragraphs (c),
(d), and (k) of this section; and any other
elements of business continuity-disaster
recovery planning and resources
included in generally accepted best
practices;
(4) Capacity and performance
planning. This category includes, but is
not limited to: Controls for monitoring
the swap execution facility’s systems to
ensure adequate scalable capacity
(including testing, monitoring, and
analysis of current and projected future
capacity and performance, and of
possible capacity degradation due to
planned automated system changes);
and any other elements of capacity and
performance planning included in
generally accepted best practices;
(5) Systems operations. This category
includes, but is not limited to: System
maintenance; configuration
management (including baseline
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configuration, configuration change and
patch management, least functionality,
inventory of authorized and
unauthorized devices and software);
event and problem response and
management; and any other elements of
system operations included in generally
accepted best practices;
(6) Systems development and quality
assurance. This category includes, but is
not limited to: Requirements
development; pre-production and
regression testing; change management
procedures and approvals; outsourcing
and vendor management; training in
secure coding practices; and any other
elements of systems development and
quality assurance included in generally
accepted best practices; and
(7) Physical security and
environmental controls. This category
includes, but is not limited to: Physical
access and monitoring; power,
telecommunication, and environmental
controls; fire protection; and any other
elements of physical security and
environmental controls included in
generally accepted best practices.
(b) In addressing the categories of risk
analysis and oversight required under
paragraph (a) of this section, a swap
execution facility shall follow generally
accepted standards and best practices
with respect to the development,
operation, reliability, security, and
capacity of automated systems.
(c) A swap execution facility shall
maintain a business continuity-disaster
recovery plan and business continuitydisaster recovery resources, emergency
procedures, and backup facilities
sufficient to enable timely recovery and
resumption of its operations and
resumption of its ongoing fulfillment of
its responsibilities and obligations as a
swap execution facility following any
disruption of its operations. Such
responsibilities and obligations include,
without limitation: Order processing
and trade matching; transmission of
matched orders to a derivatives clearing
organization for clearing, where
appropriate; price reporting; market
surveillance; and maintenance of a
comprehensive audit trail protected
from alteration, accidental erasure, or
other loss. A swap execution facility’s
business continuity-disaster recovery
plan and resources generally should
enable resumption of trading and
clearing of swaps executed on the swap
execution facility during the next
business day following the disruption.
A swap execution facility shall update
its business continuity-disaster recovery
plan and emergency procedures at a
frequency determined by an appropriate
risk analysis, but at a minimum no less
frequently than annually.
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(d) A swap execution facility satisfies
the requirement to be able to resume its
operations and resume its ongoing
fulfillment of its responsibilities and
obligations during the next business day
following any disruption of its
operations by maintaining either:
(1) Infrastructure and personnel
resources of its own that are sufficient
to ensure timely recovery and
resumption of its operations and
resumption of its ongoing fulfillment of
its responsibilities and obligations as a
swap execution facility following any
disruption of its operations; or
(2) Contractual arrangements with
other swap execution facilities or
disaster recovery service providers, as
appropriate, that are sufficient to ensure
continued trading and clearing of swaps
executed on the swap execution facility,
and ongoing fulfillment of all of the
swap execution facility’s
responsibilities and obligations with
respect to such swaps, in the event that
a disruption renders the swap execution
facility temporarily or permanently
unable to satisfy this requirement on its
own behalf.
(e) A swap execution facility shall
notify Commission staff promptly of all:
(1) Electronic trading halts and
material system malfunctions;
(2) Cyber security incidents or
targeted threats that actually or
potentially jeopardize automated system
operation, reliability, security, or
capacity; and
(3) Activations of the swap execution
facility’s business continuity-disaster
recovery plan.
(f) A swap execution facility shall
provide Commission staff timely
advance notice of all material:
(1) Planned changes to automated
systems that may impact the reliability,
security, or adequate scalable capacity
of such systems; and
(2) Planned changes to the swap
execution facility’s program of risk
analysis and oversight.
(g) A swap execution facility shall
annually prepare and submit to the
Commission an up-to-date Exhibit Q to
Form SEF—Program of Risk Analysis
and Oversight Technology
Questionnaire—in appendix A to this
part. The annual filing shall be
submitted electronically to the
Commission not later than 90 calendar
days after the end of the swap execution
facility’s fiscal year. The swap execution
facility shall file Exhibit Q with the
annual financial report and the annual
compliance report pursuant to
§ 37.1306(d) and § 37.1501(e)(2),
respectively.
(h) As part of a swap execution
facility’s obligation to produce books
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and records in accordance with § 1.31 of
this chapter, Core Principle 10
(Recordkeeping and Reporting), and
§ 37.1000 and § 37.1001, a swap
execution facility shall provide to the
Commission the following system
safeguards-related books and records,
promptly upon the request of any
Commission representative:
(1) Current copies of its business
continuity-disaster recovery plans and
other emergency procedures;
(2) All assessments of its operational
risks or system safeguards-related
controls;
(3) All reports concerning system
safeguards testing and assessment
required by this chapter, whether
performed by independent contractors
or by employees of the swap execution
facility; and
(4) All other books and records
requested by Commission staff in
connection with Commission oversight
of system safeguards pursuant to the Act
or Commission regulations, or in
connection with Commission
maintenance of a current profile of the
swap execution facility’s automated
systems.
(5) Nothing in this paragraph (h) shall
be interpreted as reducing or limiting in
any way a swap execution facility’s
obligation to comply with § 1.31 of this
chapter, Core Principle 10
(Recordkeeping and Reporting), or
§ 37.1000 or § 37.1001.
(i) A swap execution facility shall
conduct regular, periodic, objective
testing and review of its automated
systems to ensure that they are reliable,
secure, and have adequate scalable
capacity. It shall also conduct regular,
periodic testing and review of its
business continuity-disaster recovery
capabilities. Such testing and review
shall include, without limitation, all of
the types of testing set forth in this
paragraph (i).
(1) Definitions. As used in paragraph
(i):
Controls means the safeguards or
countermeasures employed by the swap
execution facility in order to protect the
reliability, security, or capacity of its
automated systems or the
confidentiality, integrity, and
availability of its data and information,
and in order to enable the swap
execution facility to fulfill its statutory
and regulatory responsibilities.
Controls testing means assessment of
the swap execution facility’s controls to
determine whether such controls are
implemented correctly, are operating as
intended, and are enabling the swap
execution facility to meet the
requirements established by this
section.
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Enterprise technology risk assessment
means a written assessment that
includes, but is not limited to, an
analysis of threats and vulnerabilities in
the context of mitigating controls. An
enterprise technology risk assessment
identifies, estimates, and prioritizes
risks to swap execution facility
operations or assets, or to market
participants, individuals, or other
entities, resulting from impairment of
the confidentiality, integrity, and
availability of data and information or
the reliability, security, or capacity of
automated systems.
External penetration testing means
attempts to penetrate the swap
execution facility’s automated systems
from outside the systems’ boundaries to
identify and exploit vulnerabilities.
Methods of conducting external
penetration testing include, but are not
limited to, methods for circumventing
the security features of an automated
system.
Internal penetration testing means
attempts to penetrate the swap
execution facility’s automated systems
from inside the systems’ boundaries, to
identify and exploit vulnerabilities.
Methods of conducting internal
penetration testing include, but are not
limited to, methods for circumventing
the security features of an automated
system.
Key controls means those controls that
an appropriate risk analysis determines
are either critically important for
effective system safeguards or intended
to address risks that evolve or change
more frequently and therefore require
more frequent review to ensure their
continuing effectiveness in addressing
such risks.
Security incident means a cyber
security or physical security event that
actually jeopardizes or has a significant
likelihood of jeopardizing automated
system operation, reliability, security, or
capacity, or the availability,
confidentiality or integrity of data.
Security incident response plan
means a written plan documenting the
swap execution facility’s policies,
controls, procedures, and resources for
identifying, responding to, mitigating,
and recovering from security incidents,
and the roles and responsibilities of its
management, staff and independent
contractors in responding to security
incidents. A security incident response
plan may be a separate document or a
business continuity-disaster recovery
plan section or appendix dedicated to
security incident response.
Security incident response plan
testing means testing of a swap
execution facility’s security incident
response plan to determine the plan’s
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effectiveness, identify its potential
weaknesses or deficiencies, enable
regular plan updating and improvement,
and maintain organizational
preparedness and resiliency with
respect to security incidents. Methods of
conducting security incident response
plan testing may include, but are not
limited to, checklist completion, walkthrough or table-top exercises,
simulations, and comprehensive
exercises.
Vulnerability testing means testing of
a swap execution facility’s automated
systems to determine what information
may be discoverable through a
reconnaissance analysis of those
systems and what vulnerabilities may be
present on those systems.
(2) Vulnerability testing. A swap
execution facility shall conduct
vulnerability testing of a scope
sufficient to satisfy the requirements set
forth in paragraph (k) of this section.
(i) A swap execution facility shall
conduct such vulnerability testing at a
frequency determined by an appropriate
risk analysis.
(ii) Such vulnerability testing shall
include automated vulnerability
scanning, which shall follow generally
accepted best practices.
(iii) A swap execution facility shall
conduct vulnerability testing by
engaging independent contractors or by
using employees of the swap execution
facility who are not responsible for
development or operation of the systems
or capabilities being tested.
(3) External penetration testing. A
swap execution facility shall conduct
external penetration testing of a scope
sufficient to satisfy the requirements set
forth in paragraph (k) of this section.
(i) A swap execution facility shall
conduct such external penetration
testing at a frequency determined by an
appropriate risk analysis.
(ii) A swap execution facility shall
conduct external penetration testing by
engaging independent contractors or by
using employees of the swap execution
facility who are not responsible for
development or operation of the systems
or capabilities being tested.
(4) Internal penetration testing. A
swap execution facility shall conduct
internal penetration testing of a scope
sufficient to satisfy the requirements set
forth in paragraph (k) of this section.
(i) A swap execution facility shall
conduct such internal penetration
testing at a frequency determined by an
appropriate risk analysis.
(ii) A swap execution facility shall
conduct internal penetration testing by
engaging independent contractors or by
using employees of the swap execution
facility who are not responsible for
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62105
development or operation of the systems
or capabilities being tested.
(5) Controls testing. A swap execution
facility shall conduct controls testing of
a scope sufficient to satisfy the
requirements set forth in paragraph (k)
of this section.
(i) A swap execution facility shall
conduct controls testing, which
includes testing of each control
included in its program of risk analysis
and oversight, at a frequency
determined by an appropriate risk
analysis. Such testing may be conducted
on a rolling basis.
(ii) A swap execution facility shall
conduct controls testing by engaging
independent contractors or by using
employees of the swap execution
facility who are not responsible for
development or operation of the systems
or capabilities being tested.
(6) Security incident response plan
testing. A swap execution facility shall
conduct security incident response plan
testing sufficient to satisfy the
requirements set forth in paragraph (k)
of this section.
(i) A swap execution facility shall
conduct such security incident response
plan testing at a frequency determined
by an appropriate risk analysis.
(ii) A swap execution facility’s
security incident response plan shall
include, without limitation, the swap
execution facility’s definition and
classification of security incidents, its
policies and procedures for reporting
security incidents and for internal and
external communication and
information sharing regarding security
incidents, and the hand-off and
escalation points in its security incident
response process.
(iii) A swap execution facility may
coordinate its security incident response
plan testing with other testing required
by this section or with testing of its
other business continuity-disaster
recovery and crisis management plans.
(iv) A swap execution facility may
conduct security incident response plan
testing by engaging independent
contractors or by using employees of the
swap execution facility.
(7) Enterprise technology risk
assessment. A swap execution facility
shall conduct enterprise technology risk
assessment of a scope sufficient to
satisfy the requirements set forth in
paragraph (k) of this section.
(i) A swap execution facility shall
conduct enterprise technology risk
assessment at a frequency determined
by an appropriate risk analysis. A swap
execution facility that has conducted an
enterprise technology risk assessment
that complies with this section may
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conduct subsequent assessments by
updating the previous assessment.
(ii) A swap execution facility may
conduct enterprise technology risk
assessments by using independent
contractors or employees of the swap
execution facility who are not
responsible for development or
operation of the systems or capabilities
being assessed.
(j) To the extent practicable, a swap
execution facility shall:
(1) Coordinate its business continuitydisaster recovery plan with those of the
market participants it depends upon to
provide liquidity, in a manner adequate
to enable effective resumption of
activity in its markets following a
disruption causing activation of the
swap execution facility’s business
continuity-disaster recovery plan;
(2) Initiate and coordinate periodic,
synchronized testing of its business
continuity-disaster recovery plan with
those of the market participants it
depends upon to provide liquidity; and
(3) Ensure that its business
continuity-disaster recovery plan takes
into account the business continuitydisaster recovery plans of its
telecommunications, power, water, and
other essential service providers.
(k) Scope of testing and assessment.
The scope for all system safeguards
testing and assessment required by this
part shall be broad enough to include
the testing of automated systems and
controls that the swap execution
facility’s required program of risk
analysis and oversight and its current
cybersecurity threat analysis indicate is
necessary to identify risks and
vulnerabilities that could enable an
intruder or unauthorized user or insider
to:
(1) Interfere with the swap execution
facility’s operations or with fulfillment
of its statutory and regulatory
responsibilities;
(2) Impair or degrade the reliability,
security, or adequate scalable capacity
of the swap execution facility’s
automated systems;
(3) Add to, delete, modify, exfiltrate,
or compromise the integrity of any data
related to the swap execution facility’s
regulated activities; or
(4) Undertake any other unauthorized
action affecting the swap execution
facility’s regulated activities or the
hardware or software used in
connection with those activities.
(l) Internal reporting and review. Both
the senior management and the Board of
Directors of a swap execution facility
shall receive and review reports setting
forth the results of the testing and
assessment required by this section. A
swap execution facility shall establish
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and follow appropriate procedures for
the remediation of issues identified
through such review, as provided in
paragraph (m) of this section, and for
evaluation of the effectiveness of testing
and assessment protocols.
(m) Remediation. A swap execution
facility shall identify and document the
vulnerabilities and deficiencies in its
systems revealed by the testing and
assessment required by this section. The
swap execution facility shall conduct
and document an appropriate analysis
of the risks presented by such
vulnerabilities and deficiencies, to
determine and document whether to
remediate or accept the associated risk.
When the swap execution facility
determines to remediate a vulnerability
or deficiency, it must remediate in a
timely manner given the nature and
magnitude of the associated risk.
Subpart P—Designation of Chief
Compliance Officer
§ 37.1500 Core Principle 15—Designation
of chief compliance officer.
(a) In general. Each swap execution
facility shall designate an individual to
serve as a chief compliance officer.
(b) Duties. The chief compliance
officer shall:
(1) Report directly to the board or to
the senior officer of the facility;
(2) Review compliance with the core
principles in this subsection;
(3) In consultation with the board of
the facility, a body performing a
function similar to that of a board, or the
senior officer of the facility, resolve any
conflicts of interest that may arise;
(4) Be responsible for establishing and
administering the policies and
procedures required to be established
pursuant to this section;
(5) Ensure compliance with the Act
and the rules and regulations issued
under the Act, including rules
prescribed by the Commission pursuant
to section 5h of the Act; and
(6) Establish procedures for the
remediation of noncompliance issues
found during compliance office reviews,
look backs, internal or external audit
findings, self-reported errors, or through
validated complaints.
(c) Requirements for procedures. In
establishing procedures under
paragraph (b)(6) of this section, the chief
compliance officer shall design the
procedures to establish the handling,
management response, remediation,
retesting, and closing of noncompliance
issues.
(d) Annual reports—(1) In general. In
accordance with rules prescribed by the
Commission, the chief compliance
officer shall annually prepare and sign
a report that contains a description of:
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(i) The compliance of the swap
execution facility with the Act; and
(ii) The policies and procedures,
including the code of ethics and conflict
of interest policies, of the swap
execution facility.
(2) Requirements. The chief
compliance officer shall:
(i) Submit each report described in
paragraph (d)(1) of this section with the
appropriate financial report of the swap
execution facility that is required to be
submitted to the Commission pursuant
to section 5h of the Act; and
(ii) Include in the report a
certification that, under penalty of law,
the report is accurate and complete.
§ 37.1501
Chief compliance officer.
(a) Definitions. For purposes of this
part, the term—
Board of directors means the board of
directors of a swap execution facility, or
for those swap execution facilities
whose organizational structure does not
include a board of directors, a body
performing a function similar to a board
of directors.
Senior officer means the chief
executive officer or other equivalent
officer of the swap execution facility.
(b) Chief compliance officer—(1)
Authority of chief compliance officer. (i)
The position of chief compliance officer
shall carry with it the authority and
resources to develop, in consultation
with the board of directors or senior
officer, the policies and procedures of
the swap execution facility and enforce
such policies and procedures to fulfill
the duties set forth for chief compliance
officers in the Act and Commission
regulations.
(ii) The chief compliance officer shall
have supervisory authority over all staff
acting at the direction of the chief
compliance officer.
(2) Qualifications of chief compliance
officer. (i) The individual designated to
serve as chief compliance officer shall
have the background and skills
appropriate for fulfilling the
responsibilities of the position.
(ii) No individual disqualified from
registration pursuant to sections 8a(2) or
8a(3) of the Act may serve as a chief
compliance officer.
(3) Appointment and removal of chief
compliance officer. (i) Only the board of
directors or the senior officer may
appoint or remove the chief compliance
officer.
(ii) The swap execution facility shall
notify the Commission within two
business days of the appointment or
removal, whether interim or permanent,
of a chief compliance officer.
(4) Compensation of the chief
compliance officer. The board of
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directors or the senior officer shall
approve the compensation of the chief
compliance officer.
(5) Annual meeting with the chief
compliance officer. The chief
compliance officer shall meet with the
board of directors or senior officer of the
swap execution facility at least
annually.
(6) Information requested of the chief
compliance officer. The chief
compliance officer shall provide any
information regarding the self-regulatory
program of the swap execution facility
as requested by the board of directors or
the senior officer.
(c) Duties of chief compliance officer.
The duties of the chief compliance
officer shall include, but are not limited
to, the following:
(1) Overseeing and reviewing
compliance of the swap execution
facility with section 5h of the Act and
any related rules adopted by the
Commission;
(2) Taking reasonable steps, in
consultation with the board of directors
or the senior officer of the swap
execution facility, to resolve any
material conflicts of interest that may
arise;
(3) Establishing and administering
written policies and procedures
reasonably designed to prevent
violations of the Act and the rules of the
Commission;
(4) Taking reasonable steps to ensure
compliance with the Act and the rules
of the Commission;
(5) Establishing procedures
reasonably designed to handle, respond,
remediate, retest, and resolve
noncompliance issues identified by the
chief compliance officer through any
means, including any compliance office
review, look-back, internal or external
audit finding, self-reported error, or
validated complaint;
(6) Establishing and administering a
compliance manual designed to
promote compliance with the applicable
laws, rules, and regulations and a
written code of ethics for the swap
execution facility designed to prevent
ethical violations and to promote
honesty and ethical conduct by
personnel of the swap execution facility;
(7) Supervising the self-regulatory
program of the swap execution facility
with respect to trade practice
surveillance; market surveillance; realtime market monitoring; compliance
with audit trail requirements;
enforcement and disciplinary
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proceedings; audits, examinations, and
other regulatory responsibilities
(including taking reasonable steps to
ensure compliance with, if applicable,
financial integrity, financial reporting,
sales practice, recordkeeping, and other
requirements); and
(8) Supervising the effectiveness and
sufficiency of any regulatory services
provided to the swap execution facility
by a regulatory service provider in
accordance with § 37.204.
(d) Preparation of annual compliance
report. The chief compliance officer
shall, not less than annually, prepare
and sign an annual compliance report
that covers the prior fiscal year. The
report shall, at a minimum, contain:
(1) A description and self-assessment
of the effectiveness of the written
policies and procedures of the swap
execution facility, including the code of
ethics and conflict of interest policies to
reasonably ensure compliance with the
Act and applicable Commission
regulations;
(2) Any material changes made to
compliance policies and procedures
during the coverage period for the report
and any areas of improvement or
recommended changes to the
compliance program;
(3) A description of the financial,
managerial, and operational resources
set aside for compliance with the Act
and applicable Commission regulations;
(4) Any material non-compliance
matters identified and an explanation of
the corresponding action taken to
resolve such non-compliance matters;
and
(5) A certification by the chief
compliance officer that, to the best of
his or her knowledge and reasonable
belief, and under penalty of law, the
annual compliance report is accurate
and complete in all material respects.
(e) Submission of annual compliance
report and related matters—(1)
Furnishing the annual compliance
report prior to submission to the
Commission. Prior to submission to the
Commission, the chief compliance
officer shall provide the annual
compliance report for review to the
board of directors of the swap execution
facility or, in the absence of a board of
directors, to the senior officer of the
swap execution facility. Members of the
board of directors and the senior officer
shall not require the chief compliance
officer to make any changes to the
report.
(2) Submission of annual compliance
report to the Commission. The annual
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62107
compliance report shall be submitted
electronically to the Commission not
later than 90 calendar days after the end
of the swap execution facility’s fiscal
year. The swap execution facility shall
concurrently file the annual compliance
report with the fourth quarter financial
report pursuant to § 37.1306.
(3) Amendments to annual
compliance report. (i) Promptly upon
discovery of any material error or
omission made in a previously filed
annual compliance report, the chief
compliance officer shall file an
amendment with the Commission to
correct the material error or omission.
The chief compliance officer shall
submit the amended annual compliance
report to the board of directors, or in the
absence of a board of directors, to the
senior officer of the swap execution
facility, pursuant to paragraph (e)(1) of
this section.
(ii) An amendment shall contain the
certification required under paragraph
(d)(5) of this section.
(4) Request for extension. A swap
execution facility may request an
extension of time to file its annual
compliance report from the
Commission. Reasonable and valid
requests for extensions of the filing
deadline may be granted at the
discretion of the Commission.
(f) Recordkeeping. The swap
execution facility shall maintain all
records demonstrating compliance with
the duties of the chief compliance
officer and the preparation and
submission of annual compliance
reports consistent with §§ 37.1000 and
37.1001.
(g) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, to the Director of the
Division of Market Oversight or such
other employee or employees as the
Director may designate from time to
time, the authority to grant or deny a
request for an extension of time for a
swap execution facility to file its annual
compliance report under paragraph
(e)(4) of this section. The Director may
submit to the Commission for its
consideration any matter that has been
delegated in this paragraph. Nothing in
this paragraph prohibits the
Commission, at its election, from
exercising the authority delegated in
this paragraph.
Appendix A to Part 37—Form SEF
BILLING CODE 6351–01–P
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COMMODITY FUTURES TRADING COMMISSION
FORMSEF
SWAP EXECUTION FACILITY
APPLICATION OR AMENDMENT TO APPLICATION FOR REGISTRATION
REGISTRATION INSTRUCTIONS
Intentional misstatements or omissions of material fact may constitute federal
criminal violations (7 U.S.C. 13 and 18 U.S.C. 1001) or grounds for disqualification
from registration.
DEFINITIONS
Unless the context requires otherwise, all terms used in this Form SEF have the same
meaning as in the Commodity Exchange Act, as amended ("Act"), and in the General
Rules and Regulations of the Commodity Futures Trading Commission ("Commission")
thereunder ( 17 CPR chapter I).
For the purposes of this Form SEF, the term "Applicant" shall include any applicant for
registration as a swap execution facility or any applicant amending a pending application.
GENERAL INSTRUCTIONS
1. This Form SEF, which includes instructions, a Cover Sheet, and required Exhibits
(together, "Form SEF"), is to be filed with the Commission by all Applicants,
pursuant to section 5h of the Act and the Commission's regulations thereunder.
Applicants may prepare their own Form SEF, but must follow the format prescribed
herein. Upon the tiling of an application for registration in accordance with the
instructions provided herein, the Commission will publish notice of the filing and
afford interested persons an opportunity to submit written comments concerning such
application. No application for registration shall be effective unless the Commission,
by order, grants such registration.
3. Signatures on all copies of the Form SEF filed with the Commission can be executed
electronically. If this Form SEF is filed by a corporation, it shall be signed in the
name of the corporation by a principal officer duly authorized; if filed by a limited
liability company, it shall be signed in the name of the limited liability company by a
manager or member duly authorized to sign on the limited liability company's behalf~
if tiled by a partnership, it shall be signed in the name of the partnership by a general
partner duly authorized; if filed by an unincorporated organization or association
which is not a partnership, it shall be signed in the name of such organization or
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2. Individuals' names, except the executing signature, shall be given in full (Last Name,
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association by the managing agent, i.e., a duly authorized person who directs or
manages or who participates in the directing or managing of its affairs.
4. If this Form SEF is being filed as an application for registration, all applicable items
must be answered in full. If any item is inapplicable, indicate by "none," "not
applicable," or "N/A," as appropriate.
5. Under section 5h of the Act and the Commission's regulations thereunder, the
Commission is authorized to solicit the information required to be supplied by this
Form SEF from any Applicant seeking registration as a swap execution facility.
Disclosure by the Applicant of the information specified in this Form SEF is
mandatory prior to the start of the processing of an application for registration as a
swap execution facility. The information provided in this Form SEF will be used for
the principal purpose of determining whether the Commission should grant or deny
registration to an Applicant. The Commission may determine that additional
information is required from an Applicant in order to process its application. A Form
SEF that is not prepared and executed in compliance with applicable
requirements and instructions may be returned as not acceptable for filing.
Acceptance of this Form SEF, however, shall not constitute a finding that the
Form SEF has been filed as required or that the information submitted is true,
current, or complete.
6. Except in cases where confidential treatment is requested by the Applicant and granted
by the Commission pursuant to the Freedom oflnformation Act and the rules of the
Commission thereunder, information supplied on this Form SEF will be included in
the public files of the Commission and will be available for inspection by any
interested person.
APPLICATION AMENDMENTS
1. An Applicant amending a pending application for registration as a swap execution
facility shall file an amended Form SEF electronically with the Secretary of the
Commission in the manner specified by the Commission.
2. When filing this Form SEF for purposes of amending a pending application, an
Applicant must re-file the entire Cover Sheet, amended if necessary, include an
executing signature, and attach thereto revised Exhibits or other materials marked to
show any amendments. The submission of an amendment to a pending application
represents that the remaining items and Exhibits that are not amended remain true,
current, and complete as previously filed.
This Form SEF must be filed electronically with the Secretary of the Commission in the
manner specified by the Commission.
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WHERE TO FILE
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Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
COMMODITY FUTURES TRADING COMMISSION
FORMSEF
SWAP EXECUTION FACILITY
APPLICATION OR AMENDMENT TO APPLICATION FOR REGISTRATION
COVER SHEET
Exact name of Applicant as specified in charter
Address of principal executive offices
D
D
If this is an APPLICATION for registration, complete in full and check here.
If this is an AMENDMENT to a pending application, complete in full, list all items
that are amended and check here.
GENERAL INFORMATION
1. Name under which the business of the swap execution facility is or will be conducted,
if different than name specified above (include acronyms, if any):
2. If name of swap execution facility is being amended, state previous swap execution
facility name:
3. Contact information, including mailing address if different than address specified
above:
Number and Street
City State Country Zip Code
Website URL E-mail Address
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Main Phone Number Fax
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62111
4. List of principal office(s) and address(es) where swap execution facility activities
are/will be conducted:
Office Address
5. If the Applicant is a successor to a previously registered swap execution facility, please
complete the following:
a. Date of succession
b. Full name and address of predecessor registrant
Name
Number and Street
City State Country Zip Code
Main Phone Number Website URL
BUSINESS ORGANIZATION
6. Applicant is a:
D
D
D
D
Corporation
Partnership
Limited Liability Company
Other form of organization (specify)
8. State of incorporation or jurisdiction of organization:
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7. Date of incorporation or formation:
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9. Date of fiscal year end of organization:
10. The Applicant agrees and consents that the notice of any proceeding before the
Commission in connection with this application may be given by sending such notice
by certified mail to the person named below at the address given.
Print Name and Title
Name of Applicant
Number and Street
City State Zip Code
SIGNATURES
11. The Applicant has duly caused this application or amendment to be signed on its
behalf by the undersigned, hereunto duly authorized, this
day of
_ _ _ _ _ _ _ _ _ _ _ _ _ _, 20 _ _ . The Applicant and the undersigned
represent hereby that all information contained herein is true, current, and complete.
It is understood that all required items and Exhibits are considered integral parts of
this Form SEF and that the submission of any amendment represents that all
unamended items and Exhibits remain true, current, and complete as previously filed.
Name of Applicant
Signature of Duly Authorized Person
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Print Name and Title of Signatory
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62113
COMMODITY FUTURES TRADING COMMISSION
FORMSEF
SWAP EXECUTION FACILITY
APPLICATION OR AMENDMENT TO APPLICATION FOR REGISTRATION
EXHIBIT INSTRUCTIONS
The following Exhibits must be filed with the Commission by each Applicant applying for
registration as a swap execution facility pursuant to section 5h of the Act and the Commission's
regulations thereunder. The Exhibits must be labeled according to the items specified in this
Form SEF.
The application must include a Table of Contents listing each Exhibit required by this Form SEF
and indicating which, if any, Exhibits are inapplicable. For any Exhibit that is inapplicable, next
to the Exhibit letter specify "none," "not applicable," or "N/A," as appropriate. The Table of
Contents must indicate whether each item submitted for each Exhibit required by this Form SEF
is subject to a request for confidential treatment.
If an Applicant seeks confidential treatment of any Exhibit or a portion of any Exhibit, the
Applicant must mark such Exhibit with a prominent stamp, typed legend, or other suitable form
of notice on each page or portion of each page stating "Confidential Treatment Requested by
[Applicant]." If marking each page is impracticable under the circumstances, a cover sheet
prominently marked "Confidential Treatment Requested by [Applicant]" should be provided for
each group of records submitted for which confidential treatment is requested. Each of the
records transmitted in this manner shall be individually marked with an identifying number and
code so that they are separately identifiable. An Applicant must also file a confidentiality
request in a form and manner specitl.ed with the Secretary of the Commission.
LIST OF EXHIBITS
EXHIBITS- BUSINESS ORGANIZATION
1. Attach as Exhibit A:
a. The name of any person who owns ten percent or more of the Applicant's stock or
who, either directly or indirectly, through agreement or otherwise, in any other
manner, may control or direct the management or policies of the Applicant.
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b. The full name and address of each such person and attach a copy of the agreement or,
if there is none written, describe the agreement or basis upon which such person
exercises or may exercise such control or direction.
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2. Attach as Exhibit B, a list ofthe present officers, directors, governors (and, in the case of an
Applicant that is not a corporation, the members of all standing committees, grouped by
committee), or persons performing functions similar to any of the foregoing, of the swap
execution facility or of any entity that performs the regulatory activities ofthe Applicant,
indicating for each:
a. Name
b. Title
c. Dates of commencement and termination of present term of office or position
d. Length of time each present officer, director, or governor has held the same office or
position
e. Brief account of the business experience of each officer and director over the last five
years
f Any other business affiliations in the derivatives or securities industry
g. For directors, list any committees on which they serve and any compensation received
by virtue of their directorship
h. A description of
(1) Any order of the Commission with respect to such person pursuant to section
Se of the Act;
(2) Any conviction or injunction against such person within the past ten years;
(3) Any disciplinary action with respect to such person within the last five years;
(4) Any disqualification under sections 8b and 8d of the Act;
(5) Any disciplinary action under section 8c of the Act; and
(6) Any violation pursuant to section 9 of the Act
3. Attach as Exhibit C:
a. A copy of the constitution, articles of incorporation, formation, or association with all
amendments thereto, partnership or limited liability agreements, and existing by-laws,
operating agreement, committee charter, rules or instruments corresponding thereto,
as applicable, of the Applicant
b. A narrative that sets forth the fitness standards for the Board of Directors and its
composition including the number and percentage of public directors.
c. A certificate of good standing dated within one week of the date of this Form SEF.
a. A narrative or graphic description of the organizational structure of the Applicant
Include a list of the legal names of all affiliates of the Applicant and indicate the
general nature of the affiliation. Note: If the swap execution facility activities of the
Applicant are or will be conducted primarily by a division, subdivision, or other
separate entity within the Applicant, corporation, or organization, describe the
relationship of such entity within the overall organizational structure and attach as
Exhibit D a description only as it applies to the division, subdivision, or separate
entity, as applicable.
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4. Attach as Exhibit D:
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62115
b. Provide any relevant jurisdictional information, including any and all jurisdictions in
which the Applicant and any affiliated entity engaged in financial services or markets
activities, including, but not limited to, trading, clearing, or reporting of swaps are
doing business; registration status, including pending applications (e.g., country,
regulator, registration category, date of registration); and nature of the business.
Provide the address for legal service of process for each jurisdiction, which cannot be
a post office box.
5. Attach as Exhibit E:
a. A narrative or graphic description of the personnel structure that specifies the reporting
lines and identifies the name and position for each officer, manager, and supervisor
employed by or seconded to the Applicant for the operation of the Applicant as a
swap execution facility. The narrative or graphic description of the personnel should
identify the reporting line and estimated number of positions within any other
category of non-management and non-supervisory employees employed by or
seconded to the Applicant or the division, subdivision, or other separate entity within
the Applicant.
b. Provide a description of the duties as well as the background, skills, and any other
qualifications necessary for each officer, manager, supervisor, and any other category
of non-management and non-supervisory employees employed by or seconded to the
Applicant or the division, subdivision, or other separate entity within the Applicant.
6. Attach as Exhibit F, a brief description of any material pending legal proceeding(s), other
than ordinary and routine litigation incidental to the business, to which the Applicant or any
of its affiliates is a party or to which any of its or their property is the subject. Include the
name of the court or agency where the proceeding(s) are pending, the date(s) instituted, the
principal parties involved, a description of the factual basis alleged to underlie the
proceeding(s), and the relief sought. Include similar information as to any proceeding(s)
known to be contemplated by the governmental agencies.
EXHIBITS- FINANCIAL INFORMATION
a. The following financial statements: balance sheet, income statement, statement of cash
flows, and all notes or schedules thereto, as of the most recent fiscal year of the
Applicant. If the Applicant is a newly-formed entity and does not have these
financial statements, then the Applicant should provide pro forma financial
statements for a six-month operating period. If any financial statements certified by
an independent public accountant are available, the Applicant should submit those
statements with this Exhibit G. The financial statements shall be prepared in
accordance with generally accepted accounting principles in the United States and
denominated in U.S. dollars. Applicants not domiciled in the United States, and not
otherwise required to prepare financial statements in accordance with generally
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7. Attach as Exhibit G:
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accepted accounting principles in the United States, may prepare their financial
statements in accordance with either the International Financial Reporting Standards
issued by the International Accounting Standards Board, or a comparable
international standard the Commission may otherwise accept in its discretion.
b. A narrative with appropriate financial calculations demonstrating:
(1) That the value of the financial resources of the Applicant exceeds the total
amount that would enable the Applicant to cover its operating costs for a
period of at least one year, calculated on a rolling basis that would enable it to
comply with the core principles set forth in section 5h of the Act and the
Commission's regulations;
(2) That the Applicant has unencumbered, liquid financial assets (i.e., cash and/or
highly liquid securities) equal to at least the greater of three months operating
costs or the cost to wind-down operations as a swap execution facility; and
(3) The methodology by which the Applicant has computed the current market
value of each financial resource used to meet its regulatory obligations
pursuant to§ 37.1301 and § 37.1303 of the Commission's regulations (17
CPR 37.1301 and 37.1303) and indicate any reductions in value which reflect
market and credit risk as appropriate.
c. Documentation demonstrating the existence of any committed lines of credit or similar
facility relied upon for the purpose of meeting the requirements of§ 37.1303 of the
Commission's regulations (17 CPR 3 7.1303) (e.g., copies of agreements establishing
or amending a credit facility or similar facility).
d. A list of the Applicant's expenses which itemizes any costs excluded or pro-rated in
determining the operating costs of the Applicant for a one-year period on a rolling
basis. Provide an explanation of the basis for the Applicant's determination to
exclude or pro-rate expenses.
e. An itemized list of all costs that the Applicant would incur to wind-down the
operations of the Applicant as a swap execution facility, the projected amount of time
of any such wind-down period, and an explanation of the basis by which the
Applicant has determined such estimated costs and time.
8. Attach as Exhibit H:
a. A complete list of all dues, fees, and other charges to be imposed by or on behalf of the
Applicant. Identify the service or services provided for each of these dues, fees, and
other charges. Identify any market maker programs, other incentive programs, or any
other discount on dues, fees, or other charges to be imposed by the Applicant.
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b. A description of the basis, methods, and any factors used in determining the level and
structure of the dues, fees, and other charges listed in paragraph (a) of this item.
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
62117
EXHIBITS- COMPLIANCE
9. Attach as Exhibit I, a regulatory compliance chart with citations to the Applicant's relevant
rules, policies, and procedures that describe the manner in which the Applicant is able to
comply with each core principle. The Applicant must provide an explanation of any novel
issues for which compliance with a core principle is not self-evident, including an
explanation of how that item satisfies the core principles.
10. Attach as Exhibit J, a copy of the Applicant's rules (as defined in§ 40.1 of the
Commission's regulations, 17 CFR 40.1) and any technical manuals, other guides, or
instructions for users of the Applicant, including minimum financial standards for market
participants. Include rules on publication of daily trading information pursuant to the
requirements of part 16 of the Commission's regulations (17 CFR part 16). The Applicant
should include an explanation and any other form of documentation that would be helpful to
explain or demonstrate how the documentation provided in this Exhibit J supports the
Applicant's compliance with the core principles.
11. Attach as Exhibit K, a copy of any compliance manual and any other documents that
describe with specificity the manner in which the Applicant will conduct trade practice,
market, and financial surveillance and maintain trading data.
12. Attach as Exhibit L, executed or executable copies of all user agreements, including, but not
limited to, on-boarding documentation, regulatory data usage consent agreements,
intermediary documentation, and arrangements for alternative dispute resolution. Provide a
narrative of the legal, operational, and technical requirements for users to directly or
indirectly access the Applicant's facility.
13. Attach as Exhibit M,
a. A list of the swap data repositories to which the Applicant will report data related to swaps
and the respective asset classes for which the Applicant will report data related to swaps
for each Commission-registered swap data repository.
b. An executed copy of all agreements regarding the reporting of data related to swaps
between the Applicant and each Commission-registered swap data repository to which
the Applicant will report data related to swaps.
c. A representation from each Commission-registered swap data repository that states that the
Applicant has satisfactorily completed all legal, technical, and operational requirements,
including all necessary testing, to enable the Commission-registered swap data repository
to reliably accept swap reporting data from the Applicant
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14. Attach as Exhibit N, which is required only for an Applicant that seeks to offer swaps for
trading that may be cleared through a clearing organization,
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a. A list ofthe (1) Commission-registered derivatives clearing organizations and (2)
derivatives clearing organizations that the Commission has determined are exempt from
registration, to which the Applicant will submit swap transactions for clearing. The list
shall identify the asset classes for which the Applicant will submit swap transactions for
clearing.
b. A representation that clearing members of each ( 1) Commission-registered derivatives
clearing organization and (2) derivatives clearing organization that the Commission has
determined is exempt from registration, will guarantee all swap transactions submitted by
the Applicant for clearing.
c. An executed copy of the clearing agreement and any related documentation for each (1)
Commission-registered derivatives clearing organization and (2) derivatives clearing
organization that the Commission has determined is exempt from Commission
registration, that will clear swap transactions submitted by the Applicant
d. A representation from each Commission-registered derivatives clearing organization and
derivatives clearing organization that the Commission has determined is exempt from
registration that will clear swap transactions for the Applicant, that states that the
Applicant has satisfactorily completed all legal, technical, and operational requirements,
including all necessary testing, to enable such clearing organization to reliably accept
swap transactions from the Applicant.
15. Attach as Exhibit 0, executed or executable copies of any agreements or contracts entered
into or to be entered into by the Applicant, including third-party regulatory service provider
agreements that enable the Applicant to comply with applicable core principles that are not
otherwise attached within Exhibits L, M, N, or Q. For each agreement, identify the services
that will be provided and the core principles addressed by such agreement
16. Attach as Exhibit P, an explanation regarding the operation of the Applicant's trading
system(s) or platform(s) and the manner in which the system(s) or platform(s) satisfy any
Commission rules, interpretations, or guidelines regarding a swap execution facility's
execution methods, including the requirements in§ 37.201(a) of the Commission's
regulations (17 CFR 37.201(a)). Where possible, this explanation should include screenshots
of the Applicant's trading system(s) or platform(s).
17. Attach as Exhibit Q, information responsive to the Program of Risk Analysis and Oversight
Technology Questionnaire This questionnaire focuses on information pertaining to the
Applicant's program of risk analysis and oversight. Main topic areas include: information
security; business continuity-disaster recovery planning and resources; capacity and
performance planning; systems operations; systems development and quality assurance; and
physical security and environmental controls. The questionnaire will be available on the
Commission's website.
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EXHIBITS- OPERATIONAL CAPABILITY
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 / Proposed Rules
62119
PROGRAM OF RISK ANALYSTS AND OVERSIGHT
TECHNOLOGY QUESTIONNAIRE
Provide all relevant documents responsive to the information requests listed within each area
below. In addition to the specific documents requested, provide any other policies, procedures,
standards or guidelines, plans, independent assessments (including internal audits), test results,
and representations that will assist the Commission in assessing the compliance of trading
platform and related supporting systems with the applicable SYSTEM SAFEGUARDS CoRE
PRINCIPLE. The Systems Safeguards Core Principle require exchanges to (1) establish and
maintain a program of risk analysis and oversight to identify and minimize sources of operational
risk, through the development of appropriate controls and procedures, and the development of
automated systems, that are reliable, secure, and have adequate scalable capacity; 1 (2) establish
and maintain emergency procedures, backup facilities, and a plan for disaster recovery that allow
for the timely recovery and resumption of operations and the fulfillment of the responsibilities
and obligations of the exchange; and (3) periodically conduct tests to verify that backup
resources are sufficient to ensure continued order processing and trade matching, transmission of
matched orders to a designated clearing organization for clearing, price reporting, market
surveillance, and maintenance of a comprehensive and accurate audit trail.
1. Organizational Structure, System Description, Facility Locations, and Geographic
Distribution of Staff and Equipment per the following:
a. Provide high-level organization charts and staffing level information for all groups
that are directly involved in supporting the development, operation, and
maintenance of the systems, including systems development, quality assurance,
system operations, event management, market operations, network and
telecommunications, information security, capacity planning, contingency
planning (including disaster recovery), market surveillance, and trade practice
investigation; include a brief biography with applicable certifications for each key
IT staffleader.
b. Describe or provide a diagram showing the locations of all facilities that house the
staff described above and the equipment on which your systems operate. Indicate
the nature of the facilities (e.g., headquarters, primary and backup data centers,
primary and backup market operations centers, etc.), and a description ofyour
rationale for the distribution of staff and system components across those
facilities.
An exchange's program of risk analysis and oversight with respect to its operations and automated systems shall
address each of the following categories: (l) Enterprise risk management and governance; (2) Infonnation security;
(3) Business continuity-disaster recovery planning and resources, including pandemic planning; (4) Capacity and
performance planning; (5) System operations (including configuration management, event management, and
incident response); (6) Systems development and quality assurance (including security controls requirements,
software change management, and outsourcing); and (7) Physical security and environmental controls. See 17 CFR
37.1401.
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1
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c. Provide a high-level application flow diagram and the specific information
requested below for all systems that perform and support trading, price reporting,
regulatory reporting, market surveillance, and trade practice investigation:
1) System description and overview.
2) A logical diagram of the software components, including the following
information for each component:
a) Name;
b) Functional description; and
c) Upstream and downstream feeds.
3) Provide a logical security architecture and description.
4) A representative physical diagram of the hardware components (servers and
communications equipment) that exist at both the primary and backup data
centers, and for each representative hardware component, provide the
following information:
a) Device type (e.g., switch, server, SAN, etc.);
b) Device 0/S;
c) Functional description;
d) Internal redundancies (e.g, power supplies, RAID); and
e) External redundancies (e.g, mirroring, clustering).
5) A physical diagram of the network topology within and between data centers
and external entities, and for each connection provide the following
information:
a) Purpose(s) of connection;
b) Type and bandwidth of each connection; and
c) Identification of carrier.
2. Enterprise Risk Management and Governance. Describe your Enterprise Risk
Management program as it relates to IT and your entity's approach for assessing and
managing the risks associated with technology and cybersecurity, including procedures
for risk escalation, adjudication, mitigation, and acceptance; include the following:
a. Provide a copy of your most recent annual Enterprise Technology Risk Assessment
and Enterprise Risk Assessment.
b. Include a description of Board of Directors and/or Board Committee involvement
in oversight of system safeguards and cybersecurity.
c. Provide a list of Board of Directors and Board Committee members, indicating for
each: name, title, and description of any system safeguards and cyber security
expenence.
e. Provide copies of Board ofDirectors and Board Committee meeting minutes
regarding system safeguards from the four most recent meetings.
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d. Provide copies of all system safeguards-related materials provided to the Board of
Directors or applicable Board Committees for the four most recent meetings.
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62121
f. Describe the process by which the Board is kept apprised of the status of systems
safeguards related initiatives and assessments, including any escalation
procedures or trigger points that automatically require Board notification and
involvement.
g. Describe any ongoing education or training that Board members receive regarding
systems safeguards, including cybersecurity. If a third party consultant is used in
matters of system safeguards and cybersecurity risk, include the name, title and
applicable qualifications for each consultant.
h. Describe your internal audit program, including:
1) Organizational structure of internal audit;
2) Audit staff qualifications and use of external staff;
3) Controls that ensure independence;
4) Process for development ofTT audit plan, including prioritization and
allocation of audit resources;
5) Follow up and resolution ofiT audit findings and recommendations and quality
assurance reviews of the internal audit program and processes; and
6) Provide the results of the most recent quality assurance review.
i. Submit the system evaluation documentation and information requested below for
each of the following systems safeguard categories: (1) risk management;
(2) systems development methodology; (3) information security; (4) system
operations; (5) capacity and performance planning; (6) physical security and
environmental controls, including data centers; and (7) business continuity and
disaster recovery.
1) Provide your most recent audit or other risk assessment documents for each
category, including complete reports (not only executive summaries),
management's responses, and mitigation plans and results for addressing
findings;
2) Describe your plans and schedule for ongoing independent audits, other risk
assessments, and tests for each category;
3) Describe how you periodically assess compliance with applicable policies and
procedures for each category.
1) Provide a copy of each service agreement currently in place for any IT services
provided by a third party.
2) Describe your process for pre-contract due diligence and screening of IT
service providers.
3) Describe your process for monitoring the performance of service agreements,
including roles and responsibilities, scope and frequency of review, and
remediation of identified deficiencies.
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j. Outsourcing and Vendor Management
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4) Describe inclusion of vendor relationships and outsourced systems in your
ongoing risk management process.
5) Describe any information systems security testing and ongoing monitoring you
may require and/or conduct of vendors.
6) Provide a list of all vendors who have any sort of connection or access to your
systems and describe how you manage and mitigate the risks to your systems
posed by this access on an ongoing basis.
7) Provide a list of critical service providers (those without whose functioning
your entity cannot function).
8) Describe all testing you perform or participate in jointly with each of your
critical service providers.
9) Describe how you ensure that you are notified of all significant changes to the
systems, operations, management, or physical resources of your critical
service providers.
3. Information Security
a. Provide documentation (policies, standards, guidelines) that attests to the
development of and adherence to an ongoing information security program.
b. Describe your background investigation program's controls and procedures to
include credit checking for the following:
1) Pre-assignment of personnel to sensitive roles; and
2) Recurring periodic investigations for staff in sensitive roles.
c. Provide information regarding security awareness training and education:
1) Describe the security awareness training provided to system users, including
periodic refresher training.
2) Identify the roles of personnel that have significant system security or system
development responsibilities and describe the security training they are
required to complete.
d. Provide information regarding the access controls and procedures that are used to
ensure the identification, authorization, and authentication of system users and
any third-party service providers.
e. Provide information regarding the procedures that are used to ensure proper
account management, including:
f. Provide information regarding the administrative procedures (such as adherence to
least privilege and separation of duties concepts) and automated systems that will
be employed to prevent and detect the unauthorized use of the system.
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1) Establishing, changing, reviewing, and removing accounts (including
emergency and other temporary accounts);
2) Password complexity and life cycle standards; and
3) Maintaining user awareness of the authorized uses of the system.
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g. Provide information (including specific products used, guidelines for use, and roles
and responsibilities) regarding the use and management of safeguards and security
tools used to protect the critical data and system components, including:
1) Encryption and data compression (data at-rest and in-transit);
2) Denial of service protection;
3) Firewalls;
4) Routers;
5) DMZs and network segmentation;
6) Intrusion detection;
7) Event logging and log analysis, including:
a) Scope of log coverage (e.g., production/development; servers/firewalls);
b) Focus of event details captured (e.g., unauthorized activities, system
issues);
c) Monitoring of system logging alerts (e.g., log failure alert); and
d) Frequency and level of log review, analysis, and reporting.
8) Virus protection;
9) Encryption and control of portable mobile devices;
10) Encryption and control of portable external media (e.g, USB drives, optical
media, external hard drives, etc.);
11) Data Loss Prevention (DLP) tools; and
12) Ongoing testing of the efficacy of safeguards and security tools for the areas
enumerated above.
h. Provide policies, guidelines, and procedures for authorization and use of remote
access capabilities to manage the system, including hardware and software tools
that protect the information and system while using those capabilities. In your
response, also address policies, guidelines or procedures governing third party
access to your systems.
i. Provide information about your procedures for sanitization, destruction, and
disposal of equipment and media.
J. Provide information regarding the manual and automated processes in place to
facilitate the capture and secure storage of all records relating to the business of
the facility, including a complete audit trail, for a period of five years 2
2
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1) Identify the specific audit trail information captured.
2) Describe the controls that provide for reliable collection of audit information,
including those that ensure sufficient capacity and alerting of audit failures.
3) For each copy of the audit trail information, describe the processes that protect
the information from accidental and deliberate alteration or destruction prior
to its planned disposal. Include information about:
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a) Access controls (physical and logical);
b) Environmental controls (e.g., fire protection) provided at storage locations;
c) Schedule and procedures for secure movement of information;
d) Retention period; and
e) Distance between storage locations.
k. Provide information about your security incident response program, including:
1) Staffing;
2) Roles and responsibilities;
3) Training;
4) Procedures (including detection, analysis, containment, and recovery);
5) Communication/notification and reporting, including notification of
appropriate regulators, law enforcement, and appropriate information sharing
organizations; and
6) Testing of security incident response procedures.
1. Describe your cybersecurity threat intelligence capabilities, including:
1) Staffing (in-house and outsourced services);
2) Roles and responsibilities;
3) Training;
4) Intelligence gathering and analysis methodology;
5) Dissemination of intelligence within the organization and with appropriate
information sharing organizations, and
6) Evaluating intelligence for tactical and strategic action.
m. Describe your participation in any information sharing organizations, e.g., FSlSAC.
4. Business Continuity and Disaster Recovery ("BC-DR"). Provide the following
information:
a. A description of your DR sites, including the following information for each site:
1) State of readiness (hot, warm, cold);
2) Whether a commercial or self-managed site; and
3) Distance from production site.
b. A description of the public infrastructure (e.g., water, electric, etc.) supporting each
of your BC-DR sites, including redundancy, resilience, and physical security.
d. A list of the mission-critical systems that each of your BC-DR sites will support in
the event of a disaster.
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c. A list of the mission-critical systems that each BC-DR site will support on a
routine, non-disaster basis, and a description of your reasons for this overall data
center strategy.
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e. Copies of all agreements, including service level agreements, with third parties to
provide services in support of your BC-DR plans.
f A description of your strategy for ensuring the availability of essential software and
data, including security and testing of backups.
g. A description of your recovery point objective ("RPO"), and a description or
assessment of your maximum potential data loss in the event of a disaster,
including loss of in-transit data.
h. A description of your strategy for staffing DR sites in the event of a disaster,
including a pandemic.
i. A description of any plans or capabilities for remote management and operation of
your primary or DR sites in the event that they become inaccessible but remain
functional. Include information regarding the systems security controls that will
be applied to internal and third party (including service provider) users.
j. Briefing materials for senior management regarding BC-DR and pandemic plans.
k BC-DR and pandemic training materials prepared for employees.
1. A description of your procedures for ensuring the currency and availability to team
members of essential documentation.
m. Your technology-related BC-DR plans, including roles and responsibilities,
staffing assignments, recovery procedures, test plans, external dependencies and
any pandemic plans.
n. Your emergency communications plan, including emergency contact information
o. A description of external communications and reporting regarding BC-DR events,
including notification of customers and appropriate regulators.
p. A description of how your BC-DR plan is coordinated with members' BC-DR
plans.
q. A description of your strategy for testing your DR sites, including frequency, types
of tests, and scope of staff and market participant involvement
r. A copy of the most recent SSAE16 Type 11 reports for each of your data centers,
s. Documentation from the three most recent operational tests conducted with respect
to your DR sites, including the test plan, the results report, and the mitigation plan
and results.
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including, if applicable, any actions taken to remediate findings in the report.
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t. Documentation from your participation in the most recent industry wide test
relating to BC-DR matters, including the test plan, the results report, and the
mitigation plan and results.
u. A description of any instances of activation of your BC-DR plans, including the
results report and the mitigation plan and results.
v. Explain your recovery time objective ("RTO") for each of the following:
1) Ability to meet the "next day" resumption of trading regulatory requirement.
2) Completed clearing of transactions executed prior to disruption.
3) Resumption of clearing of new transactions.
4) Resumption of market surveillance.
5) Access to audit trail information and resumption of trade practice surveillance.
6) Redirection to a secondary data center (when needed).
w. Explain your successfully tested recovery time capability for resuming fulfillment
of your responsibilities and obligations as an exchange. Please provide test
results.
5. Capacity Planning and Testing
a. Provide the capacity levels and associated performance (i.e., response time) for
each of the following system activities, including target, average daily, historical
high, and system stress-tested sustained and peak levels:
1) Simultaneous workstation sessions;
2) Market participant transactions;
3) Trade matches;
4) Quote vendor transactions; and
5) Data mirroring transactions.
b. Describe any formal process you employ for the ongoing review of capacity and
performance levels.
c. Describe current system bottlenecks, and the methods in which they are monitored.
d. Describe at what levels the addition of new system resources would be triggered to
ensure adequate capacity and performance.
e. Describe the methods by which additional capacity and performance resources
could be activated in an emergency situation and state how long those processes
would take.
a. Configuration management for hardware and software
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6. System Operations
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Provide information regarding the controls and procedures that will be used to
ensure:
1) Consistent inventory maintenance;
2) Adherence to standards for baseline configuration, including hardening;
3) Pre-installation testing and authorization;
4) Processes that ensure minimal configuration drift between primary and backup
environments; and
5) Post-installation monitoring and testing.
b. System change management for hardware and software
Provide information regarding the controls and procedures that will be used to
ensure the reliability of system software, including:
1) Testing;
2) Independent review for quality assurance;
3) Approval for production installation;
4) Processes that ensure minimal configuration drift between primary and backup
environments;
5) Post-change monitoring, including testing to confirm planned vs. actual system
configuration;
6) Separation of duties;
7) Controls in place to ensure quality, consistency, and security of code developed
by third party developers; and
8) Controlled access to code libraries.
c. Patch management program
Provide information regarding the controls and procedures that will be used to
ensure the timely application of essential patches, including:
1) Staffing;
2) Awareness;
3) Analysis of required patching to operational systems and any impact to
computing environments;
4) Testing and Approval;
5) Emergency patch processes and procedures, including notification, analysis,
testing, approval, and implementation;
6) Implementation and fallback procedures; and
7) Communication and reporting
1) Frequency ofuse;
2) Tools used;
3) Scope; and
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d. Password scanning
Provide information about any internal password scanning you perform,
including:
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4) Follow-up.
e. Event and problem management
Provide information regarding the controls and procedures that will be used to
ensure the timely notification about operational events and resolution of
operational problems, including:
1) Staffing;
2) Roles and responsibilities;
3) Use of monitoring systems;
4) Tracking and escalation;
5) Resolution; and
6) Internal and external reporting, including notification of appropriate regulators.
7. Systems Development Methodology
a. Describe your process, including roles and responsibilities, for identifying and
approving functional, security, and capacity/performance requirements.
b. Describe your software change management process, including quality assurance
and issue tracking and resolution.
1) Provide information regarding the testing methodology, including management
controls, used to verify the system's ability to perform as intended (regarding
functionality, security, and capacity and performance requirements).
2) Provide copies of current representative samples of your test results
documentation.
3) Identify what group is responsible for recording, correcting, and retesting
errors, and detail their procedures for those activities.
c. Describe the documentation required during the development of new software and
as part of the software release package for installation, operation, and
maintenance.
d. Describe the controls in place for promotion of application software into the
production environment, including approval, access controls, and postimplementation monitoring.
8. Physical Security and Environmental Controls
1) Perimeter and external building controls and monitoring, including:
a) Lights;
b) Cameras;
c) Motion detectors;
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a. Provide information regarding the physical security controls used in the
communications and central computer facilities to protect system components and
critical infrastructure. In your response, please address:
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d) Guards;
e) Fences, gates, and other barriers; and
f) Building entrances, including loading docks.
2) Internal building controls and monitoring, including:
a) Engineering and physical security staffing, including shift coverage,
minimum qualifications and training;
b) Metal detectors;
c) Door locks;
d) Visitor controls, including scheduling, identification, logbooks, and escort
requirements;
e) Compartmentalization of computing, communications, and building
infrastructure equipment;
f) Cameras, video recording, and monitoring stations;
g) Access authorization and review procedures; and
h) Mail and package handling procedures.
b. Provide copies of any internal or third party physical security assessments
conducted for each of your operating locations.
c. Describe plans for third party physical security assessments for each of your
operating locations.
d. Provide information regarding the environmental controls used in the
communications and central computer facilities to ensure reliable availability of
system components and critical infrastructure. Address redundancy, monitoring,
maintenance, and testing of:
e. Provide copies of any recent third party assessments of your communications and
central computer facilities, including results and plans for remediation of any
findings made.
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1) Electrical supply, including:
a) Sources and paths of commercial power;
b) Generators (and associated on-site fuel supply and fuel delivery contracts);
c) Power distribution units;
d) Uninterruptible Power Supply units; and
e) Emergency shutoff controls.
2) Cooling equipment, including:
a) HVAC units;
b) Air handlers;
c) Chillers; and
d) Other associated items such as water supply and humidifiers.
3) Fire control equipment, including:
a) Smoke and heat detection;
b) Fire suppression; and
c) Water damage protection.
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f. Provide information regarding any Single Point of Failure reviews or assessments
made of your communications, data center, and cloud infrastructure; including but
not limited to carrier line diversity, points of presence, and oversight of changes.
9. Testing Program
a. Provide information regarding your use of internal and third party vulnerability
scanning and testing to identify and eliminate vulnerabilities in the configuration
of your computing and communications equipment. Address each of the
following:
1) Scope of testing;
2) Frequency of use;
3) Methodology and tools;
4) Distribution of reports;
5) Remediation of findings by severity or risk posed; and
6) Tracking of mitigation activities, including notification of senior management
or the Board.
b. Provide the results of the two most recent internal or third party vulnerability scans
(for our assessment of progress made), including complete reports (not only
summaries), management's responses, and mitigation plans and results for
addressing findings.
c. Provide information regarding your use of internal and third party external and
internal penetration testing to identify and eliminate vulnerabilities in the
architecture and configuration of your computing and communications
equipment. Address each of the following:
1) Scope of testing;
2) Frequency of use;
3) Methodology and tools;
4) Distribution of reports;
5) Remediation of findings by severity or risk posed; and
6) Tracking of mitigation activities, including notification of senior management
or the Board.
d. Provide the results of the two most recent internal or third party penetration tests
(for our assessment of progress made), including complete reports (not only
summaries), management's responses, and mitigation plans and results for
addressing findings.
1) Selection of controls, including determination of key controls;
2) Frequency, scope, and schedule of testing;
3) Use of any third party assessors; and
4) Escalation, follow up and resolution of findings.
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e. Describe your program of periodic controls testing, including:
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5) Provide representative samples of any periodic control testing.
BILLING CODE 6531–01–C
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f. Provide the results of your most recently performed Security Incident Response
Plan test.
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Appendix B to Part 37—Guidance on,
and Acceptable Practices in,
Compliance With Core Principles
1. This appendix provides guidance on
complying with core principles, both initially
and on an ongoing basis, to maintain
registration under section 5h of the Act and
this part. Where provided, guidance is set
forth in paragraph (a) following the relevant
heading and can be used to demonstrate to
the Commission compliance with the
selected requirements of a core principle of
this part. The guidance for the core principle
is illustrative only of the types of matters a
swap execution facility may address, as
applicable, and is not intended to be used as
a mandatory checklist. Addressing the issues
set forth in this appendix would help the
Commission in its consideration of whether
the swap execution facility is in compliance
with the selected requirements of a core
principle; provided however, that the
guidance is not intended to diminish or
replace, in any event, the obligations and
requirements of applicants and swap
execution facilities to comply with the
regulations provided under this part.
2. Where provided, acceptable practices
meeting selected requirements of core
principles are set forth in paragraph (b)
following the guidance. Swap execution
facilities that follow specific practices
outlined in the acceptable practices for a core
principle in this appendix will meet the
selected requirements of the applicable core
principle; provided however, that the
acceptable practice is not intended to
diminish or replace, in any event, the
obligations and requirements of applicants
and swap execution facilities to comply with
the regulations provided under this part. The
acceptable practices are for illustrative
purposes only and do not state the exclusive
means for satisfying a core principle.
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Core Principle 1 of Section 5h of the Act—
Compliance With Core Principles
(A) In general. To be registered, and
maintain registration, as a swap execution
facility, the swap execution facility shall
comply with—the core principles described
in section 5h of the Act; and any requirement
that the Commission may impose by rule or
regulation pursuant to section 8a(5) of the
Act.
(B) Reasonable discretion of swap
execution facility. Unless otherwise
determined by the Commission by rule or
regulation, a swap execution facility
described in paragraph (A) shall have
reasonable discretion in establishing the
manner in which the swap execution facility
complies with the core principles described
in section 5h of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 2 of Section 5h of the Act—
Compliance With Rules
A swap execution facility shall:
(A) Establish and enforce compliance with
any rule of the swap execution facility,
including the terms and conditions of the
swaps traded or processed on or through the
swap execution facility and any limitation on
access to the swap execution facility;
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(B) Establish and enforce trading, trade
processing, and participation rules that will
deter abuses and have the capacity to detect,
investigate, and enforce those rules,
including means to provide market
participants with impartial access to the
market and to capture information that may
be used in establishing whether rule
violations have occurred;
(C) Establish rules governing the operation
of the facility, including rules specifying
trading procedures to be used in entering and
executing orders traded or posted on the
facility, including block trades; and
(D) Provide by its rules that when a swap
dealer or major swap participant enters into
or facilitates a swap that is subject to the
mandatory clearing requirement of section
2(h) of the Act, the swap dealer or major
swap participant shall be responsible for
compliance with the mandatory trading
requirement under section 2(h)(8) of the Act.
(a) Guidance. (1) Ethics training. (i) Section
37.201(c)(4) requires a swap execution
facility to ensure that its SEF trading
specialists receive ethics training on a
periodic basis. Such training should help
SEF trading specialists be aware, and remain
abreast, of, their continuing obligations with
respect to the rules, policies, and procedures
of the swap execution facility, as well as the
applicable provisions of the Act and
Commission regulations thereunder.
(ii) Ethics training for SEF trading
specialists should account for the level and
nature of SEF trading specialists’
responsibilities within a swap execution
facility. The training should address topics
such as an explanation of applicable laws
and regulations and the rules, policies, and
procedures of the swap execution facility;
how to act honestly and fairly and with due
skill, care, and diligence in furtherance of the
interests of market participants and the
integrity of the market; protection of
confidential information; and avoidance,
proper disclosure, and handling of conflicts
of interest. Such ethics training should also
seek to ensure that SEF trading specialists
remain current with regard to the ethical
ramifications of new developments with
respect to evolving technology, trading
practices, products, and other relevant
changes.
(iii) A swap execution facility, at its
discretion, may develop and implement its
own ethics training program or utilize a
program offered by a third-party provider, or
may implement some combination thereof.
Third-party providers may include
independent persons, firms, or industry
associations. No specific format or class
training is required, as the needs of a swap
execution facility may vary according to its
size and number of personnel that are SEF
trading specialists. A swap execution facility
may utilize electronic media, such as video
presentations, internet-based transmissions,
and interactive software programs as part of
its ethics training program. A swap execution
facility should ascertain the credentials of
any provider of ethics training or training
materials and should ensure that such
persons have the appropriate level of
industry experience and knowledge,
including with respect to the swap execution
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facility’s rules, policies, procedures, and
operations.
(iv) A swap execution facility may
determine the frequency and duration of
ethics training but such frequency and
duration should promote a corporate culture
of high ethical and professional conduct and
a continuous awareness of industry standards
and practices.
(2) Investigations—Timeliness. A swap
execution facility has reasonable discretion
to determine the timely manner in which to
complete investigations under § 37.203(f)(2).
(3) Investigations—Investigation reports. A
swap execution facility’s compliance staff
should submit all investigation reports to the
Chief Compliance Officer or other
compliance department staff responsible for
reviewing such reports and determining the
next steps in the process. The Chief
Compliance Officer or other responsible staff
should have reasonable discretion to decide
whether to take any action, such as
presenting the investigation report to a
disciplinary panel for disciplinary action.
(4) Audit trail required. A swap execution
facility’s audit trail data should be sufficient
to reconstruct all indications of interest,
requests for quotes, orders, and trades within
a reasonable period of time and to provide
evidence of any violations of the rules of the
swap execution facility.
(5) Audit trail reconstruction. An effective
audit trail reconstruction program should
annually review an adequate sample of
executed and unexecuted orders and trades
from each execution method offered by the
swap execution facility to verify the swap
execution facility’s ability to
comprehensively and accurately reconstruct
trading in a timely manner. A swap
execution facility should have reasonable
discretion to determine the meaning of
adequate sample as used in this paragraph.
(6) Enforcement staff. A swap execution
facility’s enforcement staff should not
include either members of the swap
execution facility or persons whose interests
conflict with their enforcement duties. A
member of the enforcement staff should not
operate under the direction or control of any
person or persons with trading privileges at
the swap execution facility.
(7) Disciplinary panel procedures. The
rules of a swap execution facility governing
the requirements that apply to the
adjudication of a matter by a swap execution
facility disciplinary panel should be fair,
equitable, and publicly available. Such rules
should require the disciplinary panel to
promptly issue a written decision following
a hearing or the acceptance of a settlement
offer.
(8) Emergency disciplinary actions. A swap
execution facility may impose a sanction,
including suspension, or take other summary
action against a person or entity subject to its
jurisdiction upon a reasonable belief that
such immediate action is necessary to protect
the best interest of the marketplace.
(9) Warning letters and sanctions. A swap
execution facility should have reasonable
discretion to determine when to issue
warning letters and apply sanctions under
§ 37.206(c)(1).
(b) Acceptable Practices. [Reserved]
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Core Principle 3 of Section 5h of the Act—
Swaps Not Readily Susceptible to
Manipulation
The swap execution facility shall permit
trading only in swaps that are not readily
susceptible to manipulation.
(a) Guidance. Guidance in appendix C to
this part—‘‘Demonstration of Compliance
that a Swap Contract is Not Readily
Susceptible to Manipulation’’—may be used
as guidance in meeting this core principle for
both new product listings and existing listed
contracts.
(b) Acceptable Practices. [Reserved]
Core Principle 4 of Section 5h of the Act—
Monitoring of Trading and Trade Processing
The swap execution facility shall:
(A) Establish and enforce rules or terms
and conditions defining, or specifications
detailing:
(1) Trading procedures to be used in
entering and executing orders traded on or
through the facilities of the swap execution
facility; and
(2) Procedures for trade processing of
swaps on or through the facilities of the swap
execution facility; and
(B) Monitor trading in swaps to prevent
manipulation, price distortion, and
disruptions of the delivery or cash settlement
process through surveillance, compliance,
and disciplinary practices and procedures,
including methods for conducting real-time
monitoring of trading and comprehensive
and accurate trade reconstructions.
(a) Guidance. The swap execution facility
should have rules in place that allow it to
intervene to prevent and reduce disorderly
trading and disruptions. Once threatened or
actual disorderly trading or disruption is
detected, the swap execution facility should
take steps to prevent the disorderly trading
or disruption, or reduce its severity.
(1) General requirements. Real-time
monitoring for disorderly trading and market
or system anomalies is the most effective, but
the swap execution facility’s program may
also be acceptable if some of the monitoring
is accomplished on a T+1 basis. The
monitoring of trading should use automated
alerts to detect disorderly trading and any
market or system anomalies, including
abnormal price movements and unusual
trading volumes in real-time and instances or
threats of manipulation, price distortion, and
disruptions on at least a T+1 basis. The T+1
detection and analysis should incorporate
any additional data that becomes available on
a T+1 basis, including the trade
reconstruction data. In some cases, a swap
execution facility may demonstrate that its
manual processes are effective. The swap
execution facility should act promptly to
address the conditions that are causing price
distortions or disruptions, including, when
appropriate, changes to contract terms.
(2) Physical-delivery swaps. For a physicaldelivery swap listed on the swap execution
facility, the swap execution facility should
monitor for conditions that may cause the
swap to become susceptible to manipulation,
price distortion, or market disruptions,
including: Conditions influencing the
convergence between the swap’s price and
the price of the underlying commodity such
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as the general availability of the commodity
specified by the swap, the commodity’s
characteristics, and the delivery locations;
and if available, information related to the
size and ownership of deliverable supplies.
Price convergence refers to the process
whereby the price of a physically-delivered
swap converges to the spot price of the
underlying commodity, as the swap nears
expiration. The hedging effectiveness of a
physically-delivered swap depends in part
upon the extent to which the swap price
reliably converges to the comparable cash
market price, or to a predictable differential
to the comparable cash market price.
(3) Ability to obtain information. The swap
execution facility should be able to obtain
position and trading information directly
from the market participants that conduct
trading on its facility.
(4) Risk controls for trading. In developing
and implementing an acceptable program for
preventing and reducing the potential risk of
price distortions and market disruptions, a
swap execution facility should establish and
maintain appropriate trading risk controls, in
addition to pauses and halts. Risk controls
should be adapted to the unique
characteristics of the swap execution
facility’s trading system or platform and the
swap contracts listed for trading and should
be designed to avoid price distortions and
market disruptions without unduly
interfering with that market’s price discovery
function. The swap execution facility may
choose from among controls that include:
Pre-trade limits on order size, price collars or
bands around the current price, message
throttles, and daily price limits, or design
other types of controls, as well as clear ordercancellation policies. Within the specific
array of controls that are selected, the swap
execution facility should set the parameters
for those controls, so that the specific
parameters are reasonably likely to serve the
purpose of preventing price distortions and
market disruptions. If a swap is fungible
with, linked to, or a substitute for other
swaps on the swap execution facility or
contracts on other trading venues, such risk
controls should, to the extent practicable, be
coordinated with any similar controls placed
on those other swaps or contracts. If a swap
is based on the level of an equity index, such
risk controls should, to the extent
practicable, be coordinated with any similar
controls placed on national security
exchanges.
(b) Acceptable Practices. [Reserved]
Core Principle 5 of Section 5h of the Act—
Ability To Obtain Information
The swap execution facility shall:
(A) Establish and enforce rules that will
allow the facility to obtain any necessary
information to perform any of the functions
described in section 5h of the Act;
(B) Provide the information to the
Commission on request; and
(C) Have the capacity to carry out such
international information-sharing agreements
as the Commission may require.
(a) Guidance. If position and trading
information is available through informationsharing agreements with other trading venues
or a third-party regulatory service provider,
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the swap execution facility should cooperate,
to the extent practicable, in such
information-sharing agreements.
(b) Acceptable Practices. [Reserved]
Core Principle 6 of Section 5h of the Act—
Position Limits or Accountability
(A) In general. To reduce the potential
threat of market manipulation or congestion,
especially during trading in the delivery
month, a swap execution facility that is a
trading facility shall adopt for each of the
contracts of the facility, as is necessary and
appropriate, position limitations or position
accountability for speculators.
(B) Position limits. For any contract that is
subject to a position limitation established by
the Commission pursuant to section 4a(a) of
the Act, the swap execution facility shall:
(1) Set its position limitation at a level no
higher than the Commission limitation; and
(2) Monitor positions established on or
through the swap execution facility for
compliance with the limit set by the
Commission and the limit, if any, set by the
swap execution facility.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 7 of Section 5h of the Act—
Financial Integrity of Transactions
The swap execution facility shall establish
and enforce rules and procedures for
ensuring the financial integrity of swaps
entered on or through the facilities of the
swap execution facility, including the
clearance and settlement of the swaps
pursuant to section 2(h)(1) of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 8 of Section 5h of the Act—
Emergency Authority
The swap execution facility shall adopt
rules to provide for the exercise of emergency
authority, in consultation or cooperation
with the Commission, as is necessary and
appropriate, including the authority to
liquidate or transfer open positions in any
swap or to suspend or curtail trading in a
swap.
(a) Guidance.
(1) A swap execution facility should have
rules that authorize it to take certain actions
in the event of an emergency, as defined in
§ 40.1(h) of this chapter. A swap execution
facility should have the authority to
intervene as necessary to maintain markets
with fair and orderly trading and to prevent
or address manipulation or disruptive trading
practices, whether the need for intervention
arises exclusively from the swap execution
facility’s market or as part of a coordinated,
cross-market intervention. A swap execution
facility should have the flexibility and
independence to address market emergencies
in an effective and timely manner consistent
with the nature of the emergency, as long as
all such actions taken by the swap execution
facility are made in good faith to protect the
integrity of the markets. However, the swap
execution facility should also have rules that
allow it to take market actions as may be
directed by the Commission, including
actions that the Commission requires the
swap execution facility to take as part of a
coordinated, cross-market intervention.
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Additionally, in situations where a swap is
traded on more than one platform, emergency
action should be taken as directed or agreed
to by the Commission or the Commission’s
staff. A swap execution facility’s rules should
include procedures and guidelines for
decision-making and implementation of
emergency intervention that avoid conflicts
of interest and include alternate lines of
communication and approval procedures to
address emergencies associated with real
time events. To address perceived market
threats, the swap execution facility should
have rules that allow it to take emergency
actions, including imposing or modifying
position limits, imposing or modifying price
limits, imposing or modifying intraday
market restrictions, ordering the fixing of a
settlement price, extending or shortening the
expiration date or the trading hours,
suspending or curtailing trading in any
contract, or altering any contract’s settlement
terms or conditions, or, if applicable,
providing for the carrying out of such actions
through its agreements with its third-party
provider of clearing or regulatory services.
(2) A swap execution facility should
promptly notify the Commission of its
exercise of emergency action, explaining its
decision-making process, the reasons for
using its emergency authority, and how
conflicts of interest were minimized,
including the extent to which the swap
execution facility considered the effect of its
emergency action on the underlying markets
and on markets that are linked or referenced
to the contracts traded on its facility,
including similar markets on other trading
venues. Information on all regulatory actions
carried out pursuant to a swap execution
facility’s emergency authority should be
included in a timely submission of a certified
rule pursuant to part 40 of this chapter.
(b) Acceptable Practices. [Reserved]
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Core Principle 9 of Section 5h of the Act—
Timely Publication of Trading Information
(A) In general. The swap execution facility
shall make public timely information on
price, trading volume, and other trading data
on swaps to the extent prescribed by the
Commission.
(B) Capacity of swap execution facility.
The swap execution facility shall be required
to have the capacity to electronically capture
and transmit trade information with respect
to transactions executed on the facility.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 10 of Section 5h of the Act—
Recordkeeping and Reporting
(A) In general. A swap execution facility
shall:
(1) Maintain records of all activities
relating to the business of the facility,
including a complete audit trail, in a form
and manner acceptable to the Commission
for a period of five years;
(2) Report to the Commission, in a form
and manner acceptable to the Commission,
such information as the Commission
determines to be necessary or appropriate for
the Commission to perform the duties of the
Commission under the Act; and
(3) Keep any such records relating to swaps
defined in section 1a(47)(A)(v) of the Act
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open to inspection and examination by the
Securities and Exchange Commission.
(B) Requirements. The Commission shall
adopt data collection and reporting
requirements for swap execution facilities
that are comparable to corresponding
requirements for derivatives clearing
organizations and swap data repositories.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 11 of Section 5h of the Act—
Antitrust Considerations
Unless necessary or appropriate to achieve
the purposes of the Act, the swap execution
facility shall not:
(A) Adopt any rules or take any actions
that result in any unreasonable restraint of
trade; or
(B) Impose any material anticompetitive
burden on trading or clearing.
(a) Guidance. An entity seeking registration
as a swap execution facility may request that
the Commission consider under the
provisions of section 15(b) of the Act, any of
the entity’s rules, including trading protocols
or policies, and including both operational
rules and the terms or conditions of products
listed for trading, at the time of registration
or thereafter. The Commission intends to
apply section 15(b) of the Act to its
consideration of issues under this core
principle in a manner consistent with that
previously applied to contract markets.
(b) Acceptable Practices. [Reserved]
Core Principle 12 of Section 5h of the Act—
Conflicts of Interest
The swap execution facility shall:
(A) Establish and enforce rules to minimize
conflicts of interest in its decision-making
process; and
(B) Establish a process for resolving the
conflicts of interest.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 13 of Section 5h of the Act—
Financial Resources
(A) In general. The swap execution facility
shall have adequate financial, operational,
and managerial resources to discharge each
responsibility of the swap execution facility.
(B) Determination of resource adequacy.
The financial resources of a swap execution
facility shall be considered to be adequate if
the value of the financial resources exceeds
the total amount that would enable the swap
execution facility to cover the operating costs
of the swap execution facility for a one-year
period, as calculated on a rolling basis.
(a) Guidance. [Reserved]
(b) Acceptable Practices.
(1) Reasonable calculation of projected
operating costs. In connection with a swap
execution facility calculating its projected
operating costs, the Commission has
determined that a reasonable calculation
should include all expenses necessary for the
swap execution facility to comply with the
core principles set forth in section 5h of the
Act and any applicable Commission
regulations. This calculation should be based
on the swap execution facility’s current level
of business and business model, and should
take into account any projected modification
to its business model (e.g., the addition or
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subtraction of business lines or operations or
other changes), and any projected increase or
decrease in its level of business over the next
12 months. The Commission believes,
however, that it may be reasonable for a swap
execution facility to exclude the following
expenses (‘‘excludable expenses’’) from its
projected operating cost calculations:
(i) Costs attributable solely to sales,
marketing, business development, product
development, or recruitment and any related
travel, entertainment, event, or conference
costs;
(ii) Compensation and related taxes and
benefits for swap execution facility personnel
who are not necessary to ensure that the
swap execution facility is able to comply
with the core principles set forth in section
5h of the Act and any applicable Commission
regulations;
(iii) If a swap execution facility offers two
or more bona fide execution methods (e.g., it
offers both an electronic central limit order
book and voice execution via voice brokers),
the swap execution facility may include the
costs related to at least one of the execution
methods that it offers, and may exclude the
costs related to the other execution method(s)
that it offers (i.e., if a swap execution facility
includes in its projected operating costs the
costs associated with its central limit order
book, it may exclude the costs related to its
voice execution service, or vice-versa). A
bona fide method here refers to a method
actually used by the SEF’s market
participants and not established by a SEF on
a pro forma basis for the purpose of
complying with—or evading—Core Principle
13.
(iv) Costs for acquiring and defending
patents and trademarks for swap execution
facility products and related intellectual
property;
(v) Magazine, newspaper, and online
periodical subscription fees;
(vi) Tax preparation and audit fees;
(vii) To the extent not covered by
paragraphs (b)(1)(ii) or (iii) above, the
variable commissions that a voice-based
swap execution facility may pay to its SEF
trading specialists (as defined under
§ 37.201(c)), calculated as a percentage of
transaction revenue generated by the voicebased swap execution facility. Unlike fixed
salaries or compensation, such variable
commissions are not payable unless and until
revenue is collected by the swap execution
facility; and
(viii) Any non-cash costs, including
depreciation and amortization.
(2) Pro-rated expenses. The Commission
recognizes that, in the normal course of a
swap execution facility’s business, there may
be an expense (e.g., typically related to
overhead) that is only partially attributable to
a swap execution facility’s ability to comply
with the core principles set forth in section
5h of the Act and any applicable Commission
regulations; accordingly, such expense may
need to be only partially attributed to the
swap execution facility’s projected operating
costs. For example, if a swap execution
facility’s office rental space includes
marketing personnel and compliance
personnel, the swap execution facility may
exclude the pro-rated office rental expense
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attributable to the marketing personnel. In
order to pro-rate an expense, a swap
execution facility should:
(i) Maintain sufficient documentation that
reasonably shows the extent to which an
expense is partially attributable to an
excludable expense;
(ii) Identify any pro-rated expense in the
financial reports that it submits to the
Commission pursuant to § 37.1306; and
(iii) Sufficiently explain why it pro-rated
any expense. Common allocation
methodologies that can be used include
actual use, headcount, or square footage. A
swap execution facility may provide
documentation, such as copies of service
agreements, other legal documents, firm
policies, audit statements, or allocation
methodologies to support its determination
to pro-rate an expense.
(3) Expenses allocated among affiliates.
The Commission recognizes that a swap
execution facility may share certain expenses
with affiliated entities, such as parent entities
or other subsidiaries of the parent. For
example, a swap execution facility may share
employees (including employees on
secondment from an affiliate) that perform
similar tasks for the affiliated entities or may
share office space with its affiliated entities.
Accordingly, the Commission believes that it
would be reasonable, for purposes of
calculating its projected operating costs, for
a swap execution facility to pro-rate any
shared expense that the swap execution
facility pays for, but only to the extent that
such shared expense is actually attributable
to the affiliate and for which the swap
execution facility is reimbursed. Similarly, a
reasonable calculation of a swap execution
facility’s projected operating costs must
include the pro-rated amount of any expense
paid for by an affiliated entity to the extent
that the shared expense is attributable to the
swap execution facility. In order to pro-rate
a shared expense, the swap execution facility
should:
(i) Maintain sufficient documentation that
reasonably shows the extent to which the
shared expense is attributable to and paid for
by the swap execution facility and/or
affiliated entity;
(ii) Identify any shared expense in the
financial reports that it submits to the
Commission; and
(iii) Sufficiently explain why it pro-rated
any shared expense. A swap execution
facility may provide documentation, such as
copies of service agreements, other legal
documents, firm policies, audit statements,
or allocation methodologies, that reasonably
shows how expenses are attributable to, and
paid for by, the swap execution facility and/
or its affiliated entities to support its
determination to pro-rate an expense.
Core Principle 14 of Section 5h of the Act—
System Safeguards
The swap execution facility shall:
(A) Establish and maintain a program of
risk analysis and oversight to identify and
minimize sources of operational risk, through
the development of appropriate controls and
procedures, and automated systems, that:
(1) Are reliable and secure; and
(2) Have adequate scalable capacity;
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(B) Establish and maintain emergency
procedures, backup facilities, and a plan for
disaster recovery that allow for:
(1) The timely recovery and resumption of
operations; and
(2) The fulfillment of the responsibilities
and obligations of the swap execution
facility; and
(C) Periodically conduct tests to verify that
the backup resources of the swap execution
facility are sufficient to ensure continued:
(1) Order processing and trade matching;
(2) Price reporting;
(3) Market surveillance; and
(4) Maintenance of a comprehensive and
accurate audit trail.
(a) Guidance.
(1) Risk analysis and oversight program. In
addressing the categories of its risk analysis
and oversight program, a swap execution
facility should follow generally accepted
standards and best practices with respect to
the development, operation, reliability,
security, and capacity of automated systems.
(2) Testing. A swap execution facility’s
testing of its automated systems and business
continuity-disaster recovery capabilities
should be conducted by qualified,
independent professionals. Such qualified
independent professionals may be
independent contractors or employees of the
swap execution facility, but should not be
persons responsible for development or
operation of the systems or capabilities being
tested.
(3) Coordination. To the extent practicable,
a swap execution facility should:
(i) Coordinate its business continuitydisaster recovery plan with those of the
market participants it depends upon to
provide liquidity, in a manner adequate to
enable effective resumption of activity in its
markets following a disruption causing
activation of the swap execution facility’s
business continuity-disaster recovery plan;
(ii) Initiate and coordinate periodic,
synchronized testing of its business
continuity-disaster recovery plan with those
of the market participants it depends upon to
provide liquidity; and
(iii) Ensure that its business continuitydisaster recovery plan takes into account
such plans of its telecommunications, power,
water, and other essential service providers.
(b) Acceptable Practices. [Reserved]
Core Principle 15 of Section 5h of the Act—
Designation of Chief Compliance Officer
(A) In general. Each swap execution
facility shall designate an individual to serve
as a chief compliance officer.
(B) Duties. The chief compliance officer
shall:
(1) Report directly to the board or to the
senior officer of the facility;
(2) Review compliance with the core
principles in this subsection;
(3) In consultation with the board of the
facility, a body performing a function similar
to that of a board, or the senior officer of the
facility, resolve any conflicts of interest that
may arise;
(4) Be responsible for establishing and
administering the policies and procedures
required to be established pursuant to this
section;
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(5) Ensure compliance with the Act and the
rules and regulations issued under the Act,
including rules prescribed by the
Commission pursuant to section 5h of the
Act; and
(6) Establish procedures for the
remediation of noncompliance issues found
during compliance office reviews, look backs,
internal or external audit findings, selfreported errors, or through validated
complaints.
(C) Requirements for procedures. In
establishing procedures under paragraph
(B)(6) of this section, the chief compliance
officer shall design the procedures to
establish the handling, management
response, remediation, retesting, and closing
of noncompliance issues.
(D) Annual reports.
(1) In general. In accordance with rules
prescribed by the Commission, the chief
compliance officer shall annually prepare
and sign a report that contains a description
of:
(i) The compliance of the swap execution
facility with the Act; and
(ii) The policies and procedures, including
the code of ethics and conflict of interest
policies, of the swap execution facility.
(2) Requirements. The chief compliance
officer shall:
(i) Submit each report described in clause
(1) with the appropriate financial report of
the swap execution facility that is required to
be submitted to the Commission pursuant to
section 5h of the Act; and
(ii) Include in the report a certification
that, under penalty of law, the report is
accurate and complete.
(a) Guidance. [Reserved]
(b) Acceptable Practices.
(1) Qualifications of chief compliance
officer. In determining whether the
background and skills of a potential chief
compliance officer are appropriate for
fulfilling the responsibilities of the role of the
chief compliance officer, the swap execution
facility has the discretion to base its
determination on the totality of the
qualifications of the potential chief
compliance officer, including, but not limited
to, compliance experience, related career
experience, training, and any other relevant
factors to the position. A swap execution
facility should be especially vigilant
regarding potential conflicts of interest when
appointing a chief compliance officer.
Appendix C to Part 37—Demonstration
of Compliance That a Swap Contract Is
Not Readily Susceptible to
Manipulation
The swap execution facility shall permit
trading only in swaps that are not readily
susceptible to manipulation.
(a) Guidance for cash-settled swaps.
(1) General provision. In general, a cashsettled swap contract is an agreement to
exchange a series of cash flows over a period
of time based on some reference price, which
could be a single price, such as an absolute
level or a differential, or a price index
calculated based on multiple observations.
Such a reference price may be reported by
the swap execution facility itself or by an
independent third party. When listing a swap
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contract for trading, a swap execution facility
shall ensure the swap contract’s compliance
with Core Principle 3, focusing on the
reference price used to determine the
exchanges of cash flows. A swap execution
facility should either (i) calculate its own
reference price, using suitable and wellestablished acceptable methods; or (ii)
carefully select a reliable third-party index.
(2) Reference price susceptibility to
manipulation. A swap execution facility
must specify the reference price used for its
swap contract and determine that the
reference price is not readily susceptible to
manipulation pursuant to SEF Core Principle
3. Accordingly, any reference price that is
used in establishing the swap contract’s cash
settlement price should be assessed for its
reliability as an indicator of cash market
values in the underlying commercial market.
Documentation demonstrating that the
reference price is a reliable indicator of
market values and conditions and is widely
recognized by industry/market agents should
be provided. Such documentation may be in
various forms, including carefully
documented interviews with principal
market trading agents, pricing experts,
marketing agents, etc. Additionally, careful
consideration should be given to the
potential for manipulation or distortion,
when using the reference price to establish
the swap’s cash settlement price. The cashsettlement calculation should involve
appropriate computational procedures that
eliminate or reduce the impact of potentially
unrepresentative data (i.e., outliers).
(i) Where a swap execution facility itself
generates the reference price, the swap
execution facility should establish
calculation procedures that safeguard against
potential attempts to artificially influence the
price. For example, if the reference price is
derived by the swap execution facility based
on a survey of cash market sources, then the
swap execution facility should maintain a list
of such reputable sources with knowledge of
the cash market. In addition, the sample of
sources polled should be representative of
the cash market, and the poll should be
conducted at a time when trading in the cash
market is active and include the most liquid
markets.
(ii) Where an independent, private-sector
third party calculates the reference price, the
swap execution facility should verify that the
third party utilizes business practices that
minimize the opportunity or incentive to
manipulate the cash-settlement price series.
Such safeguards may include lock-downs,
prohibitions against derivatives trading by its
employees, or public dissemination of the
names of sources and the price quotes they
provide. Because a cash-settled swap contract
may create an incentive to manipulate or
artificially influence the underlying
commercial market from which the cashsettlement price is derived or to exert undue
influence on the cash-settlement
computation in order to profit on a derivative
position in that commodity, a swap
execution facility should, whenever
practicable, enter into an information-sharing
agreement with the third-party provider
which would enable the swap execution
facility to better detect and prevent
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manipulative behavior. A swap execution
facility should also consider the need for a
licensing agreement that will ensure the
swap execution facility’s rights to the use of
the price series to settle the listed contract.
(3) Contract terms and conditions. An
acceptable specification of the terms and
conditions of a cash-settled swap contract
would include, but may not be limited to,
rules that address, as appropriate, the
following criteria and comply with the
associated standards:
(i) Commodity characteristics. The terms
and conditions of a cash-settled swap
contract should describe or define all of the
economically significant characteristics or
attributes of the commodity underlying the
contract.
(ii) Contract size and trading unit. For
standardized swap contracts, the contract
size or size range should be clearly defined
and consistent with customary transactions
in the cash market. A swap execution facility
may opt to set the swap contract size smaller
than that of standard cash market
transactions. For non-standardized swap
contracts, a swap execution facility may
allow the contract size or size range to be
negotiable.
(iii) Cash settlement procedure. A cash
settlement price should be an accurate and
reliable indicator of prices in the underlying
cash market. A cash settlement price also
should be acceptable to commercial users of
the cash-settled swap contract. A swap
execution facility should fully document that
a settlement price is accurate, reliable,
widely regarded by industry/market
participants. To the extent possible, the cash
settlement price series of the swap should be
based on reference prices that are publicly
available on a timely basis. A swap execution
facility should make the cash settlement
price, as well as any other supporting
information that is appropriate for release to
the public, available to the public when cash
settlement is conducted. If the cash
settlement price is based on reference prices
that are obtained from non-public sources
(e.g., cash market surveys conducted by the
swap execution facility or by third parties on
behalf of the swap execution facility), then a
swap execution facility should make
available to the public the cash settlement
price as well as any other supporting
information that is appropriate or feasible to
make available to the public.
(iv) Minimum price fluctuation (minimum
tick). For standardized swap contracts, the
minimum price increment (tick) should be
set at a level that is consistent with cash
market transactions for the underlying
commodity. For non-standardized swap
contracts, a swap execution facility may
choose to not specify a minimum price
increment (tick).
(v) Intraday market restrictions. A swap
execution facility may have intraday market
restrictions that pause or halt trading in the
event of extraordinary price moves that may
result in distorted prices. If a swap execution
facility adopts such restrictions, they should
not be unduly restrictive of trading. For swap
contracts based on security indexes, intraday
price limits and trading halts should be
coordinated with circuit breakers of national
security exchanges.
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(vi) Last trading day. If a swap execution
facility chooses to allow trading to occur
through the determination of a settlement
price, then the swap execution facility
should demonstrate that swap trading would
not distort the settlement price calculation.
For standardized swap contracts,
specification of the last trading day should
take into consideration whether the volume
of transactions underlying the cash
settlement price would be unduly limited by
the occurrence of holidays or traditional
holiday periods in the cash market. For nonstandardized swap contracts, a swap
execution facility may allow the last trading
day to be negotiable.
(b) Guidance for physically-settled swaps.
(1) General definition. A physically-settled
swap contract is any swap agreement, as
defined in section 1a(47) of the Act, that may
result in physical settlement. Generally, these
are agreements where the primary intent is to
transfer the financial risk associated with the
underlying commodity and not primarily to
make or take delivery of the commodity.
(2) Estimating deliverable supplies. A swap
execution facility should estimate the
deliverable supply for which a swap contract
is not readily susceptible to manipulation.
The estimate of deliverable supply should be
adequate to ensure that the swap contract is
not readily susceptible to price manipulation.
In general, the term ‘‘deliverable supply’’
means the quantity of the commodity
meeting the swap contract’s delivery
specifications that reasonably can be
expected to be readily available to short
traders and salable by long traders at its
market value in normal cash marketing
channels at the swap contract’s delivery
points during the specified delivery period,
barring abnormal movement in interstate
commerce. For a non-financial physicallysettled swap contract, this estimate should
include all available supply that meets the
swap contract’s specifications and can be
delivered at prevailing market prices via the
delivery procedures set forth in the swap
contract. Among this eligible supply, the
estimate of deliverable supply can consist of:
(i) Commercially available imports;
(ii) Product which is in storage at the
delivery point(s) specified in the swap
contract; and
(iii) Product which is available for sale on
a spot basis within the marketing channels
that normally are tributary to the delivery
point(s). Furthermore, an estimate of
deliverable supply should exclude quantities
that at current price levels are not
economically obtainable or deliverable or
were previously committed for long-term
agreements. The size of commodity supplies
that are committed to long-term agreements
may be estimated by consulting with market
participants. However, if the estimated
deliverable supply that is committed for
long-term agreements, or significant portion
thereof, can be demonstrated by the swap
execution facility to be consistently and
regularly made available to the spot market
for shorts to acquire at prevailing economic
values, then those ‘‘available’’ supplies
committed for long-term contracts may be
included in the swap execution facility’s
estimate of deliverable supply for that
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commodity. To the extent possible and that
data resources permit, deliverable supply
estimates should be constructed such that the
data reflect the market defined by the swap
contract’s terms and conditions, and should
be formulated, whenever possible, with
government or publicly available data. All
deliverable supply estimates should be fully
defined, have all underlying assumptions
explicitly stated, and have documentation of
all data/information sources in order to
permit estimate replication by Commission
staff.
(iv) Accounting for variations in
deliverable supplies. To assure the
availability of adequate deliverable supplies,
a swap contract’s terms and conditions
should assess adequately the potential range
of deliverable supplies and account for
variations in the patterns of production,
consumption, and supply over a period of at
least three years. This assessment also should
consider seasonality, growth, and market
concentration in the production/
consumption of the underlying cash
commodity. Patterns of variations in the
deliverable supply are more apparent when
deliverable supply estimates are calculated
on a monthly basis and when such monthly
estimates are provided for at least the most
recent three years for which data resources
permit. For commodities with seasonal
supply or demand characteristics, the
deliverable supply analysis should include
that period when potential supplies typically
are at their lowest levels. In addition,
consideration should be given to the relative
roles of producers, merchants, and
consumers in the production, distribution,
and consumption of the cash commodity and
whether the underlying commodity exhibits
a domestic or international export focus.
Careful consideration also should be given to
the quality of the cash commodity, the
movement or flow of the cash commodity in
normal commercial channels, and any
external factors or regulatory controls that
could affect the price or supply of the cash
commodity.
(3) Contract terms and conditions. For a
swap contract that is settled by physical
delivery, the terms and conditions of the
contract should conform to the most common
commercial practices and conditions in the
cash market for the commodity underlying
the swap contract. The terms and conditions
should be designed to avoid any
impediments to the delivery of the
commodity so as to promote convergence
between the value of the swap contract and
the cash market value of the commodity at
the expiration of the swap contract. An
acceptable specification of terms and
conditions would include, but may not be
limited to, rules that address, as appropriate,
the following criteria and comply with the
associated standards:
(i) Quality standards. The terms and
conditions of a swap contract should
describe or define all of the economically
significant characteristics or attributes of the
commodity underlying the contract. In
particular, the quality standards should be
described or defined so that such standards
reflect those used in transactions in the
commodity in normal cash marketing
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channels. Documentation establishing that
the quality standards of the swap contract’s
underlying commodity comply with those
accepted/established by the industry, by
government regulations, and/or by relevant
laws should also be submitted. For any
particular swap contract, the specific
attributes that should be enumerated depend
upon the individual characteristics of the
underlying commodity. These may include,
for example, the following items: Grade,
quality, purity, weight, class, origin, growth,
issuer, originator, maturity window, coupon
rate, source, hours of trading, etc. If the terms
of the swap contract provide for the delivery
of multiple qualities of a specific attribute of
the commodity having different cash market
values, then a ‘‘par’’ quality should be
specified with price differentials applicable
to the ‘‘non-par’’ qualities that reflect
discounts or premiums commonly observed
or expected to occur in the cash market for
that commodity.
(ii) Delivery points and facilities. Delivery
point/area specifications should provide for
delivery at a single location or at multiple
locations where the underlying cash
commodity is normally transacted or stored
and where there exists a viable cash
market(s). If multiple delivery points are
specified and the value of the commodity
differs between these locations, a swap
contract’s terms should include price
differentials that reflect usual and observed
differences in value between the different
delivery locations. If the price relationships
among the delivery points are unstable and
a swap execution facility chooses to adopt
fixed locational price differentials, such
differentials should fall within the range of
commonly observed or expected commercial
price differences. In this regard, any price
differentials should be supported with cash
price data for the delivery location(s) for a
period of three years. The price differential
should be updated periodically to reflect
prevailing market conditions. The terms and
conditions of a swap contract also should
specify, as appropriate, any conditions the
delivery facilities and/or delivery facility
operators should meet in order to be eligible
for delivery. Specification of any
requirements for delivery facilities also
should consider the extent to which
ownership of such facilities is concentrated
and whether the level of concentration would
be susceptible to manipulation of the swap
contract’s prices. Physically-settled swap
contracts also should specify appropriately
detailed delivery procedures that describe
the responsibilities of deliverers, receivers,
and any required third parties in carrying out
the delivery process. Such responsibilities
could include allocation between buyer and
seller of all associated costs such as load-out,
document preparation, sampling, grading,
weighing, storage, taxes, duties, fees, drayage,
stevedoring, demurrage, dispatch, etc.
Required accreditation for third-parties also
should be detailed. These procedures should
seek to minimize or eliminate any
impediments to making or taking delivery by
both deliverers and takers of delivery to help
ensure convergence of the cash price and
swap price.
(iii) Delivery period and last trading day.
An acceptable specification of the delivery
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period would allow for sufficient time for
deliverers to acquire the deliverable
commodity and make it available for
delivery, considering any restrictions or
requirements imposed by the swap execution
facility. For standardized swap contracts,
specification of the last trading day for
expiring swap contracts should consider
whether adequate time remains after the last
trading day to allow for delivery on the
contract. For non-standardized swap
contracts, a swap execution facility may
allow the delivery period to be negotiable.
(iv) Contract size and trading unit.
Generally, swap contract sizes and trading
units for standardized contracts should be
determined after a careful analysis of relevant
cash market trading practices, conditions,
and deliverable supply estimates, so as to
ensure that the underlying commodity
market and available supply sources are able
to support the contract sizes and trading
units at all times. For non-standardized swap
contracts, a swap execution facility may
allow the contract sizes and trading units to
be negotiable.
(v) Delivery pack. The term ‘‘delivery
pack’’ refers to the specific cash market
packaging standards (e.g., product may be
delivered in burlap or polyethylene bags
stacked on wooden pallets) or non-quality
related standards regarding the composition
of commodity within a delivery unit (e.g.,
product must all be imported from the same
country or origin). An acceptable
specification of the delivery pack or
composition of a swap contract’s delivery
unit should reflect, to the extent possible,
specifications commonly applied to the
commodity traded or transacted in the cash
market.
(vi) Delivery instrument. An acceptable
specification of the delivery instrument (e.g.,
warehouse receipt, depository certificate or
receipt, shipping certificate, bill of lading, inline transfer, book transfer of securities, etc.)
would provide for its conversion into the
cash commodity at a commerciallyreasonable cost. Transportation terms (e.g.,
FOB, CIF, freight prepaid to destination) as
well as any limits on storage or certificate
daily premium fees should be specified.
These terms should reflect cash market
practices and the customary provision for
allocating delivery costs between buyer and
seller.
(vii) Inspection provisions. Any
inspection/certification procedures for
verifying compliance with quality
requirements or any other related delivery
requirements (e.g., discounts relating to the
age of the commodity, etc.) should be
specified in the swap contract’s rules. An
acceptable specification of inspection
procedures would include the establishment
of formal procedures that are consistent with
procedures used in the cash market. To the
extent that formal inspection procedures are
not used in the cash market, an acceptable
specification would contain provisions that
assure accuracy in assessing the commodity,
that are available at a low cost, that do not
pose an obstacle to delivery on the swap
contract and that are performed by a
reputable, disinterested third party or by
qualified swap execution facility employees.
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Inspection terms also should detail which
party pays for the service, particularly in
light of the possibility of varying inspection
results.
(viii) Delivery months. Delivery months
should be established based on the risk
management needs of commercial entities as
well as the availability of deliverable
supplies in the specified months.
(ix) Minimum price fluctuation (minimum
tick). For standardized swap contracts, the
minimum price increment (tick) should be
set at a level that is in line with cash market
transactions for the underlying commodity.
For non-standardized swap contracts, a swap
execution facility may choose to not specify
a minimum price increment (tick).
(x) Maximum price fluctuation limits. A
swap execution facility may adopt price
limits to (1) reduce or constrain price
movements in a trading day that may not be
reflective of true market conditions but might
be caused by traders overreacting to news
and (2) provide a ‘‘cooling-off’’ period for
swap market participants to respond to bona
fide changes in market supply and demand
fundamentals that would lead to large cash
and swap price changes. If price limit
provisions are adopted, the limits should be
set at levels that are not overly restrictive in
relation to price movements in the cash
market for the commodity underlying the
swap contract.
(c) Guidance for options on swap contracts.
The Commission believes that, provided
the underlying swap complies with the
relevant guidance in this Appendix C, any
specification of the following terms would be
acceptable; the primary requirement is that
such terms be specified in an objective
manner in the option contract’s rules:
(1) Exercise method;
(2) Exercise procedure;
(3) Strike price provisions;
(4) Automatic exercise provisions;
(5) Contract size;
(6) Option expiration and last trading day;
and (vii) option type and trading convention;
and
(7) For non-standardized swap contracts, a
swap execution facility may allow these
contract terms to be negotiable.
(d) Guidance for options on physicals
contracts.
(1) Under the Commission’s regulations,
the term ‘‘option on physicals’’ refers to
option contracts that do not provide for
exercise into an underlying futures contract.
Upon exercise, options on physicals can be
settled via physical delivery of the
underlying commodity or by a cash payment.
Thus, options on physicals raise many of the
same issues associated with trading in other
types of swap contracts such as the adequacy
of deliverable supplies or acceptability of the
cash settlement price series. In this regard, an
option that is cash settled based on the
settlement price of a futures contract or a
swap contract would be considered an
‘‘option on physicals’’ and the futures or
swap settlement price would be considered
the cash price series.
(2) In view of the above, acceptable
practices for the terms and conditions of
options on physicals contracts include, as
appropriate, those practices set forth above
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for physical-delivery or cash-settled swap
contracts plus the practices set forth for
options on swap contracts.
PART 38—DESIGNATED CONTRACT
MARKETS
9. The authority citation for part 38
continues to read as follows:
■
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e,
6f, 6g, 6i, 6j, 6k, 6l, 6m, 6n, 7, 7a–2, 7b, 7b–
1, 7b–3, 8, 9, 15, and 21, as amended by the
Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111–203,
124 Stat. 1376.
§ § 38.11 and 38.12
reserved]
[Removed and
10. Remove and reserve §§ 38.11 and
38.12.
■
PART 39—DERIVATIVES CLEARING
ORGANIZATIONS
11. The authority citation for part 39
continues to read as follows:
■
Authority: 7 U.S.C. 2, 7a–1, and 12a; 12
U.S.C. 5464; 15 U.S.C. 8325.
12. In § 39.12, revise paragraph (b)(7)
to read as follows:
■
accept or reject for clearing all
agreements, contracts, and transactions
as quickly after submission to the
derivatives clearing organization as
would be technologically practicable if
fully automated systems were used. The
derivatives clearing organization shall
accept all agreements, contracts, and
transactions:
(A) For which the executing parties
have clearing arrangements in place
with clearing members of the
derivatives clearing organization;
(B) For which a derivatives clearing
organization has been identified as the
intended clearinghouse; and
(C) That satisfy the criteria of the
derivatives clearing organization,
including, but not limited to, applicable
risk filters; provided that such criteria
are non-discriminatory across trading
venues and are applied as quickly as
would be technologically practicable if
fully automated systems were used.
*
*
*
*
*
PART 43—REAL-TIME PUBLIC
REPORTING
13. The authority citation for part 43
continues to read as follows:
■
§ 39.12
Participant and product eligibility.
*
*
*
*
*
(b) * * *
(7) Time frame for clearing—(i)
Coordination with markets and clearing
members. (A) Each derivatives clearing
organization shall coordinate with each
designated contract market and swap
execution facility that lists for trading a
product that is cleared by the
derivatives clearing organization in
developing rules and procedures to
facilitate prompt, efficient, and accurate
processing and routing of all
agreements, contracts, and transactions
submitted to the derivatives clearing
organization for clearing.
(B) Each derivatives clearing
organization shall coordinate with each
clearing member that is a futures
commission merchant, swap dealer, or
major swap participant to establish
systems that enable the clearing
member, or the derivatives clearing
organization acting on its behalf, to
accept or reject each agreement,
contract, or transaction submitted to the
derivatives clearing organization for
clearing by or for the clearing member
or a customer of the clearing member as
quickly as would be technologically
practicable if fully automated systems
were used.
(ii) Agreements, contracts, and
transactions submitted for clearing to a
derivatives clearing organization. Each
derivatives clearing organization shall
have rules that provide that the
derivatives clearing organization will
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Authority: 7 U.S.C. 2(a), 12a(5) and 24a, as
amended by Pub. L. 111–203, 124 Stat. 1376
(2010).
■
14. Revise § 43.2 to read as follows:
§ 43.2
Definitions.
As used in this part:
Act means the Commodity Exchange
Act, as amended, 7 U.S.C. 1 et seq.
Affirmation means the process by
which parties to a swap verify (orally,
in writing, electronically or otherwise)
that they agree on the primary economic
terms of a swap (but not necessarily all
terms of the swap). Affirmation may
constitute ‘‘execution’’ of the swap or
may provide evidence of execution of
the swap, but does not constitute
confirmation (or confirmation by
affirmation) of the swap.
Appropriate minimum block size
means the minimum notional or
principal amount for a category of
swaps that qualifies a swap within such
category as a block trade or large
notional off-facility swap.
As soon as technologically practicable
means as soon as possible, taking into
consideration the prevalence,
implementation and use of technology
by comparable market participants.
Asset class means a broad category of
commodities including, without
limitation, any ‘‘excluded commodity’’
as defined in section 1a(19) of the Act,
with common characteristics underlying
a swap. The asset classes include
interest rate, foreign exchange, credit,
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equity, other commodity and such other
asset classes as may be determined by
the Commission.
Block trade means a publicly
reportable swap transaction that:
(1) Involves a swap that is listed on
a registered swap execution facility or
designated contract market;
(2) Is executed on a registered swap
execution facility or occurs away from
a designated contract market’s trading
system or platform and is executed
pursuant to that designated contract
market’s rules;
(3) Has a notional or principal amount
at or above the appropriate minimum
block size applicable to such swap; and
(4) Is reported subject to the rules and
procedures of the registered swap
execution facility or designated contract
market and the rules described in this
part, including the appropriate time
delay requirements set forth in § 43.5.
Business day means the twenty-four
hour day, on all days except Saturdays,
Sundays and legal holidays, in the
location of the reporting party or
registered entity reporting data for the
swap.
Business hours mean the consecutive
hours of one or more consecutive
business days.
Cap size means, for each swap
category, the maximum notional or
principal amount of a publicly
reportable swap transaction that is
publicly disseminated.
Confirmation means the
consummation (electronic or otherwise)
of legally binding documentation
(electronic or otherwise) that
memorializes the agreement of the
parties to all terms of a swap. A
confirmation shall be in writing
(electronic or otherwise) and shall
legally supersede any previous
agreement (electronic or otherwise)
relating to the swap.
Confirmation by affirmation means
the process by which one party to a
swap acknowledges its assent to the
complete swap terms submitted by the
other party to the swap. If the parties to
a swap are using a confirmation service
vendor, complete swap terms may be
submitted electronically by a party to
such vendor’s platform and the other
party may affirm such terms on such
platform.
Economically related means a direct
or indirect reference to the same
commodity at the same delivery
location or locations, or with the same
or a substantially similar cash market
price series.
Embedded option means any right,
but not an obligation, provided to one
party of a swap by the other party to the
swap that provides the party holding the
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option with the ability to change any
one or more of the economic terms of
the swap as those terms previously were
established at confirmation (or were in
effect on the start date).
Executed means the completion of the
execution process.
Execution means an agreement by the
parties (whether orally, in writing,
electronically, or otherwise) to the terms
of a swap that legally binds the parties
to such swap terms under applicable
law. Execution occurs simultaneous
with or immediately following the
affirmation of the swap.
Futures-related swap means a swap
(as defined in section 1a(47) of the Act
and as further defined by the
Commission in implementing
regulations) that is economically related
to a futures contract.
Large notional off-facility swap means
an off-facility swap that has a notional
or principal amount at or above the
appropriate minimum block size
applicable to such publicly reportable
swap transaction and is not a block
trade as defined in § 43.2.
Major currencies mean the currencies,
and the cross-rates between the
currencies, of Australia, Canada,
Denmark, New Zealand, Norway, South
Africa, South Korea, Sweden, and
Switzerland.
Non-major currencies mean all other
currencies that are not super-major
currencies or major currencies.
Novation means the process by which
a party to a swap transfers all of its
rights, liabilities, duties and obligations
under the swap to a new legal party
other than the counterparty to the swap.
The transferee accepts all of the
transferor’s rights, liabilities, duties and
obligations under the swap. A novation
is valid as long as the transferor and the
remaining party to the swap are given
notice, and the transferor, transferee and
remaining party to the swap consent to
the transfer.
Off-facility swap means any publicly
reportable swap transaction that is not
executed on or pursuant to the rules of
a registered swap execution facility or
designated contract market.
Other commodity means any
commodity that is not categorized in the
other asset classes as may be determined
by the Commission.
Physical commodity swap means a
swap in the other commodity asset class
that is based on a tangible commodity.
Public dissemination and publicly
disseminate means to publish and make
available swap transaction and pricing
data in a non-discriminatory manner,
through the internet or other electronic
data feed that is widely published and
in machine-readable electronic format.
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Publicly reportable swap transaction
means:
(1) Unless otherwise provided in this
part—
(i) Any executed swap that is an
arm’s-length transaction between two
parties that results in a corresponding
change in the market risk position
between the two parties; or
(ii) Any termination, assignment,
novation, exchange, transfer,
amendment, conveyance, or
extinguishing of rights or obligations of
a swap that changes the pricing of the
swap.
(2) Examples of executed swaps that
do not fall within the definition of
publicly reportable swap may include:
(i) Internal swaps between onehundred percent owned subsidiaries of
the same parent entity; and
(ii) Portfolio compression exercises.
(3) These examples represent swaps
that are not at arm’s length and thus are
not publicly reportable swap
transactions, notwithstanding that they
do result in a corresponding change in
the market risk position between two
parties.
Real-time public reporting means the
reporting of data relating to a swap
transaction, including price and
volume, as soon as technologically
practicable after the time at which the
swap transaction has been executed.
Reference price means a floating price
series (including derivatives contract
prices and cash market prices or price
indices) used by the parties to a swap
or swaption to determine payments
made, exchanged or accrued under the
terms of a swap contract.
Remaining party means a party to a
swap that consents to a transferor’s
transfer by novation of all of the
transferor’s rights, liabilities, duties and
obligations under such swap to a
transferee.
Reporting party means the party to a
swap with the duty to report a publicly
reportable swap transaction in
accordance with this part and section
2(a)(13)(F) of the Act.
Super-major currencies mean the
currencies of the European Monetary
Union, Japan, the United Kingdom, and
United States.
Swaps with composite reference
prices mean swaps based on reference
prices that are composed of more than
one reference price from more than one
swap category.
Transferee means a party to a swap
that accepts, by way of novation, all of
a transferor’s rights, liabilities, duties
and obligations under such swap with
respect to a remaining party.
Transferor means a party to a swap
that transfers, by way of novation, all of
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its rights, liabilities, duties and
obligations under such swap, with
respect to a remaining party, to a
transferee.
Trimmed data set means a data set
that has had extraordinarily large
notional transactions removed by
transforming the data into a logarithm
with a base of 10, computing the mean,
and excluding transactions that are
beyond four standard deviations above
the mean.
Unique product identifier means a
unique identification of a particular
level of the taxonomy of the product in
an asset class or sub-asset class in
question, as further described in
§ 43.4(f) and appendix A to this part.
Such unique product identifier may
combine the information from one or
more of the data fields described in
appendix A to this part.
Widely published means to publish
and make available through electronic
means in a manner that is freely
available and readily accessible to the
public.
Issued in Washington, DC, on November 6,
2018, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not
appear in the Code of Federal Regulations.
Appendices To Swap Execution
Facilities and Trade Execution
Requirement—Commission Voting
Summary, Chairman’s Statement, and
Commissioners’ Statements
Appendix 1—Commission Voting
Summary
On this matter, Chairman Giancarlo and
Commissioners Quintenz, Behnam, and
Stump voted in the affirmative.
Commissioner Berkovitz voted in the
negative.
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Appendix 2—Statement of Chairman J.
Christopher Giancarlo
I start by referencing an important White
Paper written in 1970 by a young graduate
student in economics at UC Berkeley. That
White Paper, entitled, ‘‘Preliminary Design
for an Electronic Market,’’ written for the
Pacific Commodity Exchange, was the
world’s first written conceptualization of a
fully electronic, for-profit futures exchange.
The White Paper was written by Dr.
Richard Sandor. That White Paper has now
been republished in a new book by Dr.
Sandor.1 In it, he recounts how his idea lay
mostly dormant through the 1970s to mid1980s before being slowly developed, in fits
and starts, first in Europe in the 1990s and
then in the United States in the 2000s. His
book notes that electronic execution of
1 Sandor, Richard L., ‘‘Electronic Trading &
Blockchain: Yesterday, Today and Tomorrow,’’
2018, World Scientific Publishing Co. Pte. Ltd.
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futures products with continuous liquidity
has become almost ubiquitous today, while
other exchange traded asset classes with
more episodic liquidity, like options and
swaps, continue to trade by voice.
What I found fascinating in Dr. Sandor’s
recounting of this five-decade long evolution
from trading pits to electronic trading of
futures was the absence of any grand plan
behind the transformation. Instead, it was a
series of incremental commercial
developments and technology innovations.
At all times, the impetus was the demands
of market participants and the response of
market operators to reduce trading costs and
transaction friction. At no time, did
government step in and say, ‘‘Henceforth, all
futures trading shall be on electronic
exchanges.’’ Instead, market evolution
happened because a good idea was coupled
with capable technology and mutual
commercial interest with enough time to
catch on and gain traction.
Before I joined the Commission, I spent a
decade and a half at a leading operator of
swaps marketplaces. We launched many
innovative electronic platforms still in use
today. Some of the platforms caught right on
with our customers, others did not. Yet, we
designed all of them to increase efficiency
and reduce trading friction. It was just that
sometimes our competitors designed better or
cheaper ones or just simply got the timing
right.
The point is that the design of trading
platforms and the evolution of market
structure is best done by platform operators,
through trial and error, customer demand,
commercial response and technological
innovation. Regulators will never be close
enough to the heartbeat of the markets, the
spark of technology or the cost of
development to prescribe the optimal design
of trading platforms or business methods.
Regulators can never know which trading
methods will work best in the full range of
market conditions, from low to extreme
volatility.
Congress understood this. That is why
Title VII of Dodd-Frank permits Swap
Execution Facilities (SEFs) to conduct their
activities through ‘‘any means of interstate
commerce,’’ not ‘‘such means that may be
chosen by regulators.’’
Once regulators step in and dictate who
serves who with what type of service, we are
picking winners and losers. We are simply
not authorized, nor are we competent, to act
in this way. If we do, the winners will
invariably be those with the most persuasive
voices and best lobbyists.
Congress knew that swaps are not traded
by retail participants, but for sophisticated,
institutional traders. Wall Street banks, hedge
funds, prop shops and large energy
companies have the wherewithal to demand
the transaction services they need without
regulators holding their hands. And the
platform operators are not public utilities,
but seasoned competitors. If there is money
to be made, trading efficiencies to be
achieved, customers to be served or costs to
be saved, they will find them. If there is a
better mousetrap to be built, they will build
it.
Unfortunately, the CFTC did not listen to
Congress. Contrary to provisions of Dodd-
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Frank that permit SEFs to operate by ‘‘any
means of interstate commerce,’’ the current
SEF rules constrain swaps trading to two
methods of execution—request-for-quote or
order book. While swaps not subject to the
trade execution mandate can utilize other
methods, SEFs must nevertheless provide an
order book for such permitted transactions.
All other ‘‘required’’ transactions have to be
executed exclusively on one of those two
options. Further, the rules incorporate a
number of practices from futures markets that
are antithetical to swaps trading, such as the
15 second ‘‘cross’’ and execution of block
trades off platform. Additionally, the SEF
core principles are interpreted in ways that
are not conducive to environments in which
swaps liquidity is formed and price
discovery is conducted.
One effect of this approach has been to
incentivize the shift of swaps price discovery
and liquidity formation away from SEFs to
introducing brokers (or ‘‘IBs’’). SEFs have
turned into booking engines for trades
formulated elsewhere, often on IBs. Yet, IBs
are not appropriate vehicles to formulate
swaps transactions. The intended purpose of
IBs in the CFTC’s regulatory framework is to
solicit orders for futures transactions, not
swaps. Moving swaps price discovery and
liquidity formation away from SEFs to IBs is
not what Congress intended in Dodd-Frank.
The goal was to have the entire process of
swaps liquidity formation, price discovery
and trade execution take place on licensed
SEF platforms. IBs are not subject to conduct
and compliance requirements appropriate for
swaps trading. Their employees are not
required to pass exams for proficiency in
serving institutional market participants in
over-the-counter swaps markets but they are
for retail customers who are prohibited from
trading swaps.
Another effect of the current approach is
the paucity of platform innovation and new
platform operators competing for market
share. The stagnation has allowed a few
incumbents to consolidate and dominate
market share. According to one large swaps
trader, ‘‘the biggest disappointment of SEFs
is that nothing has really changed. I’m still
trading the same way today as I was 10 years
ago.’’ 2 And, yet, the current rules were
supposed to have caused as much as a
hundred firms to register as SEFs.3
I have written a few white papers of my
own. I have called for revising our current
restrictions on SEF activity and allowing
flexible methods of execution for swaps
transactions using any means of interstate
commerce, exactly as Congress intended.4
2 Robert Mackenzie Smith, ‘‘SEF reforms could
distort new, sounder benchmark rates,’’ Risk.net, 19
Oct. 2016, at: https://www.risk.net/derivatives/
6049931/sef-reforms-could-distort-new-sounderbenchmark-rates.
3 Christopher Doering & Roberta Rampton, ‘‘US
May See 100 New Swaps Execution Entities:
Broker,’’ Reuters, Oct. 12, 2010, at: https://
www.reuters.com/article/us-financial-regulationsefs/u-s-may-see-100-new-swap-execution-entitiesbroker-idUSTRE69B69020101012.
4 Commissioner J. Christopher Giancarlo, ProReform Reconsideration of the CFTC Swaps Trading
Rules: Return to Dodd-Frank, Jan. 29, 2015, https://
www.cftc.gov/idc/groups/public/@newsroom/
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Today’s proposal does just that. It will
allow SEFs to innovate to meet customer
demand and operate trading environments
that are more salutatory to the more episodic
nature of swaps liquidity. At the same time,
it will make the ‘‘made available for trading’’
determination synonymous with the clearing
determination to include all swaps subject to
the clearing requirement and listed by a SEF
or DCM. This is meant to bring the full range
of liquidity formation, price discovery and
trade execution on SEFs for a broader range
of swaps products.
The promotion of swaps trading on SEFs
brings ‘‘daylight to the marketplace’’ by
subjecting a much broader range of swaps
products to SEF record keeping, regulatory
supervision and oversight, just as Congress
intended.
It is said that if CFTC mandates for
minimum trading functionality go away, so
will the current degree of electronic
execution in the market. Sorry, but that is a
naı¨ve concern. Those electronic SEF
platforms that are successful provide too
much competitive advantage and cost
efficiency and sunk costs to be shut down
simply because they are no longer subject to
a regulatory mandate. No firm is going to give
up electronic trading market share and
profitability and increase trading friction
because regulation suddenly becomes less
prescriptive.
A word about ‘‘impartial access,’’ DoddFrank requires SEFs to have rules to provide
market participants with ‘‘impartial access’’
to the market and permits SEFs to establish
rules regarding any limitation on access.
‘‘Impartial access’’ means just that,
‘‘impartial’’. It does not mean that SEFs must
serve every type of market participant in an
all-to-all environment. If it did, then
Congress would not have allowed SEFs to
establish rules for limitation of access.
The new proposal would establish what is
meant by ‘‘impartial access’’. The proposal
will generally define ‘‘impartial’’ as
transparent, fair and non-discriminatory as
applied to all similarly situated market
participants in a fair and non-discriminatory
manner based on objective, pre-established
requirements.
Today’s proposal would also enhance the
professionalism of SEF personnel who
exercise discretion by adopting proficiency
requirements and conduct standards suitable
for swaps. Furthermore, the proposal adopts
rule changes in a number of places where
staff has previously issued guidance or noaction relief from the current rules, thereby
increasing regulatory clarity and certainty.
We have approached today’s proposal with
the principle that the CFTC engage its
international counterparts with respect and
due consideration. The staff of the CFTC and
I have made every effort to ensure that nonU.S. authorities had the opportunity to
review and discuss the 2015 SEF White
Paper that set out the concepts underlying
today’s proposal. Based on that outreach, I
see no reason why today’s proposal would be
documents/file/sefwhitepaper012915.pdf; (‘‘2015
SEF White Paper’’); and Swaps Regulation Version
2.0: An Assessment of the Current Implementation
of Reform and Proposals for Next Steps, April 26,
2018.
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viewed as inconsistent with the regulatory
systems of other G20 jurisdictions. We
certainly welcome further dialogue with
them. In fact, today’s proposal is entirely
consistent with, and anticipated by, recent
discussions with foreign authorities about the
CFTC’s SEF regime, including the
equivalence agreement for swaps trading
platforms with the European Commission
that EC Vice President Dombrovskis and I
announced one year ago here in this room.
That agreement, which focused on an
outcomes-based approach toward EU
equivalence and CFTC exemptions, was
made by both parties with full knowledge
and understanding of the changes advocated
in the 2015 SEF White Paper and presented
to us today.
Let me briefly address today’s request for
comment on the practice of name give up in
swaps markets. There are a range of
perspectives on this market practice. I have
an open mind as to the advisability of
restrictions on the practice and what form a
rule would take, if at all. I look forward to
comments and hearing more about the
current impact of this practice in the
marketplace.
One final point: Today’s proposal will
invariably be slammed by opponents of
change as a ‘‘rollback’’ of Dodd-Frank. Any
such characterization would be
disingenuous.
Those who examine my record know that
I have been a consistent supporter of the
swaps reforms embodied in Title VII of the
Dodd-Frank Act. In fact, of the current five
Commissioners, I may have been the first to
publicly state my support for Title VII.5 And,
I have not waivered since. Congress got Title
VII right. There, I said it again.
My support for the Title VII reforms—
swaps clearing, swap dealer registration and
requirements, trade reporting and regulated
swaps execution—is not based on academic
theory or political ideology. It is based on
fifteen years of commercial experience. Done
right, the reforms are good for American
markets.
So is today’s proposal. It is not a rollback,
but a policy improvement, a step forward, to
enhance swaps market health and vitality
that is true to Congressional intent and
purpose. I trust that market participants and
interested parties will fairly consider it with
the good faith with which it is presented. I
look forward to a broad and active
discussion.
In closing, I compliment the DMO staff for
putting together a balanced rule proposal and
request for comment. I would like to
commend them for their many hours of hard
work, the quality of the written proposal and
their thoughtfulness and engagement
throughout.
You know, it is satisfying to see how an old
White Paper, with ample time and reflection,
can become a formal proposal, an arrow
hitting its mark.
5 Wholesale Markets Brokers’ Association,
Americas, Commends Historic US Financial
legislation, Jul. 21 2010, available at: https://
www.lexissecuritiesmosaic.com/gateway/CFTC/
Speech/01_WMBAA-Dodd-Frank-Law-press-releasefinal123.pdf.
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I look forward to the public’s comments,
healthy discussion, and a final rule in 2019.
Appendix 3—Supporting Statement of
Commissioner Brian D. Quintenz
I will vote in favor of issuing today’s
proposed rule and the request for comment
reforming the regulatory regime of swap
execution facilities (SEFs). The Chairman has
shown great thought leadership and
transparency in consistently and fully
articulating his vision for swaps trading rules
that would create a more cohesive, liquid
swap marketplace. Today’s proposal
represents a significant step toward executing
that vision. I look forward to hearing from
market participants about how these broad
reforms will work collectively to impact SEF
trading dynamics and liquidity formation.
Mr. Chairman, I know this day has been a
long time coming, and I congratulate you and
the Division of Market Oversight for all of
your and their tireless work on this proposed
rule.
Appendix 4—Concurring Statement of
Commissioner Rostin Behnam
Introduction
Today, the Commission votes to issue
proposed rules that would constitute an
overhaul of the existing framework for swap
execution facilities (SEFs). Given the breadth
and complexity of the proposed rules before
us, the process of public comment is
particularly important. I look forward to
receiving input from market participants and
the public who would be impacted, in any
way, by a reworking of the SEF rules.
Background
As we consider the goals and therefore the
direction of any SEF reform, I think it is very
important that we first review how we got
where we are today. Prior to the 2008
financial crisis, swaps were largely exempt
from regulation and traded exclusively overthe-counter, rather than on a regulated
exchange.1 Lack of transparency in the overthe-counter swaps market contributed to the
financial crisis because both regulators and
market participants lacked the visibility
necessary to identify and assess swaps
market exposures and counterparty
relationships.2 In the aftermath of the
financial crisis, Congress enacted the DoddFrank Wall Street Reform and Consumer
Protection Act in 2010 (Dodd-Frank Act).3
The Dodd-Frank Act largely incorporated the
international financial reform initiatives for
over-the-counter derivatives laid out at the
2009 G20 Pittsburgh Summit aimed at
improving transparency, mitigating systemic
1 See Commodity Futures Modernization Act of
2000, Public Law 106–554, 114 Stat. 2763 (2000).
2 See The Financial Crisis Inquiry Commission,
The Financial Crisis Inquiry Report: Final Report of
the National Commission on the Causes of the
Financial and Economic Crisis in the United States
(Official Government Edition), at 299, 352, 363–364,
386, 621 n. 56 (2011), available at https://
www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPOFCIC.pdf.
3 See Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111–203, 124
Stat. 1376 (2010).
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risk, and protecting against market abuse.4
Title VII of the Dodd-Frank Act amended the
Commodity Exchange Act (CEA or Act) to
establish a comprehensive new swaps
regulatory framework that includes the
registration and oversight of a new registered
entity—SEFs. A key goal of Title VII of the
Dodd-Frank Act is to bring greater pre-trade
and post-trade transparency to the swaps
market. The concept of transparency runs
throughout Title VII—starting with the title
itself: The ‘‘Wall Street Transparency and
Accountability Act of 2010.’’ 5
As part of the Dodd-Frank effort to provide
more transparency, in 2013 the Commission
adopted the part 37 rules in order to
implement a regulatory framework for SEFs.6
In so doing, the Commission emphasized that
‘‘[pre-trade] transparency lowers costs for
investors, consumers, and businesses; lowers
the risks of the swaps market to the economy;
and enhances market integrity to protect
market participants and the public.’’ 7
The relatively young SEF framework has in
many ways been a success. There are
currently 25 registered SEFs.8 Trading
volume on SEF has been steadily growing
each year.9 The Commission’s work to
promote swaps trading on SEFs has resulted
in increased liquidity, while adding pre-trade
price transparency and competition.10
This is not to say that the SEF rules were
perfect from the start and would not benefit
from some targeted changes. Most SEFs
operate under multiple no-action letters
granted by the Division of Market Oversight.
While the purpose of this form of targeted
relief was often to smooth the
implementation of the SEF framework,
codifying or eliminating the need for existing
no-action relief would provide market
participants with greater legal certainty.
The current SEF rules have not brought as
much trading onto SEFs as intended or
envisioned. We can improve upon that.
Currently, the Commission has a regulatory
process for SEFs to demonstrate through a
multi-factor analysis that a swap has been
made-available-to-trade, or ‘‘MAT,’’ 11
4 G20, Leaders’ Statement, The Pittsburgh Summit
(Sept. 24–25, 2009) at 9, available at https://
www.treasury.gov/resource-center/international/g7g20/Documents/pittsburgh_summit_leaders_
statement_250909.pdf.
5 See Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111–203, title
VII, Section 701, 124 Stat. 1376 (2010).
6 Core Principles and Other Requirements for
Swap Execution Facilities, 78 FR 33476 (Jun. 4,
2013).
7 Id. at 33477.
8 See Trading Organizations—Swap Execution
Facilities (SEF), CFTC.gov, https://sirt.cftc.gov/
SIRT/SIRT.aspx?Topic=SwapExecutionFacilities
(last visited Nov. 4, 2018).
9 See FIA SEF Tracker, FIA.org, https://fia.org/
node/1901/ (last visited Nov. 4, 2018).
10 See Bank of England Staff Working Paper No.
580, Centralized Trading, Transparency and Interest
Rate Swap Market Liquidity: Evidence from the
Implementation of the Dodd-Frank Act (May 2018),
pp. 2–4, 18–24, available at https://
www.bankofengland.co.uk/-/media/boe/files/
working-paper/2018/centralized-tradingtransparency-and-interest-rate-swap-marketliquidity-update.
11 See 17 CFR 37.10, 38.12.
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meaning that it is required to trade on a SEF
or DCM. The current process has resulted in
relatively few MAT determinations and, after
an initial flurry of submissions for the most
standardized and liquid products, no further
submissions have been made. I believe that
addressing the MAT process could bring
more activity on SEF, bringing pre-trade
transparency to more products without
dismantling the aspects of the SEF rules that
are working currently.
Notice of Proposed Rulemaking (NPRM)
While I believe targeted reforms could
bring more products onto SEFs, increase
transparency, and lower costs for market
participants, today’s NPRM is far from
targeted, and in some instances may
represent a regulatory overreach. I therefore
have a number of very serious concerns with
the NPRM’s approach and its far-ranging
alterations. First, the NPRM violates the clear
language of the Act, which states that one of
the major goals of the SEF regulatory regime
is to promote pre-trade transparency in the
swaps market. As discussed below, the
NPRM does exactly the opposite. Second, in
addition to reducing transparency, the
proposed rule also increases limitations on
access to SEFs. The NPRM purports to
increase choice and flexibility for SEFs;
however, it simultaneously allows SEFs to
limit choice and flexibility for market
participants. Third, as commenters and the
Commission think about the NPRM, I think
it is also important to consider whether we
would be creating a new registration scheme
that adds significant costs for market
participants, while failing to address the
fixable issues that exist in the market today.
Pre-Trade Transparency
Section 1a(50) of the Act defines a SEF as
‘‘a trading system or platform in which
multiple participants have the ability to
execute or trade swaps by accepting bids and
offers made by multiple participants in the
facility or system, through any means of
interstate commerce. . . .’’ 12 Section 5h(e)
of the Act states that ‘‘[t]he goal of this
section is to promote trading of swaps on
swap execution facilities and to promote pretrade transparency in the swaps market.’’ 13
The existing SEF rules establish two methods
of execution for required transactions: The
central limit order book (CLOB) and the
Request for Quote (RFQ) system.14 These
methods were chosen specifically because
they provide pre-trade transparency.
I am concerned that the NPRM goes too far
by allowing, literally, any means of
execution. The NPRM’s preamble states that
the approach ‘‘should also promote pre-trade
transparency in the swaps market by
allowing execution methods that maximize
participation and concentrate
liquidity. . . .’’ This simply cannot be true.
Absent a clear standard of what constitutes
pre-trade transparency, it is fairly easy to
envision an execution method that would not
provide pre-trade transparency—one need
look no further than the over-the-counter
12 7
U.S.C. 1a(50).
U.S.C. 7b–3(e).
14 See 17 CFR 37.9.
13 7
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system that preceded the financial crisis. But
this is more than a case of what the
Commission should or should not do. The
statute is clear. The Commission must
‘‘promote pre-trade transparency in the
swaps market.’’ Today’s NPRM would not do
that.
That is not to say that expanding methods
of execution—in a more limited and targeted
way—is a bad idea or violates the Act. There
are likely other execution methods that fit
within section 1a(50) and would promote
pre-trade transparency. I look forward to
hearing from commenters as to what those
methods might be, and debating with my
fellow Commissioners as to whether they are
appropriate within the confines of
congressional intent and ultimately the Act.
Made Available To Trade
As I mentioned earlier, the MAT process is
seemingly broken. The Commission stopped
receiving MAT submissions after an initial
set of submissions for the most standardized
and liquid swaps contracts.15 The
Commission has not received any MAT
submissions or made any MAT
determinations since 2014.16 This is not what
the Commission envisioned in promulgating
the Made Available to Trade rule.17 The
solution posited today is, in a sense, a
simple, elegant one. The NPRM states that
the phrase ‘‘makes the swap available to
trade’’ in CEA section 2h(8) should be
interpreted to mean that ‘‘once the clearing
requirement applies to a swap, then the trade
execution requirement applies to that swap
upon any single SEF or DCM listing the swap
for trading.’’ This would take both the SEF
and the Commission out of the determination
process.
My concern, however, is that there may be
products that are more appropriately traded
off SEF. In addition, tying the trade execution
requirement to the clearing requirement
could have unintended consequences—it
could actually discourage voluntary central
clearing.
I look forward to hearing from commenters
regarding the appropriate interpretation of
the term ‘‘made available to trade’’, including
how to improve the existing process.
Impartial Access
One of the most troubling aspects of the
NPRM is that it would alter the
Commission’s interpretation of ‘‘impartial
access’’ under SEF Core Principle 2. Core
Principle 2 of the Act requires SEFs to
establish and enforce participation rules that
‘‘provide market participants with impartial
access to the market.’’ 18 Current Commission
regulation 37.202(a) states that a SEF ‘‘shall
provide any eligible contract participant . . .
15 See CFTC, Industry Oversight, Industry Filings,
Swaps Made Available to Trade Determination,
https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20Swaps
MadeAvailableToTradeDetermination.
16 Id.
17 See Process for a Designated Contract Market or
Swap Execution Facility To Make a Swap Available
to Trade, Swap Transaction Compliance and
Implementation Schedule, and Trade Execution
Requirement Under the Commodity Exchange Act,
78 FR 33606 (Jun. 4, 2013).
18 7 U.S.C. 7b–3(f)(2).
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with impartial access to its market(s) and
market services.’’ (emphasis added). The
Commission was clear in the preamble to the
existing rules that ‘‘the purpose of the
impartial access requirement is to prevent a
SEF’s owners from using discriminatory
access requirements as a competitive tool’’
against certain eligible contract
participants.19 The current rule provides that
a SEF can restrict access based on
disciplinary history or financial or
operational soundness, if objective, preestablished criteria are used. What a SEF
cannot do is restrict access to certain types
of participants.
Today’s NPRM would roll back this
interpretation, leaving the term ‘‘impartial
access’’ an empty shell. The proposed rule
would ‘‘allow SEFs to serve different types of
market participants or have different access
criteria for different execution methods.’’
This is exactly the type of discrimination that
the ‘‘impartial access’’ provision in the Act
was intended to prevent.
I believe that all market participants
should have impartial access to a SEF whose
access criteria is applied in a fair and nondiscriminatory manner. Rather than erecting
new barriers to participation, we should
focus on applying our existing regulations as
they are clearly written. It seems to me that
impartial access theoretically would go handin-hand with the proposed widening of SEF
execution methods. Instead, the Commission
seems to be bending over backwards to be
impartial regarding SEFs’ modes of
execution, while allowing the SEFs
themselves to discriminate. This threatens to
take us back to the world as it was pre-DoddFrank and pre-financial crisis, undermining
some of the key successes of the existing SEF
regulatory regime regarding transparency and
market access.
Registration/Costs
I would like to turn for a minute to the
potential costs to market participants—and
the Commission—from this proposed rule.
Currently, there are 25 registered SEFs.20 The
Proposal will drastically increase the number
of SEFs—likely by multiples. In the cost
benefit considerations to the NPRM, the
Commission estimates that approximately
40–60 swaps broking entities, including
interdealer brokers, and one single-dealer
aggregator platform would need to register as
a SEF. That is the universe that we know—
the market as we understand it to exist today.
There could be more—perhaps many more—
entities that will fall under the expanded
registration requirements. Just as
importantly, we do not know how these new
rules will incentivize SEFs—whether they
will lead to consolidation or myriad SEFs
with myriad methods of execution.
The new registration regime, and the many
changes that come along with it, will result
in substantial costs all around: To both
existing SEFs and new SEF registrants, and
to their participants. I note with some
concern that, while the preamble provides a
19 Supra
note 7 at 33508.
20 See Trading Organizations—Swap Execution
Facilities (SEF), CFTC.gov, https://sirt.cftc.gov/
SIRT/SIRT.aspx?Topic=SwapExecutionFacilities
(last visited Nov. 4, 2018).
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laundry list of what rule changes will result
in costs, there is no effort to quantify them.
Operating or participating in a regulated
market comes with costs; but, these
incremental costs are offset, in part, by the
benefits of having access to a transparent,
safe market ecosystem that demands
accountability and punishes wrongdoers. I do
not mean to suggest anything else. However,
as the Commission proceeds with this NPRM,
I am hopeful that the best, most cost effective
regulatory solutions will prevail as the
Commission seeks to improve and advance
the health and vibrancy of the SEF
marketplace.
Comment Period
I also want to quickly raise a nonsubstantive concern, but one that may greatly
impact the substance of the NPRM. The
comment period for the proposal is only 75
days. As I have stated previously, this
rulemaking is complex and impacts a wide
range of market participants in fundamental
ways. There are 105 numbered questions for
commenters in the NPRM’s preamble, in
addition to general requests for comment. I
think it is very important that we give market
participants time to carefully consider the
proposed rule and make reasoned comments.
Recent proposed rules that raised complex
issues, like the capital rule and Reg AT, had
90 day comment periods followed by
extensions of at least an additional 60 days.21
The original part 37 notice of proposed
rulemaking ultimately had open comment
periods totaling 90 days, and market
participants had 7 months between
publication of the notice of proposed
rulemaking and the end of the final comment
period.22 Today’s NPRM deserves careful
consideration, both from the public and from
the Commission, and I hope that the
Commission will give market participants the
time they need to respond thoughtfully and
thoroughly.
Name Give Up Request for Comment
Before I conclude, I would like to turn
briefly to the name give-up request for
comment that is before us as well, as it is
inextricably tied to the SEF NPRM. Post-trade
name give-up also relates to the issue of
impartial access, which I discussed earlier.
While today’s SEF NPRM reworks the SEF
rules generally, the NPRM does not address
the long standing practice of disclosing the
identity of each swap counterparty to the
other after a trade has been matched
anonymously. Instead, the Commission is
voting to issue a request for comment seeking
21 Capital Requirements of Swap Dealers and
Major Swap Participants, 81 FR 91252 (proposed
Dec. 16, 2016), and Capital Requirements of Swap
Dealers and Major Swap Participants, 82 FR 13971
(March 16, 2017) (extending comment period an
additional 60 days); Regulation Automated Trading,
80 FR 78824 (proposed Dec. 17, 2015), Regulation
Automated Trading, 81 FR 85334 (proposed Nov.
25, 2016), and Regulation Automated Trading, 82
FR 8502 (Jan. 26, 2017).
22 Reopening and Extension of Comment Periods
for Rulemakings Implementing the Dodd-Frank
Wall Street Reform and Consumer Protection Act,
76 FR 25274 (May 4, 2011), available at https://
www.gpo.gov/fdsys/pkg/FR-2011-05-04/pdf/201110884.pdf.
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public comment on the practice. While I
appreciate the desire to be measured and
thoughtful on this issue, I fear that not taking
a view at this time in the proposal may
function as an endorsement of the status quo.
The request for comment puts name give-up
on a slower track than the rest of the rule.
Any rule to address the issue will now be
well behind the process for the rest of the
SEF rules.
Conclusion
As outlined above, I have numerous
concerns about this NPRM, both in terms of
what the Commission should do as policy
makers, and in terms of what the
Commission can do under the law. Congress
was clear in the Dodd-Frank Act—the
Commission is tasked with bringing greater
pre-trade transparency to the swaps market.
Today’s NPRM not only fails to advance pretrade transparency, it actually undermines
pre-trade transparency that has been
achieved through our existing regulations. In
addition to the few issues I raise today, the
NPRM’s changes also demand thoughtful
deliberation on equally important issues
related to cross-border implications,
investigations, audit trails, recordkeeping,
and disciplinary hearings to name just a few.
As I read through the NPRM, I noticed a
common thread that naturally aims to shift
the current part 37 regime to a less
prescriptive, and more principles based
regime. The frequent weaving of words into
the text of the NPRM like, defer, flexible,
reasonable, and discretion stand as a clear
declaration of where this proposal’s authors
want it to go. I have long been a proponent
of sensible principles based regulation. I
believe our markets, and more importantly
this agency, are strongly rooted in a
principles based regulatory regime. However,
like the words of this NPRM, I have woven
my own thoughts on striking the right
balance between principles based and rules
based regulation. Principles based regulation
certainly does not mean an absence of rules—
or the absence of supervision.
In remarks I delivered in February of this
year, I stated, ‘‘. . . [w]hile I strongly oppose
any roll backs of Dodd-Frank initiatives, I
believe a principles-based approach to
implementation can be suitable in certain
instances. A principles-based approach
provides greater flexibility, but more
importantly focuses on thoughtful
consideration, evaluation, and adoption of
policies, procedures, and practices as
opposed to checking the box on a
predetermined, one-size-fits-all outcome.
However, the best principles-based rules in
the world will not succeed absent: (1) Clear
guidance from regulators; (2) adequate means
to measure and ensure compliance; and (3)
willingness to enforce compliance and
punish those who fail to ensure compliance
with the rules.’’ 23
If the Commission was voting on a final
rule today, my vote would be no. However,
23 Rostin Behnam, Commissioner, U.S. Comm.
Fut. Trading Comm’n, Remarks of Rostin Behnam
before FIA/SIFMA Asset Management Group, Asset
Management Derivatives Forum 2018, Dana Point,
California (Feb. 8, 2018), https://www.cftc.gov/
PressRoom/SpeechesTestimony/opabehnam2.
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I fully recognize that our existing part 37
rules are not perfect. Bringing more activity
on SEF is a laudable goal, both from a policy
perspective and because Congress has tasked
the Commission with doing so. I will support
today’s proposed rule because I believe that
it is important that we hear from market
participants regarding what aspects of the
NPRM will improve the regulatory
framework for SEFs, while staying within our
responsibilities under the law.
Appendix 5—Dissenting Statement of
Commissioner Dan M. Berkovitz
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I. Summary of Dissenting Views
I respectfully dissent from the Commodity
Futures Trading Commission’s (‘‘CFTC’’ or
‘‘Commission’’) notice of proposed
rulemaking regarding Swap Execution
Facilities and Trade Execution Requirement
(the ‘‘Proposal’’). This Proposal would reduce
competition and diminish price transparency
in the swaps market, which will lead to
higher costs for end users and increase
systemic risks.
The Proposal would abandon the
commitments the United States made at the
G20 Summit in Pittsburgh in 2009 to trade
standardized swaps on exchanges or
electronic trading platforms and is contrary
to Congressional direction in the Dodd-Frank
Act and the Commodity Exchange Act
(‘‘CEA’’) reflecting those commitments. It
would retreat from the progress made by the
Commission and the financial industry in
implementing those reforms.
The Proposal would reduce competition by
cementing the oligopoly of the largest bank
dealers as the main source of liquidity and
pricing in the swaps markets. It would
diminish transparency by removing the
requirement that highly liquid swaps be
traded through competitive methods of
trading. By reducing competition and
diminishing price transparency, the Proposal
would increase systemic risks and lead to
higher swaps prices for commercial and
financial end-users. Ultimately, the millions
of Americans who indirectly participate in
the swaps market through their investments
in retirement accounts, pension plans, home
mortgages, and mutual funds will pay that
higher cost. Finally, the Proposal would
provide SEFs with too much discretion to set
their own rules and in so doing, weaken
regulatory oversight and enforcement
capabilities.
II. Major Flaws in the Proposal
The evidence is clear that the Dodd-Frank
reforms, including the Commission’s swap
execution regulations, have led to more
competition, greater liquidity, more
electronic trading, better price transparency,
and lower prices for swaps that are required
to be traded on regulated platforms.
Numerous academic studies and reports by
market consultants have documented these
benefits.1 The Proposal ignores this evidence
and analysis.
The Proposal would jettison the regulatory
foundation for the way swap execution
facilities (‘‘SEFs’’) currently operate. It would
delete the requirement that swaps that are
1 See
infra section II.
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subject to the trade execution mandate
(‘‘Required Transactions’’) be traded either
on Order Book or by a request for quote from
at least three market participants (‘‘RFQ–3’’).
This would undermine the Congressional
directive in the Dodd-Frank Act that for
Required Transactions, a SEF provide
multiple participants with ‘‘the ability to
execute or trade swaps by accepting bids and
offers made by multiple participants in the
facility or system.’’ 2 Consequently, the
Proposal would lead to less price
transparency and less competition.
The Proposal also would gut the impartial
access requirement in the Dodd-Frank Act.
The statute requires SEFs to establish rules
that ‘‘provide market participants with
impartial access to the market.’’ 3 Authorizing
discrimination based on the type of entity
will permit the largest bank-dealers to
establish and maintain exclusive pools of
liquidity for themselves. By denying other
market participants access to the most
favorable prices in the dealer-to-dealer
market, bank dealers can prevent others from
cost-effectively competing with them for
customers. Eliminating competition will
result in higher prices for customers.
Permitting large banks and dealers to
discriminate in this manner is inconsistent
with sound economic principles
underpinning competitive markets and the
CEA’s impartial access requirement.
In pursuit of the goal of ‘‘flexibility’’ for
SEF markets, the Proposal deletes, reverses,
or waters down many key trading, access,
and compliance requirements for SEFs. The
wide latitude that would be granted to SEFs
as to how swaps may be traded, who may
trade them, the oversight of the marketplace,
and the conduct of the brokers looks very
much like the ‘‘light-touch’’ approach to
regulation that was discredited by the
financial crisis.
Seven years ago, as the Commission was
formulating the current regulations, very
little data was available on swap trading and
pricing. But now, after six years of
experience with those regulations, we have
an extensive amount of data, collected by
SEFs and swap data repositories. The
Commission should base its regulatory
decisions on this data and the studies and
literature that have analyzed this data and
demonstrated the benefits of the current
swap trading requirements.
Unfortunately, the Proposal does not
consider the available data and market
studies that demonstrate the current RFQ–3
system is working well to provide highly
competitive prices and low transaction costs.
For example, the Proposal ignores the
following studies and conclusions:
• CFTC economists’ study (2018).4 This
study, conducted by four CFTC economists,
concluded: ‘‘Judged from our evidence, SEFtraded index CDS market seems to be
working well after Dodd-Frank—dealers’
response rates are high, the vast majority of
27
U.S.C. 1a(50).
U.S.C. 7b–3(f)(2)(B)(i).
4 Lynn Riggs (CFTC), Esen Onur (CFTC), David
Reiffen (CFTC) & Haoxiang Zhu (MIT, NBER, and
CFTC), Swap Trading after Dodd-Frank: Evidence
from Index CDS (Jan. 26, 2018) (‘‘CFTC Economist
Study’’).
37
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customer orders result in trades, and
customers’ transaction costs are low.’’ 5 With
respect to the most liquid CDS index swaps,
the CFTC economists found that ‘‘the average
transaction cost is statistically and
economically close to zero.’’ 6
• Bank of England Staff Working Paper
(2018).7 This Bank of England paper
concluded that the CFTC’s trade execution
mandate, including the RFQ–3 requirement,
has led to a ‘‘sharp increase in competition
between swap dealers’’ in dealer-to-customer
transactions for interest rate swaps subject to
the mandate.8 The study concluded that this
competition had led to ‘‘a substantial
reduction in execution costs,’’ amounting ‘‘to
daily savings in execution costs of as much
as $3–$6 million for end-users of USD
swaps.’’ 9
• Study of ‘‘Market Structure and
Transaction Costs of Index CDSs’’ (2017).10
This study found that prices customers
obtained in the dealer-to-customer market
through the RFQ system often were better
than the prices that were available on the
interdealer Order Book.11 ‘‘[O]ur results
show that the current market structure
delivers very low transaction costs. . . .12
The Proposal conjectures that novel
‘‘flexible methods of execution’’ will benefit
the trading of all swaps. The Proposal,
however, does not identify any trading
methodology that can provide lower costs
than the RFQ–3 method as applied to interest
rate swaps and index CDS subject to the
current trade execution mandate. In
discarding the trading requirements for
Required Transactions to bring more swaps
onto SEFs, the Proposal throws the baby out
with the bathwater.
Today, a small number of large dealers
provide liquidity to the swaps market. Five
very large banks were party to over 60
percent of interest rate swap transactions.13
Liquidity in highly standardized swaps is
fragmented between a dealer-to-dealer market
and a dealer-to-customer market. There are
no non-dealers in the dealer-to-dealer market.
This high degree of reliance on a few large
bank dealers to supply liquidity to all swaps
market participants presents systemic risks as
well as other types of risk that arise in highly
concentrated markets.
One of the fundamental purposes of the
CEA is to ‘‘promote responsible innovation
5 Id.
at 50.
at 43.
7 Evangelos Benos, Richard Payne & Michalis
Vasios, Centralized trading, transparency and
interest rate swap market liquidity: Evidence from
the implementation of the Dodd-Frank Act, Bank of
England Staff Working Paper No. 580 (May 2018)
(‘‘Bank of England Study’’).
8 Id. at 31.
9 Id. The authors explain that during this period
these EUR-mandated swaps were not traded on
SEFs due to the fragmentation of the EUR swaps
market. Id. at 28.
10 Pierre Collin-Dufresne, Benjamin Junge &
Anders B. Trolle, Market Structure and Transaction
Costs of Index CDSs (Sept. 12, 2017) (‘‘CollinDufresne, Junge, and Trolle Study’’).
11 Id. at 38.
12 Id. at 6.
13 Quantifying Interest Rate Swap Order Book
Liquidity, Greenwich Associates, Q1 2016
(‘‘Greenwich Report’’), at 8.
6 Id.
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and fair competition among boards of trade,
other markets and market participants.’’ 14 It
is the CFTC’s mission, and incumbent upon
this agency in carrying out that mission, to
ensure that there is fair competition among
all market participants. This means ensuring
no market participant or limited group of
participants has excessive market power.
Market structure and price competition
should develop in the interest of all market
participants, rather than in the interest of just
a few of the largest banks. The Commission
should strive to remove the existing barriers
to broader participation and fair competition
in the swaps markets. In my view, the
Proposal seeks to perpetuate existing barriers.
III. Targeted Reforms To Consider
The current system is not perfect; there are
flaws that should be addressed. But the
evidence is clear that the current system has
provided substantial benefits over the
unregulated system that existed prior to the
financial crisis and the Dodd-Frank reforms.
The Proposal would return the swaps market
to the dealer-dominated, trade-however-youwant system heavily reliant on voice brokers
that existed prior to the financial crisis. At
the G20 Summit in Pittsburgh in 2009, the
United States made an international
commitment to move away from the dealerdominated, voice-brokered approach and
Congress expressly rejected the dealerdominated, flexible approach when it
adopted the Dodd-Frank Act.
My sense from working with and talking to
swap market participants is that many do not
see a need for a major overhaul of the swaps
regulatory framework. The benefits of the
current system are due not just to the
regulations, but also are the result of major
efforts and investments by market
participants and operators of SEFs in
electronic trading technology and personnel.
Many market participants do not want to deal
with another round of costs and uncertainties
that wholesale regulatory changes will
generate. They believe the current system is
working, despite its flaws. They prefer that
we consider more targeted reforms to address
specific issues with the current system,
rather than scrap the current system entirely.
They do not want to face the possibility that
the Commission will continue to engage in a
repetitive cycle of de-regulation and reregulation.
Rather than completely rewrite the SEF
regulatory structure, and turn our back on the
progress made in transparency and
competition, I favor a more limited, databased approach to build on our progress and
improve upon the current structure. This
could be accomplished by removing some of
the unnecessary barriers to greater
participation on SEFs. Banks and other swap
dealers play a critical role in providing
liquidity. We need them to participate.
However, a highly concentrated dealer
oligopoly is not a prerequisite for sufficient
liquidity. We should seek ways to bring in
more sources of liquidity and competition.
Robust competition leads to healthier
markets and improves the overall welfare of
all market participants.
14 7
U.S.C. 5(b).
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I support the goal of bringing more types
of swaps onto the SEF trading environment.
I could support a more narrow approach to
achieve this goal that does not undermine the
progress that has been made to date.
I am not persuaded that we should
continue to have two separate pools of
liquidity in the swaps market for all types of
swaps, regardless of liquidity
characteristics—one in which the dealers
trade amongst themselves, and another in
which the dealers trade with customers.
Perhaps we should look for ways to
consolidate rather than separate the swaps
markets.
Specifically, I support considering the
following regulatory measures to improve
competition in the swaps market:
• Abolish Name Give-Up. The
Commission should prohibit the practice of
name give-up for cleared swaps. On many
platforms that provide anonymous trading,
the identity of a counterparty is provided to
the dealer after the completion of a trade.
Name give-up is a major deterrent to nondealers seeking to participate on dealer-only
platforms as it provides the dealers with
valuable information about a counterparty’s
positions. Name give-up is a relic of the preDodd-Frank era when most swaps were not
cleared and the identity of the counterparty
was necessary to manage credit risks.
• Expand Floor Trader registration. The
Commission should amend the floor trader
provision in the swap dealer definition to
remove overly restrictive conditions. This
would permit a wider range of proprietary
traders to provide liquidity and compete with
large bank dealers on price.
• Revise capital requirements. The
Commission should work with the prudential
regulators to ensure that capital requirements
do not unduly restrict the availability of
clearing services by futures commission
merchants (‘‘FCMs’’). The current capital
requirements have had the unintended
consequences of discouraging FCMs from
providing additional clearing services to the
cleared swaps market.
• Enable average pricing. The Commission
should work with market participants and
facilities to enable buy-side firms to obtain
average pricing for buy-side swap trades.
Although average pricing is available for
futures, it currently is not available for
swaps, which limits the direct participation
of buy-side asset managers on SEFs.
We should explore these and other ways to
increase competition in the swaps market
rather than retreat from the progress that has
been made. What follows is a more detailed
explanation of how the current regulatory
system has improved the swaps market and
how the Proposal would undermine those
improvements.
IV. Specific Concerns With the Proposal
The Proposal raises the following specific
concerns:
• Less competition
• Less transparency
• Higher prices for end-users
• Diminished CFTC supervision and
enforcement abilities
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A. Less Competition, Less Transparency, and
Higher Prices
The first three concerns—higher prices,
less competition, and less transparency—
arise from the repeal of two critical and interrelated provisions of the current regulations.
Elimination of Order Book/RFQ–3. The
Dodd-Frank Act sets forth a Rule of
Construction that the goal of the SEF
regulations is ‘‘to promote the trading of
swaps on swap execution facilities and to
promote pre-trade price transparency in the
swaps market.’’ 15 A key requirement
facilitating the statutory goal of pre-trade
price transparency is that all Required
Transactions must be traded by Order Book
or RFQ–3.16 Under RFQ–3, a customer must
request quotes from at least three dealers
prior to entering into a transaction. In this
manner, dealers must compete on price.
The Proposal would delete the Order Book/
RFQ–3 requirement, even for swaps already
traded on SEFs and subject to the trade
execution requirement. Instead, the Proposal
states that ‘‘a SEF may utilize ‘any means of
interstate commerce’ for purposes of
execution and communication, including,
but not limited to, the mail, internet, email
and telephone.’’ 17
Authorizing discrimination; eviscerating
impartial access. Next, the Proposal flips on
its head the impartial access requirement.
CEA section 5h(f)(2)(B)(i) requires a SEF to
‘‘provide market participants with impartial
access to the market.’’ 18 Under existing
Commission Regulation 37.202, which
implements this statutory provision, any SEF
criteria governing access must be ‘‘impartial,
transparent, and applied in a fair and nondiscriminatory manner.’’ 19 In the 2013 SEF
rulemaking, the Commission explicitly
rejected a proposed interpretation that would
permit SEFs to discriminate against types of
market participants. ‘‘[T]he Commission
believes that the impartial access
requirement of Core Principle 2 does not
allow a SEF to limit access to its trading
systems or platforms to certain types of
[eligible contract participants (‘‘ECPs’’)] or
[independent software vendors (‘‘ISVs’’)] as
requested by some commenters. The
Commission notes that the rule states
15 7
U.S.C. 7b–3(e).
CFR 37.9. In the 2013 rulemaking adopting
the current SEF regulations, the Commission
explained the rationale for this requirement: ‘‘[T]he
Commission believes that an RFQ System, as
defined in § 37.9, operating in conjunction with a
SEF’s minimum trading functionality (i.e., Order
Book) is consistent with the SEF definition and
promotes the goals provided in [CEA Section 5h(e),
7 U.S.C. 7b–3(e)], which are to: (1) Promote the
trading of swaps on SEFs and (2) promote pre-trade
price transparency in the swaps market. The
Commission notes that the RFQ System definition
requires SEFs to provide market participants the
ability to access multiple market participants, but
not necessarily the entire market, in conformance
with the SEF definition.’’ Core Principles and Other
Requirements for Swap Execution Facilities (‘‘2013
SEF Rulemaking’’), 78 FR 33476, 33496 (June 4,
2013).
17 Notice of proposed rulemaking, Swap
Execution Facilities and Trade Execution
Requirement (‘‘Proposal’’), section IV.I.4.b.
18 7 U.S.C. 7b–3(f)(2)(B)(i).
19 17 CFR 37.202(a)(1).
16 17
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‘impartial’ criteria and not ‘selective’ criteria
as recommended by some commenters.’’ 20
The Proposal would replace this critical
requirement and allow each SEF to establish
exclusionary criteria determining what types
of market participants are ‘‘similarly situated
market participants’’ that are allowed to trade
on the SEF (let’s call this what it is, the
‘‘Discriminatory Access Provision’’). This
approach flips the statutory ‘‘impartial
access’’ requirement on its head by
empowering SEFs to build limited liquidity
pools for a select few market participants
such as the dealers seeking to hedge with
each other.
Under the Discriminatory Access
Provision, it is reasonable to expect that the
large bank swap dealers would encourage
discriminatory SEF participation criteria
such that only large bank swap dealers would
be ‘‘similarly situated market participants’’
able to participate in dealer-to-dealer
liquidity pools. Proprietary trading firms and
smaller dealers provide competition to the
large banks in pricing swaps, and are one
major reason customers are able to obtain
favorable prices through the current RFQ
process. If discrimination is permitted, these
other types of firms would not be able to use
the dealer-to-dealer market to effectively
hedge or offset trades with customers, and
therefore would not be able to compete with
the large bank swap dealers in the dealer-tocustomer market. In this manner, the
Discriminatory Access Provision would
result in a significant loss of competition in
the dealer-to-customer market, which
ultimately would result in higher prices for
end users.21
If the current trade execution requirement
is repealed, dealers also could establish
single-dealer platforms and call them SEFs to
siphon liquidity away from the RFQ
platforms. The dealers wield significant
market power in the swaps market. Five
dealers currently account for nearly twothirds of the interest rate swap market, which
is the largest swap product category.22
Although SEFs that currently offer RFQ–3
20 2013 SEF Rulemaking, 78 FR at 33508. The
Commission also stated that ‘‘the purpose of the
impartial access requirements is to prevent a SEF’s
owners or operators from using discriminatory
access requirements as a competitive tool against
certain ECPs or ISVs.’’ Id.
21 It is unclear under the Proposal what happens
to market participants subject to the SEF trading
requirements who are not given access to a SEF
because of the Discriminatory Access Provision.
22 Greenwich Report at 8. One market participant
has commented on the ability of the dealers to
determine market structure through the exercise of
their market power:
‘‘There is no commercial explanation for having
a market that is not open to a lot more people. It
just doesn’t make any sense. But the ability of
people to enforce change outside the incumbent
dealers is very limited,’’ says the expert. ‘‘The part
that frustrates me more than anything is pretending
that the leverage of the incumbent dealers over this
market isn’t real. When I hear people talk about the
natural market evolution, I would contend that
progress has been 100% prevented to date.’’
Robert Mackenzie Smith, US swap trading
overhaul may reinforce market split, users warn,
Risk.net, Mar. 21, 2018, https://www.risk.net/
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functionality might continue to do so even if
the requirement is repealed, once the
customers are no longer required to use that
functionality, the dealers could undermine
the effectiveness of the RFQ process by
offering incentives to trade on single-dealer
platforms or voice-brokered SEFs. This
outcome would reduce liquidity for the RFQ
platforms. In the long run, draining liquidity
from RFQ–3 platforms to single-dealer or
voice-brokered systems will result in less
direct competition between dealers, less
transparency, and higher costs for
customers.23
The Proposal asserts that all-to-all markets
are ‘‘inimical’’ to ‘‘fundamental’’ swaps
trading features.24 The Proposal also states
that ‘‘market participants have rarely used
Order Books to trade swaps on SEFs,’’ and
that ‘‘this low level of swaps trading on
Order Books is attributable to an Order
Book’s inability to support the broad and
diverse range of products traded in the swaps
market that trade episodically, rather than on
a continuous basis.’’ 25 Following a brief
discussion of why the Order Book is
unsuitable for some swaps, the Proposal
states that the Order Book should be
eliminated for all swaps: ‘‘[B]ased in part on
its experience, the Commission proposes to
eliminate the minimum trading functionality
requirement and the regulatory Order Book
definition.’’ 26
Similarly, the Proposal eliminates the RFQ
requirement because it states that this
method of execution may be unsuitable for
some additional types of swaps that are
currently traded off SEF. ‘‘[T]he Commission
believes that [Order Book and RFQ–3] would
not be suitable for the broad swath of the
swaps market that would become newly
subject to the trade execution
requirement.’’ 27
This reasoning is flawed. From the
proposition that an Order Book may be
unsuitable for some episodically traded
swaps, it does not follow that an Order Book
is unsuitable for all swaps, even highly liquid
ones. Nor does it follow from the proposition
that the RFQ process may be unsuitable for
some swaps that it should be removed for all
swaps. Yet this flawed logic appears to be the
rationale for the elimination of both the
Order Book and RFQ–3 functionality
requirements, even for highly liquid
standardized swaps.28
23 In the equities market, the forced transition
away from a market centered around multiple
dealers improved prices substantially. See, e.g.,
Michael J. Barclay, William G. Christie, Jeffrey H.
Harris, Eugene Kandel & Paul H. Schultz, The
Effects of Market Reform on the Trading Costs and
Depths of Nasdaq Stocks, Journal of Finance, Vol.
54, Issue 1, at 1–2 (1999) (‘‘Our results indicate that
quoted and effective spreads fell dramatically
without adversely affecting market quality.’’).
24 Proposal at section VII.A.1.a.
25 Id. at section IV.C.2.
26 Id.
27 Proposal at section IV.I.4.b.
28 In the Cost-Benefit Considerations, the
Proposal acknowledges that ‘‘the overall amount of
pre-trade price transparency in swap transactions
currently subject to the trade execution requirement
may decline if the Order Book and RFQ-to-3
requirement[s are] eliminated. This potential
reduction in pre-trade price transparency could
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RFQ–3 has improved competition and
lowered trading costs. Empirical evidence
demonstrates that the Order Book/RFQ–3 and
impartial access requirements for
standardized, highly liquid cleared swaps
have increased competition and transparency
and brought low trading costs to swap
markets. The Bank of England Study found
that the RFQ–3 requirement significantly
improved liquidity for U.S. dollar interest
rate swaps, which reduced swap execution
costs for end-users by an estimated $3 to $6
million per day relative to Euro swaps, which
were not traded pursuant to the trade
execution mandate.29
The Bank of England Study also assessed
the impact of the SEF trading mandate on
dealer market power.30 The study found that,
prior to the SEF trading mandate, 28 percent
of customers for U.S. and Euro interest rate
swaps that became subject to the mandate
dealt with only a single dealer, and over 50
percent of customers dealt with three or
fewer dealers.31 After the SEF trading
requirements went into effect, those
percentages dropped to 8 percent and 20
percent, respectively.32 The study states that
‘‘[w]ith the improvements in pre-trade
transparency, customer search costs have
fallen and it has become easier for customers
to trade with the dealer showing the best
price.’’ 33
Other studies have found similar results.
Collin-Dufresne, Junge, and Trolle compared
the prices on the Order Books used in the
interdealer market with the prices generated
in the dealer-to-customer market through the
RFQ system. The authors found that prices
customers obtained in the dealer-to-customer
market through the RFQ system often were
better than the prices that were available on
the interdealer Order Book.34
Economists in the CFTC’s Office of Chief
Economist examined data regarding the
customer trading of index CDS on the
Bloomberg and Tradeweb SEFs, which are
the leading SEFs for dealer-to-customer
trading.35 The CFTC economists found that
very little customer trading occurred on the
Central Limit Order Book (‘‘Clob’’) of either
facility, but rather that most of the trading
occurred either by RFQ or by request-forstreaming (‘‘RFS’’).36 Focusing on customer
reduce the liquidity of certain swaps trading on
SEFs and increase the overall trading costs.’’
Proposal at section XXIII.C.
29 Bank of England Study at 31. As discussed
further below, the Proposal appears to consider
liquidity solely in terms of total volume of trades.
The Bank of England Study measures liquidity
using various price dispersion measures
complemented by a price impact measure and a
bid-ask spread. See id. at 4. This measure of
liquidity better assesses how liquidity affects
efficient execution, pricing, and timing of trading.
30 Id. at section 5.
31 Id. at 26.
32 Id.
33 Id.
34 Collin-Dufresne, Junge, and Trolle Study at 38.
35 The study reports that, according to the SEF
Tracker, at the time of the study, Bloomberg held
a market share of 71% and Tradeweb held a market
share of 13.6%. CFTC Economist Study at 2.
36 Under RFS, customers ask multiple dealers to
send indicative quotes in a continuous manner, and
can respond to one of them by proposing to trade
at the dealers’ quote.
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trading through the RFQ mechanism, the
CFTC economists found that, on average, a
customer requests quotes from 4.1 dealers
and gets back 3.6 responses.37
The CFTC economists concluded that the
current regulatory structure is working well:
‘‘Judged from our evidence, SEF-traded index
CDS market seems to be working well after
Dodd-Frank—dealers’ response rates are
high, the vast majority of customer orders
result in trades and customers’ transaction
costs are low.’’ 38 Specifically, the CFTC
economists found that transaction costs were
low for index CDS contracts:
The transaction costs of on-the-run
CDX.NA.IG and iTraxx Europe have a mean
around 0.2 bps and a standard deviation of
1.4 bps, so the average transaction cost is
statistically and economically close to zero.
For on-the-run CDX.NA.HY and iTraxx
Crossover, the average costs are larger, at
about 0.5 and 1.1 bps, but again not
significant compared to their standard
deviations of about 2.6 and 3.5 bps. The first
off-the-run contracts have comparable
average transaction costs but a much higher
standard deviation due to the relatively few
number of trades in these contracts.39
Market participants have expressed similar
concerns about removing the Order Book/
RFQ–3 and impartial access requirements.
One senior executive at a trading firm
recently stated that the SEF regulations have
helped halve the bid-offer spread in US
dollar swaps and increased price
competition. ‘‘My fear is we take too big a
step back from having the competitive
pricing in the market,’’ he said. ‘‘It is still a
dealer-controlled market and if the biggest
dealers simply say: ‘Great, I don’t have to put
a competitive price on the screen anymore,
and if someone wants my most competitive
price then you’ve got to pick up the phone
again,’ I don’t want to take that step
backwards.’’ 40
Similarly, the CEO of one SEF cautioned,
‘‘[o]ne of the risks of this concept of ‘any
means of interstate commerce’ is you have
benchmarks and fixings that rely on better
liquidity coming in from liquid Clobs. You
wouldn’t want to go backwards in that
respect.’’ 41
In 2016, Greenwich Associates reported
that ‘‘the buy side feels the executions they
are receiving under the current paradigm are
sufficient, if not excellent.’’ 42 Greenwich
Associates noted that, for many asset
managers, sending a request for quote to
37 Id. at 17. The study also found that customers
are more likely to request quotes from dealers with
whom they have a clearing or pre-existing trading
relationship, although customers realize small
actual price benefits from requesting quotes from
relationship dealers. Id. at 5.
38 Id. at 50.
39 Id. at 43.
40 Robert Mackenzie Smith, Sef reforms could
distort new, sounder benchmark rates, Risk.net,
Oct. 19, 2018, https://www.risk.net/derivatives/
6049931/sef-reforms-could-distort-new-sounderbenchmark-rates (remarks of Stephen Berger,
Managing Director, Government and Regulatory
Policy, Citadel).
41 Id. (remarks of Scott Fitzpatrick, Chief
Executive Officer, Tradition SEF).
42 Greenwich Report at 7.
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three market participants and selecting the
best-priced response (no matter how many
respond) ‘‘has long been considered an
appropriate approach to achieving best
execution.’’ 43
The Proposal does not reference any of
these findings or views of market
participants. In contrast to these data-based
empirical studies regarding the benefits of
the current regulatory system, the Proposal
speculates—without any evidentiary
support—that the ‘‘flexibility’’ afforded by
the elimination of the Order Book/RFQ–3
requirement may provide various benefits.
For example, the Proposal asserts ‘‘SEFs
would have broader latitude to innovate and
develop new and different methods of
execution tailored to their markets.’’ 44 The
Proposal further opines that these new,
flexible methods ‘‘could be more efficient,’’
‘‘may lead to reduced costs and increased
transparency,’’ and ‘‘may provide
opportunities for new entrants in the SEF
market.’’ 45
However, the Proposal provides no factual
basis for any of these hypothetical benefits.
In light of the very low execution costs that
have been documented for interest rate and
index CDS swaps traded through RFQ–3, it
is difficult to understand why RFQ–3 should
be eliminated, at least for the swaps to which
it currently applies.
Effect of expanded trading mandate on
liquidity. The overriding rationale for the
Proposal is to attract greater liquidity
formation to SEFs. The Proposal seeks to
accomplish this goal by expanding the SEF
trading requirement to include all
mandatorily cleared swaps for which SEF
trading exists, with several exceptions.
Although the Proposal would expand the
trade execution mandate in this manner, it
also would eliminate the Order Book/RFQ–
3 requirements and provide effectively
unlimited flexibility as to the trading
methods for all swaps subject to the
expanded trading mandate. The Proposal
broadly asserts, without providing any
evidentiary support, that the expanded
trading mandate will improve liquidity and
pre-trade price transparency and reduce
market fragmentation.
In asserting that the expanded execution
mandate will increase on-SEF liquidity, the
Proposal appears to measure liquidity solely
in terms of volume. But volume does not
equal liquidity. It is not apparent how simply
moving this volume from off SEF to being
traded within a SEF will have any effect on
other traditional measures of liquidity, such
as cost of transaction or price dispersion.
Indeed, the only difference is that the swaps
would be traded on SEF, but by the same
people and using the same methods that they
now use to trade them off SEF. It is not
apparent how this would lead to any greater
price transparency or lower costs.
How many and what types of swaps would
be brought onto SEFs under the expanded
trading mandate? The Proposal presents
little data to answer this question. One
43 Id.
at 11.
44 Proposal
at section XXIII.C.4.b(1) (emphasis
added).
45 Id.
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approach would be to assume that all swap
transactions that are currently subject to
clearing would become subject to the
expanded trading mandate under the
Proposal. This amount may be significantly
larger than the actual result because many
swaps subject to clearing may not be easily
traded on SEF. But by comparing this amount
to the amount of swaps currently traded on
SEF, we can estimate an upper bound on the
incremental increase in on-SEF trading
resulting from the Proposal.
The Proposal notes that an estimated 57%
of the notional amount of interest rate swaps
are being traded on SEF, and that 85% are
subject to the clearing requirement.
Accordingly, an upper bound of about 28%
of interest rate swaps could be moved on SEF
under the Proposal.46 This estimate is
consistent with a recent estimate provided by
Clarus that approximately two-thirds of the
fixed/float USD interest rate swap market is
traded on SEF.47 Examining the one-third of
interest rate swaps that are being traded off
SEF, Clarus found that ‘‘[g]enerally speaking,
everything off-SEF is bespoke.’’ 48
Again, it is not apparent how moving the
trading of bespoke swaps from being traded
by introducing brokers (‘‘IBs’’) outside a SEF
to being traded by swap trading specialists
inside a SEF will have any effect on the
prices of those bespoke swaps. It is even less
apparent how the trading of these bespoke
swaps within a SEF will have any impact
upon the trading of the highly liquid
standardized swaps already being traded
within a SEF under the RFQ–3 methodology.
In fact, eliminating RFQ–3 for those liquid
swaps could raise the prices for those swaps,
and in turn may also negatively impact
pricing for less liquid swaps, because most
interest rate swaps—including bespoke
swaps—are priced in part on a standard rate
curve developed from prices for liquid swaps
at various point along the curve.
Other impacts from excessive flexibility
and discretion. The Proposal establishes an
overly flexible approach that allows each SEF
to self-determine how it will operate in
almost every respect. Among other areas, a
SEF would use discretion (a word used over
150 times in the Proposal) to tailor policies
and procedures regarding trading procedures
and rules, access, pre-execution
communication, personnel oversight and
ethics training, SEF compliance
requirements, trading surveillance, error
trade policies, record keeping, trade
documentation, internal investigations and
enforcement, setting fees, financial resource
requirements, and supervision of third party
services. Most of these changes would loosen
current regulatory requirements.
Documentation of executed swaps would
no longer be required at the time of
execution, but as soon as technologically
46 Using the same method, available data from
ISDA indicates that only about 4–5% of index CDS
that are currently subject to mandatory clearing are
not currently traded on SEF. See SwapsInfo Full
Year 2017 and Fourth Quarter 2017 Review, ISDA,
at 13–14 (Feb. 2018).
47 What is Left Off-SEF, Clarus Financial
Technology (Mar. 16, 2016), https://
www.clarusft.com/what-is-left-off-sef/.
48 Id.
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possible. The Proposal acknowledges that
creating flexibility for execution methods and
trading technology makes simultaneous
documentation ‘‘impracticable.’’ 49 In other
words, moving away from electronic trading
back to telephones will delay the time within
which counterparties receive full
confirmation of price and terms, preventing
precision in the time of pricing, creating a
higher likelihood of errors, and leading to
less pre-trade price transparency.
Many of the changes in the Proposal would
allow the SEF to exercise discretion in
brokering trades and establishing rules to
facilitate broking away from electronic
platforms. The Proposal explains that one of
the reasons for granting the SEF greater
discretion is to allow voice-broking to occur
directly within the SEF.
Traditional introducing broking, by its
nature, is slower and less transparent at
establishing prices as compared to electronic
trading. As a broker calls around to multiple
dealers for prices, the broker might make
trade adjustments over time and prices from
one call to the next may change. As time
passes, prices may become stale, even within
seconds. Dealers and other liquidity
providers will add a cushion to the spread to
account for this delay. This means that as the
length of time increases between when a
quote is first received and when the trade is
executed and the price is reported, spreads
become wider and pricing becomes less
transparent. For certain trades, such as block
trades, timing delays in price transparency
might be appropriate for reasons related to
the unique nature of each trade. However, we
should not be adopting regulations that
would degrade the current level of
transparency for liquid swaps that are being
efficiently traded using an Order Book or
RFQ system.
Similarly, the Proposal would allow
extensive pre-trade negotiation for all swaps
so long as the SEF defines it into the SEF’s
trading rules. Pre-trade negotiation may be
appropriate for certain bespoke or large sized
swaps. However, to create flexibility in SEF
trading methods, the Proposal would allow
SEFs to include pre-trade negotiations for
any and all types of swaps including
standardized swaps currently traded
electronically. However, the Proposal would
allow SEFs to include pre-trade negotiations
for more liquid, standardized swaps for
which pre-trade price transparency is better
achieved through electronic trading, as
explained in the studies discussed above.
In addition, the Proposal would allow SEF
trading specialists, when acting as brokers, to
exercise discretion in sharing different
market information with different market
participants. The Proposal acknowledges that
this ‘‘trading discretion exercised by SEF
trading specialists may affect the manner in
which market participants are treated on a
facility.’’ 50 The Proposal suggests that this is
somehow ‘‘consistent with impartial access’’
because it facilitates more trading. More
likely, this greater degree of sanctioned
discretion—the extent of which is largely left
up to the SEFs to determine—would lead to
49 Proposal
50 Proposal
at section IV.F.2.b.
at section VII.A.1.a(1)(iii).
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unfair treatment of different market
participants and less pre-trade price
transparency because SEF trading specialists
can decide who gets what information pretrade.
The statements above should not be
interpreted as critical of intermediary broking
services. These services provide important
options for trading and pricing certain types
of swaps, such as bespoke swaps, package
trades, and block sizes. Rather, my concern
is that these important services and the
professionals who provide them may become
less regulated, and that they will become
intermediaries for transactions that are
required to be traded electronically.
B. Diminished Oversight and Enforcement
I am also concerned that this Proposal
waters down the robust, and uniform,
standards of conduct and supervision to
which it currently holds SEFs, IBs, associated
persons (‘‘APs’’) of IBs, and other market
participants. This could lead to SEFs
reducing their focus on compliance, require
the Commission to take on an enhanced
oversight role, and constrain the
Commission’s ability to investigate and
prosecute abusive trade practices involving
SEFs.
As previously discussed, this Proposal
grants extensive discretion to SEFs to create
rules governing their operations and does
away with some of the specific compliance
and recordkeeping obligations currently
required by the regulations governing SEFs,
set forth in Part 37 of the Commission’s
Regulations.51 The Proposal suggests that
providing SEFs with greater flexibility to
tailor their compliance and oversight
programs will mitigate compliance
challenges that SEFs have encountered in
implementing part 37, yet fails to describe in
any detail those challenges.52 On the other
hand, we know that our current system of
oversight provides market participants and
regulatory authorities with uniform and
descriptive standards of conduct and
compliance procedures. Enumerating these
standards (1) prevents a race to the bottom,
in which market participants pare back their
policies and procedures to the bare
minimum, and (2) provides the registrant and
the Commission with the tools they need to
successfully enforce compliance with those
standards.
As an example, the Proposal would remove
the requirement set forth in Regulation
37.203(c) that a SEF establish and maintain
sufficient compliance staff and resources to
(i) conduct specific monitoring, including
audit trail reviews, trade practice and market
surveillance, and real-time market
monitoring; (ii) address unusual market or
trading events; and (iii) complete
investigations in a timely manner. Rather, the
Proposal would only require that the SEF
establish and maintain sufficient compliance
staff and resources to ensure that it can fulfill
its self-regulatory obligations under the CEA
and Commission Regulations. Without
specific requirements on what compliance
resources are needed, each SEF will be free
51 17
CFR part 37.
at section I.C.
52 Proposal
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to determine what level of resources is
sufficient for such a broad mandate. In
essence, the SEF need not map its
compliance resources to specific compliance
tasks. Additionally, experience has shown
that conducting oversight and examinations
of the sufficiency of a registrant’s compliance
resources is more difficult to undertake on a
standard and fair basis across registrants
when each one has a different view of what
resources will meet the generalized
requirement.
As another example, the Proposal
eliminates the specific requirements that a
SEF establish an annual audit trail review
and related enforcement program, and retain
certain categories of documents currently
required by Regulation 37.205. The Proposal
assumes, however that ‘‘SEFs would
continue to fulfill their information
collection burdens in a manner similar to the
status quo.’’ 53 If the expectation is that SEFs
will continue to comply with the current
requirements, then why is it necessary to
remove or weaken them? Many still view the
compliance function as a cost center. It is
unrealistic to assume that we can remove
many of the specific conduct and
recordkeeping obligations and expect that
market participants will continue to comply,
when competitive market pressures will
drive the allocation of resources elsewhere.
Moreover, market participants have
dedicated significant resources to developing
these compliance policies and systems, and
changing them without sufficient
justification does not make practical sense.
As a final example, the Proposal removes
some of the specific requirements in
Regulation 37.204 for oversight of third-party
regulatory services. SEFs would no longer be
required to conduct regular meetings with,
and periodic reviews of, service providers or
provide records of such oversight to the
Commission. Instead, SEFs are given broad
latitude to determine the necessary processes
to supervise these providers. When
registrants delegate critical functions to thirdparty providers, it is imperative that the
registrant maintain diligent supervision over
the provider’s handling of these functions.54
In my view, the Proposal does not provide
satisfactory reasons for removing these
unambiguous requirements, considering that
doing so could hamper the Commission’s
ability hold SEFs accountable for supervising
third-party providers.
Equally concerning is the sweeping change
the Proposal makes to the way in which SEFs
and their employees and agents will be
registered, and in turn, the Commission’s
oversight of their conduct. Under the current
system, swaps broking entities that meet the
definition of an IB must be registered with
53 Proposal
at section XXIII.B.1.f.
e.g., In re AMP Global Clearing LLC, CFTC
No. 18–10, 2018 WL 898755 (Feb. 12, 2018)
(consent order) (charging registrant with failing to
supervise diligently its information technology
provider’s implementation of registrant’s
information systems security program); In re Tillage
Commodities, LLC, No. 17–27, 2017 WL 4386853
(Sept. 28, 2017) (consent order) (charging registrant
with failing to supervise diligently its fund
administrator’s operation of the registrant’s bank
account containing participant funds).
54 See,
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the Commission as such. The individuals
who are involved in soliciting or accepting
orders at IBs, or involved in supervising such
individuals, must register as APs of IBs. As
NFA members, IBs and APs are not only
subject to the applicable Commission
Regulations, but are also subject to uniform
rules governing swaps brokering, trade
practices, reporting, minimum financial
requirements, proficiency testing, training
standards, and supervision. In addition, NFA
monitors IBs’ swaps broking activity and
compliance with all applicable statutes and
rules. In furtherance of that responsibility,
NFA conducts periodic examinations of swap
IB member firms and has the ability to
discipline IBs and APs where appropriate.
Under the Proposal, which limits the
activity that can be conducted off SEF, IBs
will need to register with the Commission as
SEFs to continue to broker swaps
transactions. Given that the majority of IBs
engaging in swap transactions on SEF are
affiliated with SEFs, it is likely that many of
these entities, or their employees, will merge
into or join the affiliated SEF. We can also
expect to see the formation of new SEFs,
which presumably would not be required to
register as IBs.55 SEFs and SEF employees
would be free to withdraw their IB and AP
registrations and memberships with NFA,
leaving a regulatory vacuum with no selfregulatory organization oversight. Already
strained Commission resources inevitably
would need to fill that void.
Further, the Proposal creates an entirely
new category of persons: The SEF trading
specialist. As proposed, SEF trading
specialists will perform ‘‘core functions’’ that
facilitate swaps trading and execution,
including negotiating trade terms, arranging
bids and offers, and discussing market color
with market participants, or directly
supervising a person who engages in such
functions. In fact, the Proposal notes that
broadening the SEF registration and trade
execution requirements would increase the
level of discretion that these SEF employees
and agents would exercise in connection
with swaps trading. However, despite these
key, customer-facing functions, SEF trading
specialists would not be required to register
with the Commission.
For this reason, I am also concerned that
the Proposal would weaken the supervisory
function within the SEF. Regulation 166.3
imposes a duty on all Commission registrants
who act in a supervisory capacity, including
APs, to diligently supervise the activities of
employees and agents relating to their
business as a Commission registrant.56
However, if the SEF is not registered as an
IB, and its employees are thereby not
registered as APs, the SEF employees
themselves will have no duty to supervise
under Regulation 166.3. The Proposal
imposes a separate duty on SEFs to supervise
the activities of its SEF trading specialists ‘‘in
the facilitation of trading and execution on
the swap execution facility.’’ 57 Critically,
however, that duty runs only to the SEF as
an entity and not to its employees, including
the SEF trading specialists. As a result, SEF
trading specialists or other SEF employees
with supervisory duties cannot be held
individually liable for failure to supervise
under any Commission regulation if they are
not duly registered as APs of IBs. Individual
accountability is an important tool in
incentivizing corporate responsibility and I
think it must be preserved.
Finally, in at least one instance, the
flexibility afforded to SEFs to establish a
code of conduct for their SEF trading
specialists is in direct conflict with the
supervision rules applicable to all registrants
under Regulation 166.3. The Proposal states
that a SEF’s Code of Conduct ‘‘may provide’’
that, among other things, a SEF trading
specialist ‘‘not engage in fraudulent,
56 17
CFR 166.3.
at section VI.A.3.f. Unlike Regulation
166.3, which applies to all activities relating to a
registrant’s business, the language ‘‘in facilitation of
trading and execution on the swap execution
facility’’ is susceptible to various interpretations
and could considerably narrow the conduct that is
required to be supervised.
57 Proposal
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55 The Proposal is not clear on whether an
existing IB that now must register as a SEF, but
continues to primarily conduct phone broking and
other IB-related activities, and continues to meet
the IB definition, would need to be dually
registered.
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manipulate, or disruptive conduct.’’ 58
However, Regulation 166.3 requires that
Commission registrants establish and
maintain meaningful procedures for
detecting and deterring fraud and other
prohibited conduct by their employees and
agents.59 This could create another potential
gap in our supervisory structure that could
weaken the Commission’s enforcement
capabilities.
V. Conclusion
This Proposal is a fundamental overhaul of
the SEF regulatory regime. The changes
create a trading system that is so flexible that
all swaps traded on SEFs—including the
most liquid—could be traded the same way
they were before the Dodd-Frank reforms
were adopted. The Proposal would allow the
largest dealers to establish separate dealer-todealer liquidity pools through exclusionary
access criteria. Competition would be
reduced and price transparency diminished.
This is not what Congress intended when it
passed the Dodd-Frank Act.
I am open to appropriate, targeted
amendments to the regulations, several of
which I have suggested above. However,
empirical studies have shown that the
existing SEF regulations have made great
progress in achieving the statutory goals of
promoting on-SEF trading and pre-trade price
transparency. With respect to the swaps
markets that are working and providing low
costs to the buy side and end users, we
should live by the adage, ‘‘if it ain’t broke,
don’t fix it.’’
[FR Doc. 2018–24642 Filed 11–29–18; 8:45 am]
BILLING CODE 6351–01–P
58 Id.
at section VI.A.3.e (emphasis added).
e.g., CFTC v. Sidoti, 178 F.3d 1132, 1137
(11th Cir. 1999); Sansom Refining Co. v. Drexel
Burnham Lambert, Inc., CFTC No. 82–R448, 1990
WL 10830742 (Feb. 16, 1990) (registrant has ‘‘a duty
to develop procedures for the ‘detection and
deterrence of possible wrongdoing by its agents.’ ’’).
Moreover, various provisions of the CEA and
Commission Regulations prohibit fraudulent and
manipulative conduct, so adequate supervision
necessarily dictates that entities and supervisors
monitor for this conduct. See, e.g., 7 U.S.C. 6b, 9.
59 See,
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]]>Agencies
[Federal Register Volume 83, Number 231 (Friday, November 30, 2018)]
[Proposed Rules]
[Pages 61946-62149]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-24642]
[[Page 61945]]
Vol. 83
Friday,
No. 231
November 30, 2018
Part III
Commodity Futures Trading Commission
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17 CFR Parts 9, 36, et al.
Swap Execution Facilities and Trade Execution Requirement; Proposed
Rule
Federal Register / Vol. 83, No. 231 / Friday, November 30, 2018 /
Proposed Rules
[[Page 61946]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 9, 36, 37, 38, 39, and 43
RIN 3038-AE25
Swap Execution Facilities and Trade Execution Requirement
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing amendments to regulations relating to the trade
execution requirement under the Commodity Exchange Act (``CEA'' or
``Act'') and amendments to existing regulations relating to swap
execution facilities (``SEFs'') and designated contract markets
(``DCMs''). Among other amendments, the proposed rules apply the SEF
registration requirement to certain swaps broking entities and
aggregators of single-dealer platforms; broaden the scope of the trade
execution requirement to include all swaps subject to the clearing
requirement under the Act that a SEF or a DCM lists for trading; allow
SEFs to offer flexible execution methods for all swaps that they list
for trading; amend straight-through processing requirements; and amend
the block trade definition. The proposed rules, which also include non-
substantive amendments and various conforming changes to other
Commission regulations, reflect the Commission's enhanced knowledge and
experience with swaps trading characteristics and would further the
Dodd-Frank Act's statutory goals for SEFs, i.e., promote more SEF
trading and pre-trade price transparency in the swaps market. Further,
the proposed rules are intended to strengthen the existing swaps
regulatory framework by reducing unnecessary complexity, costs, and
other burdens that impede SEF development, innovation, and growth.
DATES: Comments must be received on or before February 13, 2019.
ADDRESSES: You may submit comments, identified by ``Swap Execution
Facilities and Trade Execution Requirement'' and RIN 3038-AE25, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, be
accompanied by an English translation. Comments will be posted as
received to https://comments.cftc.gov. You should submit only
information that you wish to make available publicly. If you wish the
Commission to consider information that you believe is exempt from
disclosure under the Freedom of Information Act (``FOIA''), a petition
for confidential treatment of the exempt information may be submitted
according to the procedures established under Sec. 145.9 of the
Commission's regulations.\1\
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\1\ 17 CFR 145.9.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all
submissions from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the FOIA.
FOR FURTHER INFORMATION CONTACT: Nhan Nguyen, Special Counsel, (202)
418-5932, [email protected]; Roger Smith, Special Counsel, (202) 418-
5344, [email protected]; or David Van Wagner, Chief Counsel, (202) 418-
5481, [email protected], Division of Market Oversight; Michael
Penick, Senior Economist, (202) 418-5279, [email protected], Office of
the Chief Economist, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background and Introduction
A. Statutory Background: The Dodd-Frank Act
B. Regulatory History: The Part 37 Rules
1. Challenges of Existing Regulatory Approach
a. Lack of MAT Determinations
b. Swaps Market Characteristics
c. Operational Complexities and Costs
C. Proposed Approach
D. Summary of Proposed Revisions
E. Consultation With Other U.S. Financial Regulators
II. Part 9--Rules Relating To Review of Exchange Disciplinary,
Access Denial or Other Adverse Actions
III. Part 36--Trade Execution Requirement
IV. Part 37--Subpart A: General Provisions
A. Sec. 37.1--Scope
B. Sec. 37.2--Applicable Provisions and Definitions
1. Sec. 37.2(a)--Applicable Provisions
2. Sec. 37.2(b)--Definition of ``Market Participant''
a. Applicability of Sec. 37.404(b) to Market Participants
b. SEF Jurisdiction Over Clients of Market Participants
C. Sec. 37.3--Requirements and Procedures for Registration
1. Sec. 37.3(a)--Requirements for Registration
a. Footnote 88
b. Single-Dealer Aggregator Platforms
c. Swaps Broking Entities, Including Interdealer Brokers
(1) Structure and Operations of Swaps Broking Entities,
Including Interdealer Brokers
(2) SEF Registration Requirement for Swaps Broking Entities,
Including Interdealer Brokers
d. Foreign Swaps Broking Entities and Other Foreign Multilateral
Swaps Trading Facilities
(1) Proposed Delay of SEF Registration Requirement
(2) Proposed Conditions for Delay of SEF Registration
Requirement
2. Sec. 37.3(a)(2) Through (3)--Minimum Trading Functionality
and Order Book Definition
3. Sec. 37.3(b)--Procedures for Registration
a. Elimination of Temporary Registration
b. Sec. 37.3(b)(1)--Application for Registration
(1) Form SEF Exhibits--Business Organization
(2) Form SEF Exhibits--Financial Information
(3) Form SEF Exhibits--Compliance
(4) Form SEF Exhibits--Operational Capability
(5) Other Form SEF Amendments
(6) Request for Legal Entity Identifier
c. Sec. 37.2(b)(2)--Request for Confidential Treatment
d. Sec. 37.3(b)(3)--Amendment of Application for Registration
e. Sec. 37.3(b)(4)--Effect of Incomplete Application
f. Sec. 37.3(b)(5)--Commission Review Period
g. Sec. 37.3(b)(6)--Commission Determination
4. Sec. 37.3(c)--Amendment to an Order of Registration
5. Sec. 37.3(d)--Reinstatement of Dormant Registration
6. Sec. 37.3(e)--Request for Transfer of Registration
7. Sec. 37.3(f)--Request for Withdrawal of Application for
Registration
8. Sec. 37.3(g)--Request for Vacation of Registration
9. Sec. 37.3(h)--Delegation of Authority
D. Sec. 37.4--Procedures for Implementing Rules
E. Sec. 37.5--Provision of Information Relating to a Swap
Execution Facility
[[Page 61947]]
1. Sec. 37.5(a)--Request for Information
2. Sec. 37.5(b)--Demonstration of Compliance
3. Sec. 37.5(c)--Equity Interest Transfer
4. Sec. 37.5(d)--Delegation of Authority
F. Sec. 37.6--Enforceability
1. Sec. 37.6(a)--Enforceability of Transactions
2. Sec. 37.6(b)--Swap Documentation
a. Sec. 37.6(b)(1)--Legally Binding Documentation
b. Sec. 37.6(b)(2)--Requirements for Swap Documentation
G. Sec. 37.7--Prohibited Use of Data Collected for Regulatory
Purposes
H. Sec. 37.8--Boards of Trade Operating Both a Designated
Contract Market and a Swap Execution Facility
I. Sec. 37.9--Methods of Execution for Required and Permitted
Transactions; Sec. 37.10--Process for a Swap Execution Facility To
Make a Swap Available to Trade; Sec. 37.12--Trade Execution
Compliance Schedule; Sec. 38.11--Trade Execution Compliance
Schedule; Sec. 38.12--Process for a Designated Contract Market To
Make a Swap Available to Trade
1. Trade Execution Requirement and MAT Process
2. Execution Method Requirements
3. Implementation of Existing Requirements
4. Proposed Approach
a. Sec. 36.1(a)--Trade Execution Requirement
b. Elimination of Required Execution Methods
V. Part 37--Subpart B: Core Principle 1 (Compliance With Core
Principles)
VI. Part 37 Regulations Related to SEF Execution Methods--Subpart C:
Core Principle 2 (Compliance With Rules)
A. Sec. 37.201--Requirements for Swap Execution Facility
Execution Methods
1. Sec. 37.201(a)--Required Swap Execution Facility Rules
a. Sec. 37.201(a)(1)--Trading and Execution Protocols and
Procedures
b. Sec. 37.201(a)(2)--Discretion
c. Sec. 37.201(a)(3)--Market Pricing Information
2. Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec.
37.9(b)--Time Delay Requirement
a. Sec. 37.201(b)--Pre-Execution Communications
(1) Exception for Swaps Not Subject to the Trade Execution
Requirement
(2) Sec. 37.201(b)(1)--Exception for Package Transactions
3. Sec. 37.201(c)--SEF Trading Specialists
a. Sec. 37.201(c)(1)--Definition of ``SEF Trading Specialist''
b. Sec. 37.201(c)(2)--Fitness
c. Sec. 37.201(c)(3)--Proficiency Requirements
d. Sec. 37.201(c)(4)--Ethics Training
(1) Guidance to Core Principle 2 in Appendix B--Ethics Training
e. Sec. 37.201(c)(5)--Standards of Conduct
f. Sec. 37.201(c)(6)--Duty To Supervise
g. Sec. 37.201(c)(7)--Additional Sources for Compliance
VII. Additional Part 37 Regulations--Subpart C: Core Principle 2
(Compliance With Rules)
A. Sec. 37.202--Access Requirements
1. Sec. 37.202(a)--Impartial Access to Markets, Market
Services, and Execution Methods
a. Sec. 37.202(a)(1)--Impartial Access Criteria
(1) Application of Impartial Access Requirement
(i) Eligibility and Onboarding Criteria
(ii) Access to Execution Methods
(iii) Use of Discretion
b. Sec. 37.202(a)(2)--Fees
2. Sec. 37.202(b)--Limitations on Access
3. Sec. 37.202(c)--Eligibility
4. Sec. 37.202(d)--Jurisdiction
B. Sec. 37.203--Rule Enforcement Program
1. Sec. 37.203(a)--Abusive Trading Practices Prohibited
2. Sec. 37.203(b)--Authority To Collect Information
3. Sec. 37.203(c)--Compliance Staff and Resources
4. Sec. 37.203(d)--Automated Trade Surveillance System
5. Sec. 37.203(e)--Error Trade Policy
a. Error Trades--Swaps Submitted for Clearing
b. Current SEF Error Trade Policies
c. Sec. 37.203(e)--Error Trade Policy
6. Sec. 37.203(f)--Investigations
7. Sec. 37.203(g)--Additional Sources for Compliance
C. Sec. 37.204--Regulatory Services Provided by a Third Party
1. Sec. 37.204(a)--Use of Regulatory Service Provider Permitted
2. Sec. 37.204(b)--Duty To Supervise Regulatory Service
Provider
3. Sec. 37.204(c)--Delegation of Authority
D. Sec. 37.205--Audit Trail
1. Sec. 37.205(a)--Audit Trail Required
2. Sec. 37.205(b)--Elements of an Acceptable Audit Trail
Program
a. Sec. 37.205(b)(1)--Original Source Documents; Sec.
37.205(b)(2)--Transaction History Database; Sec. 37.205(b)(3)--
Electronic Analysis Capability
3. Sec. 37.205(c)--Audit Trail Reconstruction
E. Sec. 37.206--Disciplinary Procedures and Sanctions
1. Sec. 37.206(a)--Enforcement Staff
2. Sec. 37.206(b)--Disciplinary Program
3. Sec. 37.206(c)--Hearings
4. Sec. 37.206(d)--Decisions
5. Sec. 37.206(e)--Disciplinary Sanctions
6. Sec. 37.206(f)--Warning Letters
7. Sec. 37.206(g)--Additional Sources for Compliance
F. Part 9--Rules Relating To Review of Exchange Disciplinary,
Access Denial or Other Adverse Actions
VIII. Part 37--Subpart D: Core Principle 3 (Swaps Not Readily
Susceptible to Manipulation)
A. Sec. 37.301--General Requirements
1. Appendix C--Demonstration of Compliance That a Swap Contract
Is Not Readily Susceptible to Manipulation
IX. Part 37--Subpart E: Core Principle 4 (Monitoring of Trading and
Trade Processing)
A. Sec. 37.401--General Requirements
B. Sec. 37.402--Additional Requirements for Physical-Delivery
Swaps
C. Sec. 37.403--Additional Requirements for Cash-Settled Swaps
D. Sec. 37.404--Ability To Obtain Information
E. Sec. 37.405--Risk Controls for Trading
F. Sec. 37.406--Trade Reconstruction
G. Sec. 37.407--Regulatory Service Provider; Sec. 37.408--
Additional Sources for Compliance
X. Part 37--Subpart F: Core Principle 5 (Ability To Obtain
Information)
A. Sec. 37.501--Establish and Enforce Rules
B. Sec. 37.502--Provide Information to the Commission
C. Sec. 37.503--Information-Sharing
D. Sec. 37.504--Prohibited Use of Data Collected for Regulatory
Purposes
XI. Part 37--Subpart G: Core Principle 6 (Position Limits or
Accountability)
A. Sec. 37.601--Additional Sources for Compliance; Guidance to
Core Principle 6 in Appendix B
XII. Part 37--Subpart H: Core Principle 7 (Financial Integrity of
Transactions); Sec. 39.12--Participant and Product Eligibility
A. Sec. 37.701--Required Clearing
B. Sec. 37.702--General Financial Integrity
1. Sec. 37.702(a)--Minimum Financial Standards
2. Sec. 37.702(b) and Sec. 39.12(b)(7)--Time Frame for
Clearing
a. ``Prompt and Efficient'' Standard and AQATP Standard
b. Proposed Approach to Straight-Through Processing
(1) Sec. 37.702(b)(1) and Sec. 39.12(b)(7)(i)(A)--``Prompt,
Efficient, and Accurate'' Standard
(2) Sec. 39.12(b)(7)(ii)--AQATP Standard for Registered DCOs
(3) Sec. 37.702(b)(2) Through (3)--Pre-Execution Credit
Screening
3. Applicability of Sec. 37.702(b) to SEFs That Do Not
Facilitate Clearing
C. Sec. 37.703--Monitoring for Financial Soundness
XIII. Part 37--Subpart I: Core Principle 8 (Emergency Authority)
A. Sec. 37.801--Additional Sources for Compliance
XIV. Part 37--Subpart J: Core Principle 9 (Timely Publication of
Trading Information)
XV. Part 37--Subpart K: Core Principle 10 (Recordkeeping and
Reporting)
XVI. Part 37--Subpart L: Core Principle 11 (Antitrust
Considerations)
XVII. Part 37--Subpart M: Core Principle 12 (Conflicts of Interest)
XVIII. Part 37--Subpart N: Core Principle 13 (Financial Resources)
A. Sec. 37.1301--General Requirements
1. Sec. 37.1301(a)
2. Sec. 37.1301(b)
3. Sec. 37.1301(c)
B. Sec. 37.1302--Types of Financial Resources
C. Sec. 37.1303--Liquidity of Financial Resources
D. Sec. 37.1304--Computation of Costs To Meet Financial
Resources Requirement
1. Acceptable Practices to Core Principle 13 in Appendix B
E. Sec. 37.1305--Valuation of Financial Resources
F. Sec. 37.1306--Reporting to the Commission
1. Sec. 37.1306(a)
2. Sec. 37.1306(b)
3. Sec. 37.1306(c)
4. Sec. 37.1306(d)
5. Sec. 37.1306(e)
[[Page 61948]]
G. Sec. 37.1307--Delegation of Authority
XIX. Part 37--Subpart O: Core Principle 14 (System Safeguards)
A. Sec. 37.1401(c)
B. Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire
C. Sec. 37.1401(j)
XX. Part 37--Subpart P: Core Principle 15 (Designation of Chief
Compliance Officer)
A. Sec. 37.1501--Chief Compliance Officer
1. Sec. 37.1501(a)--Definitions
2. Sec. 37.1501(b)--Chief Compliance Officer
a. Acceptable Practices to Core Principle 15 in Appendix B
3. Sec. 37.1501(c)--Duties of Chief Compliance Officer
4. Sec. 37.1501(d)--Preparation of Annual Compliance Report
5. Sec. 37.1501(e)--Submission of Annual Compliance Report and
Related Matters
6. Sec. 37.1501(f)--Recordkeeping
7. Sec. 37.1501(g)--Delegation of Authority
XXI. Part 36--Trade Execution Requirement
A. Sec. 36.1--Trade Execution Requirement
1. Sec. 36.1(a)--Trade Execution Requirement
2. Sec. 36.1(b)--Exemption for Certain Swaps Listed Only by
Exempt SEFs
a. Discussion of CEA Section 4(c) Enumerated Factors
3. Sec. 36.1(c)--Exemption for Swap Transactions Excepted or
Exempted From the Clearing Requirement Under Part 50
a. Discussion of CEA Section 4(c) Enumerated Factors
4. Sec. 36.1(d)--Exemption for Swaps Executed With Bond
Issuance
a. Discussion of CEA Section 4(c) Enumerated Factors
5. Sec. 36.1(e)--Exemption for Swaps Executed Between
Affiliates That Elect To Clear
a. Discussion of CEA Section 4(c) Enumerated Factors
B. Sec. 36.2--Registry of Registered Entities Listing Swaps
Subject to the Trade Execution Requirement; Appendix A to Part 36--
Form TER
C. Sec. 36.3--Trade Execution Requirement Compliance Schedule
1. Sec. 36.3(c)(1)--Category 1 Entities
2. Sec. 36.3(c)(2)--Category 2 Entities
3. Sec. 36.3(c)(3)--Other Counterparties
4. Sec. 36.3(e)--Future Compliance Schedules
XXII. Part 43--Sec. 43.2--Definition of ``Block Trade''
A. Sec. 43.2--Definition--Block Trade; Sec. 37.203(a)--
Elimination of Block Trade Exception to Pre-Arranged Trading
XXIII. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Information Provided by Reporting Entities/Persons
a. Sec. 37.3(a)--Requirements for Registration
b. Sec. 37.3(b)--Procedures for Registration
c. Sec. 37.3(c)--Amendment to an Order of Registration
d. Sec. 37.5(c)--Provision of Information Relating to a Swap
Execution Facility
e. Sec. 37.6(b)(1)--Legally Binding Documentation
f. Sec. 37.203(d)--Automated Trade Surveillance System
g. Sec. 37.203(e)--Error Trade Policy
h. Sec. 37.205(a)--Audit Trail Required
i. Sec. 37.205(b)--Elements of an Acceptable Audit Trail
Program
j. Sec. 37.205(c)--Audit Trail Reconstruction
k. Sec. Sec. 37.206(b)-(d)--Disciplinary Program
l. Sec. 37.401--General Requirements for Monitoring of Trading
and Trade Processing
m. Sec. 37.1301(b)--General Requirements for Financial
Resources
n. Sec. 37.1306--Financial Reporting to the Commission
o. Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire
p. Sec. 37.1501(d)--Preparation of Annual Compliance Report
q. Part 36--Trade Execution Requirement
2. Information Collection Comments
C. Cost-Benefit Considerations
1. Introduction
2. Baseline
3. SEF Registration
a. Overview
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
b. Benefits
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
c. Costs
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
4. Market Structure and Trade Execution
a. Overview
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
b. Benefits
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
c. Costs
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
5. Compliance and SRO Responsibilities
a. Overview
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
b. Benefits
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
c. Costs
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
6. Design and Monitoring of Swaps
a. Overview
(1) Swaps Not Readily Susceptible to Manipulation
(2) Monitoring of Trading and Trade Processing
b. Benefits
(1) Swaps Not Readily Susceptible to Manipulation
(2) Monitoring of Trading and Trade Processing
c. Costs
(1) Swaps Not Readily Susceptible to Manipulation
[[Page 61949]]
(2) Monitoring of Trading and Trade Processing
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
7. Financial Integrity of Transactions
a. Overview
b. Benefits
c. Costs
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
8. Financial Resources
a. Overview
b. Benefits
c. Costs
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
(2) Efficiency, Competitiveness, and Financial Integrity of
Markets
(3) Price Discovery
(4) Sound Risk Management Practices
(5) Other Public Interest Considerations
D. Antitrust Considerations
I. Background and Introduction
A. Statutory Background: The Dodd-Frank Act
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'') \2\ amended the Commodity Exchange
Act (``CEA'' or ``Act'') \3\ to establish a comprehensive new swaps
regulatory framework that includes the registration and the oversight
of swap execution facilities (``SEFs'').\4\ As amended, CEA section
1a(50) defines a SEF as a trading system or platform that allows
multiple participants to execute or trade swaps with multiple
participants through any means of interstate commerce.\5\ CEA section
5h(a)(1) establishes the SEF registration requirement, which requires
an entity to register as a SEF prior to operating a facility for the
trading or processing of swaps.\6\ CEA section 5h(f) requires
registered SEFs to comply with fifteen core principles.\7\ Further, the
trade execution requirement in CEA section 2(h)(8) provides that swap
transactions that are subject to the clearing requirement in CEA
section 2(h)(1)(A) \8\ must be executed on a DCM, SEF, or a SEF that is
exempt from registration pursuant to CEA section 5h(g) (``Exempt
SEF''),\9\ unless no DCM or SEF \10\ ``makes the swap available to
trade'' or the related transaction is subject to a clearing requirement
exception pursuant to CEA section 2(h)(7).
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, tit. VII, 124 Stat. 1376 (2010) (codified
as amended in various sections of 7 U.S.C.), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrfederalregister/documents/file/2013-12242a.pdf.
\3\ 7 U.S.C. 1 et seq.
\4\ 7 U.S.C. 7b-3 (adding a new CEA section 5h to establish a
registration requirement and regulatory regime for SEFs).
\5\ As amended by the Dodd-Frank Act, CEA section 1a(50)
specifically defines a ``swap execution facility'' as a trading
system or platform in which multiple participants have the ability
to execute or trade swaps by accepting bids and offers made by
multiple participants in the facility or system, through any means
of interstate commerce, including any trading facility, that
facilitates the execution of swaps between persons; and is not a
designated contract market. 7 U.S.C. 1a(50).
\6\ CEA section 5h(a)(1) states that no person may operate a
facility for the trading or processing of swaps unless the facility
is registered as a SEF or as a DCM under section 5h. 7 U.S.C. 7b-
3(a)(1).
\7\ 7 U.S.C. 7b-3(f).
\8\ Section 723(a)(3) of the Dodd-Frank Act added a new CEA
section 2(h) to establish the clearing requirement for swaps. 7
U.S.C. 2(h). CEA section 2(h)(1)(A) provides that it is unlawful for
any person to engage in a swap unless that person submits such swap
for clearing to a derivatives clearing organization that is
registered under the Act or a derivatives clearing organization that
is exempt from registration under this Act if the swap is required
to be cleared. 7 U.S.C. 2(h)(1)(A). CEA section 2(h)(2) specifies
the process for the Commission to review and determine whether a
swap, group, category, type or class of swap should be subject to
the clearing requirement. 7 U.S.C. 2(h)(2). The Commission further
implemented the clearing determination process under part 50, which
also specifies the swaps that are currently subject to the
requirement. 17 CFR part 50.
\9\ The Commission notes that CEA section 2(h)(8)(A)(ii)
contains a typographical error that specifies CEA section 5h(f),
rather than CEA section 5h(g), as the provision that allows the
Commission to exempt a SEF from registration. Where appropriate, the
Commission corrects this reference in the discussion herein.
\10\ CEA sections 2(h)(8)(A)(i)-(ii) provide that with respect
to transactions involving swaps subject to the clearing requirement,
counterparties shall execute the transaction on a board of trade
designated as a contract market under section 5; or execute the
transaction on a swap execution facility registered under 5h or a
swap execution facility that is exempt from registration under
section 5h(g) of the Act. Given this reference in CEA section
2(h)(8)(A)(ii), the Commission accordingly interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g).
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B. Regulatory History: The Part 37 Rules
Pursuant to its discretionary rulemaking authority in CEA sections
5h(f)(1) and 8a(5), the Commission identified the relevant areas in
which the statutory SEF framework would benefit from additional rules
or regulations.\11\ Accordingly, the Commission adopted the part 37
rules to implement a regulatory framework for SEFs and for the trading
and execution of swaps \12\ on such facilities.\13\ Among other
provisions, subpart A to part 37 applies the SEF registration
requirement to facilities that meet the statutory SEF definition;
specifies a minimum trading functionality that a SEF must offer to
participants for all listed swaps, i.e., an ``Order Book''; \14\ and
specifies the process for a SEF to make a swap ``available to trade''
(``MAT''), i.e., required to be executed on a SEF or DCM pursuant to
the trade execution requirement.\15\ Subpart A also defines swaps
subject to the trade execution requirement as ``Required Transactions''
and requires a SEF to offer either (i) an Order Book or (ii) a request-
for-quote system that sends a request-for-quote to no less than three
unaffiliated market participants and operates in conjunction with an
Order Book (``RFQ System'') for the execution of these
transactions.\16\ Swaps that are not subject to the trade execution
requirement are defined as ``Permitted Transactions,'' for which a SEF
may offer any execution method and for which market participants may
voluntarily trade on a SEF.\17\ The Commission's regulations specify
additional requirements that correspond to the use of an Order Book or
RFQ System to execute Required Transactions.\18\ Subparts B through O
[[Page 61950]]
set forth regulations that further implement each of the fifteen SEF
core principles in CEA section 5h(f). Appendix B provides further
guidance and acceptable practices associated with the SEF core
principles.\19\
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\11\ To implement the SEF core principles, Core Principle 1
provides that the Commission may, in its discretion, determine by
rule or regulation the manner in which SEFs comply with the core
principles. 7 U.S.C. 7b-3(f)(1)(B).
\12\ The Commission notes that, unless otherwise stated, the
terms ``trades,'' ``transactions,'' and ``swaps'' are used
interchangeably in the discussion herein.
\13\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476 (Jun. 4, 2013) (``SEF Core Principles Final
Rule''); Process for a Designated Contract Market or Swap Execution
Facility To Make a Swap Available to Trade, Swap Transaction
Compliance and Implementation Schedule, and Trade Execution
Requirement Under the Commodity Exchange Act, 78 FR 33606 (Jun. 4,
2013) (``MAT Final Rule'').
\14\ 17 CFR 37.3(a)(2). An Order Book is defined as (i) an
``electronic trading facility,'' as that term is defined in CEA
section 1a(16); (ii) a ``trading facility,'' as that term is defined
in CEA section 1a(51); or (iii) a trading system or platform in
which all market participants have the ability to enter multiple
bids and offers, observe or receive bids and offers entered by other
market participants, and transact on such bids and offers. 17 CFR
37.3(a)(3).
\15\ 17 CFR 37.10. Given that swaps subject to the trade
execution requirement may also be executed on a DCM, the Commission
adopted the same process for a registered DCM to make a swap
``available to trade'' in part 38. 17 CFR 38.12. Accordingly,
discussion in this notice with respect to the application of the
trade execution requirement or the MAT process to SEFs should be
interpreted to also apply to DCMs.
\16\ 17 CFR 37.9(a). With the exception of block trades, as
defined under Sec. 43.2, Required Transactions must be executed on
a SEF's Order Book or RFQ System. 17 CFR 37.9(a)(2)(i).
\17\ 17 CFR 37.9(c).
\18\ See infra notes 85 (15-second time delay for the entry of
pre-arranged or pre-negotiated transactions to an Order Book) and
242 (additional requirements for RFQ Systems) and accompanying
discussion.
\19\ 17 CFR part 37 app. B.
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These rules reflect a more limited and prescriptive regulatory
approach to implementing the statutory provisions and promoting the
statutory goals of section 5h of the Act, i.e., promoting the trading
of swaps on SEFs and promoting pre-trade price transparency in the
swaps market.\20\ In particular, the Commission focused on achieving
pre-trade price transparency by mandating a minimum trading
functionality requirement for all swaps listed on a SEF and two
specific, limited execution methods for Required Transactions. The
Commission adopted the Order Book requirement both as a minimum trading
functionality for SEF registration and as an execution method for
Required Transactions.\21\ To provide some execution flexibility for
Required Transactions,\22\ the Commission also allowed SEFs to offer an
RFQ System, as described above.\23\ To further the goal of pre-trade
price transparency with respect to trading via an RFQ System, however,
the Commission required that an RFQ must be submitted to three
unaffiliated market participants and that a requester receive
applicable firm bids and offers from the Order Book in addition to any
RFQ responses.\24\ Recognizing that only certain swaps are well-suited
to be traded and executed through an Order Book or RFQ System, the
Commission interpreted the trade execution requirement in CEA section
2(h)(8), in particular the phrase ``makes the swap available to
trade,'' to have a scope of application that is consistent with the use
of these methods. Accordingly, the Commission interpreted the phrase,
which the Act does not otherwise define, to implement a voluntary MAT
process for determining the swaps that must be executed on a SEF; this
process primarily focuses on whether a swap has ``sufficient trading
liquidity'' to be executed via an Order Book or RFQ System.\25\
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\20\ 7 U.S.C. 7b-3(e) (specifying the rule of construction for
CEA section 5h).
\21\ 17 CFR 37.3(a)(2) (minimum trading functionality
requirement); 17 CFR 37.9(a)(2)(i)(A) (Required Transactions
requirement).
\22\ SEF Core Principles Final Rule at 33564-65.
\23\ 17 CFR 37.9(a)(3).
\24\ SEF Core Principles Final Rule at 33497, 33499.
\25\ MAT Final Rule at 33609 (noting that a MAT determination
may focus on whether a swap is sufficiently liquid to be subject to
the trade execution requirement).
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The Commission noted that the prescribed trading methods, such as
the Order Book, are consistent with the SEF definition in CEA section
1a(50) of the Act as they allow multiple market participants to post
bids or offers and accept bids and offers that are transparent to
multiple market participants.\26\ The Commission stated that the RFQ
System is consistent with the SEF definition because it requires market
participants to be able to access multiple market participants, but not
necessarily the entire market.\27\ Further, in response to commenters'
feedback that the Commission's approach is inconsistent with the Act,
the Commission stated that the limited execution methods for Required
Transactions are consistent with the phrase ``through any means of
interstate commerce'' in the SEF definition because a SEF ``may for
purposes of execution and communication use `any means of interstate
commerce,' including, but not limited to, the mail, internet, email,
and telephone, provided that the chosen execution method satisfies the
requirements . . . for Order Books or . . . for [RFQ Systems].'' \28\
The Commission also noted that a SEF may provide any method of
execution for Permitted Transactions as further justification for its
approach under the Act.\29\
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\26\ SEF Core Principles Final Rule at 33501.
\27\ Id. at 33496.
\28\ Id. at 33501.
\29\ Id. at 33484.
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In adopting a regulatory framework that would effectuate the
statutory SEF provisions and goals, the Commission relied in part upon
its experience with the futures market, including DCM oversight and DCM
core principles implementation.\30\ While the Commission did provide
flexibility for certain swap requirements relative to the DCM
rules,\31\ the Commission sought, where possible, to harmonize SEF
regulations with DCM regulations based on the similarities in the
statutory core principles between SEFs and DCMs, and the ability of
both types of entities to offer swaps for trading and execution.\32\
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\30\ Id. at 33477.
\31\ For example, the RFQ System requirement for Required
Transactions on SEFs is less restrictive than the RFQ-to-all
approach that is used by some DCMs. The Commission decided that the
former approach was more appropriate for SEFs due to the less
standardized nature of the swaps market. SEF Core Principles Final
Rule at 33497 n.270.
\32\ Id. at 33478, 33553 (noting the similarities between the
statutory requirements for SEFs and DCMs).
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1. Challenges of Existing Regulatory Approach
The Commission's existing regulatory approach has transitioned some
degree of swaps trading and market participants to SEFs, but has also
created several challenges for swaps trading on SEFs, as described
below.
a. Lack of MAT Determinations
The voluntary, SEF-driven MAT determination process has resulted in
a limited set of products that are required to be executed on SEFs.
Since 2014, SEFs have submitted a limited number of swaps, relative to
the scope of swaps subject to the clearing requirement, as ``available
to trade'' to the Commission.\33\ The swaps that SEFs have submitted--
``on-the-run'' index credit default swaps (``CDS'') and fixed-to-
floating interest rate swaps (``IRS'') in benchmark tenors--are
generally the most standardized and liquid swaps contracts.\34\ Beyond
this initial set of MAT determinations, the Commission has not received
any filings for additional swaps despite the subsequent expansion of
the clearing requirement.\35\
[[Page 61951]]
The lack of additional determinations is partly attributable to market
participants' concerns over the Commission's required methods of
execution for Required Transactions.\36\ Based on those concerns, SEFs
have not pursued making additional swaps subject to the trade execution
requirement. This lack of additional submissions has effectively
limited the number of swaps that must be executed on SEFs which has
limited the amount of trading and liquidity formation occurring on
SEFs.
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\33\ For a list of MAT determinations that have been submitted
to the Commission, see CFTC, Industry Oversight, Industry Filings,
Swaps Made Available to Trade Determination, https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination. For
a current list of swaps that have been made ``available to trade''
and are subject to the trade execution requirement, see CFTC,
Industry Oversight, Industry Filings, Swaps Made Available to Trade,
https://www.cftc.gov/sites/default/files/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf. For a list of swaps
subject to the clearing requirement, see 17 CFR 50.4; see also CFTC,
Industry Oversight, Industry Filings, Swaps Subject to Clearing
Requirement, https://www.cftc.gov/sites/default/files/idc/groups/public/@otherif/documents/ifdocs/clearingrequirementcharts9-16.pdf.
\34\ See, e.g., Bloomberg SEF, Submission No. 2013-R-9,
Bloomberg SEF LLC--Made Available to Trade (``MAT'') Submission of
Certain Credit Default Swaps (``CDS'') and Interest Rate Swaps
(``IRS'') pursuant to [CFTC] Regulation 40.6 at 3 (Dec. 5, 2013)
(stating that its MAT determination consists of only the most
standardized and liquid swaps, which represent a majority of market
traded volume), https://www.cftc.gov/sites/default/files/stellent/groups/public/@otherif/documents/ifdocs/bsefmatdetermltr120513.pdf;
``TW SEF,TW SEF LLC--Clarification and Amendment to Self-
Certification for Swaps to be Made Available to Trade'' at 8 (Nov.
29, 2013) (stating that its MAT determinations with respect to IRS
represent the ``standard benchmarks, which are the most standard,
liquid, and transparent of the IRS market, and trade with market-
accepted, standard, plain vanilla dates), https://www.cftc.gov/sites/default/files/stellent/groups/public/@otherif/documents/ifdocs/twsefamendmatltr112913.pdf.
\35\ In 2016, the Commission expanded the clearing requirement
for IRS in the four classes (fixed-to-floating swaps, basis swaps,
forward rate agreements, overnight index swaps) to additional
currencies. CFTC, Press Releases, Release No. 7457-16, CFTC Expands
Interest Rate Swap Clearing Requirement, https://www.cftc.gov/PressRoom/PressReleases/pr7457-16 (Sept. 28, 2016). See also
Clearing Requirement Determination Under Section 2(h) of the
Commodity Exchange Act for Interest Rate Swaps, 81 FR 71202 (Oct.
14, 2016) (``Second Clearing Determination Final Rule'').
\36\ See CFTC Public Roundtable: The Made Available to Trade
Process, 151-152, 192-193 (July 15, 2015), https://www.cftc.gov/idc/groups/public/%40newsroom/documents/file/transcript071515.pdf
(``2015 MAT Roundtable'') (discussing the prescriptive nature of the
required methods of execution and noting the relationship to the MAT
determination process).
---------------------------------------------------------------------------
b. Swaps Market Characteristics
Over the course of the part 37 implementation process, the
Commission has gained greater familiarity with the swaps markets, in
particular the nature of the products and how market participants trade
and execute those products. Based on what it has learned, the
Commission believes that the existing regulatory framework has
contributed to the limited amount of swaps that are subject to the
trade execution requirement, and therefore, the limited scope of swaps
trading that occurs on SEFs.
Swaps consist of many highly variable terms and conditions beyond
price and size that can be negotiated and tailored to suit a market
participant's specific and unique needs. While some swaps are
relatively standardized, others are customized and consist of
innumerable permutations, making them generally less standardized and
more bespoke than futures contracts. Given the ability to customize
swaps to address specific and often large risks that cannot be offset
through more standardized instruments, the swaps market is generally
comprised of a relatively concentrated number of sophisticated market
participants in contrast to the futures market. In this regard, the
Commission notes that CEA section 2(e) limits swaps trading on SEFs to
``eligible contract participants'' (``ECPs''), as defined by CEA
section 1a(18).\37\ These swaps market characteristics contribute to
varying liquidity profiles for swaps that range from relatively
illiquid to episodic to relatively liquid.
---------------------------------------------------------------------------
\37\ 7 U.S.C. 2(e); 7 U.S.C. 1a(18).
---------------------------------------------------------------------------
Historically, these particular characteristics have contributed to
the use of a variety of execution methods--electronic, voice-based, or
a hybrid of both (``voice-assisted'')--by market participants.
Utilizing one execution method or another depends on considerations
such as the type of swap, transaction size, complexity, the swap's
liquidity at a given time, the number of potential liquidity providers,
and the associated desire to minimize potential information leakage and
front-running risks. For swaps with standard tenors that are relatively
liquid, market participants may utilize a method of trading and
execution, such as an electronic order book platform, that disseminates
trading interests to all other market participants on the platform.
Trading and execution in less standardized products, however, generally
occur on systems or platforms that are more discreet in disseminating
trading interests, such as auction platforms. The Commission's existing
approach to required execution methods, as described above, creates a
tension with swaps market characteristics that necessitate flexible
execution methods. This tension has otherwise hindered the expansion of
the trade execution requirement.
c. Operational Complexities and Costs
The Commission has learned that its approach to other part 37 rules
may have imposed certain burdens on SEFs, including operating
complexities and costs that have impeded development, innovation, and
growth in the swaps market. SEFs have indicated that they are unable to
comply with some of these requirements because they are impractical or
unachievable due to technology limitations or incompatible with
existing market practices. For example, as discussed further below,
SEFs have informed the Commission that the confirmation requirement for
uncleared swaps under Sec. 37.6(b) and the electronic analysis
capability requirements with respect to audit trail data for voice
orders under Sec. 37.205 have been operationally difficult and
impractical to implement.\38\ Even where SEFs have been able to comply
with some of the requirements, they have asserted that the compliance
costs are high and compliance is unnecessary in helping them satisfy
their self-regulatory obligations and the SEF core principles. For
example, SEFs have noted the high costs of the financial resources
requirements imposed by the Core Principle 13 regulations.\39\ SEFs and
market participants have attributed the limited development,
innovation, and growth of SEFs to these ongoing burdens.
---------------------------------------------------------------------------
\38\ See infra Section IV.F.--Sec. 37.6--Enforceability
(discussion of SEF confirmation requirements); Section VII.D.--Sec.
37.205--Audit Trail (discussion of SEF audit trail requirements).
\39\ See Letter from Wholesale Markets Brokers' Association,
Americas (``WMBAA''), Swap Execution Facility Regulations, Made
Available to Trade Determinations, and Swap Trading Requirements at
5 (Mar. 11, 2016) (``2016 WMBAA Letter''); see also CFTC Letter No.
17-25, Division of Market Oversight Guidance on Calculating
Projected Operating Costs By Designated Contract Markets and Swap
Execution Facilities (Apr. 28, 2017) (``CFTC Letter No. 17-25'').
---------------------------------------------------------------------------
As a result of these burdens, the Commission believes that a
significant amount of swaps liquidity formation activity occurs away
from registered SEFs in a manner similar to the pre-Dodd-Frank Act
swaps trading environment. These examples include (i) entities that
aggregate single-dealer platforms to allow market participants to
obtain indicative or firm pricing and execute swaps with multiple
single-dealer liquidity providers away from SEFs; and (ii) swaps
broking entities, including interdealer brokers \40\ that facilitate
swaps trading between multiple market participants through non-
registered voice or electronic platforms. While some of these
interdealer brokers are affiliated with registered SEFs, the Commission
understands that they have nevertheless maintained a bifurcated
operating structure under which a SEF primarily executes and processes
orders that have already been negotiated or arranged on an affiliated
broker platform, in effect limiting a SEF's role to a swaps transaction
booking and processing engine.\41\ By operating in this manner, the
Commission believes that many entities have been able to avoid the
burdens arising from SEF registration and compliance under part 37.
---------------------------------------------------------------------------
\40\ The Commission believes that most of these swaps broking
entities are currently registered with the Commission as introducing
brokers (``IBs''). See infra note 340 and accompanying discussion.
\41\ The Commission notes that these swaps broking entities and
their affiliated SEFs primarily operate as part the ``dealer-to-
dealer'' segment of the swaps market, which primarily facilitates
swaps trading between swap dealers. See infra Section
VII.A.1.a.(1)(i).--Eligibility and Onboarding Criteria (discussion
of impartial access requirements).
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When necessary or appropriate to mitigate these burdens in the
course of implementing part 37, Commission staff has issued various
guidance and time-limited no-action relief to SEFs and market
participants. The no-action relief has afforded additional time for
compliance with certain part 37 regulations and related procedures or
has provided an opportunity to
[[Page 61952]]
determine whether a longer-term regulatory solution--such as those
proposed in this notice--is warranted.\42\ Where compliance could not
be achieved or impractical compliance burdens arose from the existing
part 37 rules, SEFs may have been impeded from pursuing beneficial
market initiatives, such as developing new trading systems and
protocols to attract greater swaps liquidity. The Commission believes
that it is appropriate to address these issues as part of the changes
to the existing regulations proposed in this notice.
---------------------------------------------------------------------------
\42\ See infra notes 223 (no-action relief from existing Sec.
37.6(b) confirmation requirements for uncleared swap transactions
executed on a SEF), 433 (no-action relief from existing Sec. 37.9
and Sec. 37.203(a) with respect to the correction of error trades
on SEFs), 474 (no-action relief from existing Sec. 37.205(a) with
respect to capturing of trade allocation information in a SEF
transaction history database), 822 (no-action relief from existing
Sec. 37.1501(f) with respect to SEF annual compliance report filing
requirements), 898 (no-action relief from certain ``block trade''
definitional requirements under existing Sec. 43.2) and
accompanying discussion.
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C. Proposed Approach
Given the challenges described above and the Commission's enhanced
knowledge and experience from implementing part 37, the Commission is
proposing to strengthen its swaps trading regulatory framework, while
still effectuating the statutory SEF provisions and better promoting
the statutory SEF goals. The Commission's proposed approach also more
appropriately accounts for swaps market characteristics and should
reduce certain complexities and costs that have contributed to a
significant amount of swaps liquidity formation occurring away from
SEFs; limited the scope of swaps that are subject to the trade
execution requirement; and impeded SEF development, innovation, and
growth. In this regard, the Commission proposes a simple but
comprehensive approach that provides SEFs with flexibility, where
appropriate, to calibrate their trading and compliance functions based
on their respective trading operations and markets. The Commission
believes that this proposed approach will attract greater liquidity
formation on SEFs.
First, the Commission aims to effectuate the SEF registration
requirement to ensure that multiple-to-multiple trading of swaps occurs
on a SEF by requiring that swaps broking entities and certain single-
dealer aggregator platforms register as SEFs (emphasis added). In
particular, consistent with the statutory SEF provisions and goals,
this proposed rulemaking would apply the SEF registration requirement
in CEA section 5h(a)(1) and Sec. 37.3(a) to swaps broking entities,
including interdealer brokers, that are currently registered with the
Commission as IBs, and their personnel currently facilitating swaps
trading away from SEFs. Based on its experience and observation of
market developments since the adoption of part 37, the Commission has
witnessed the various ways in which swaps broking entities, including
interdealer brokers, have structured themselves to facilitate swaps
trading, and therefore liquidity formation, outside of the existing SEF
regulatory framework.
Second, the Commission aims to facilitate increased trading and
liquidity on SEFs by proposing a revised interpretation of the trade
execution requirement that is consistent with CEA section 2(h)(8). The
Commission's proposed interpretation would apply the trade execution
requirement to all swaps that are both subject to the clearing
requirement under section 2(h)(1) of the Act and listed for trading on
a SEF. As a result of this approach, the Commission would also withdraw
the existing voluntary MAT process.
The proposed expansion of the trade execution requirement is
expected to capture a greater number of swaps with different liquidity
profiles, thereby reinforcing the need to establish a more flexible
regulatory approach to swaps trading and execution that would help
foster customer choice, promote competition between and innovation by
SEFs, and better account for fundamental swaps market characteristics.
Accordingly, the Commission also proposes to allow a SEF to offer any
method of execution for all swaps trading and execution, rather than
only an Order Book or RFQ System.
Rather than dictating certain execution methods for Required
Transactions, the Commission's proposed flexible approach would enable
SEFs to provide, and ultimately allow market participants to choose,
execution methods that are appropriate for the liquidity and other
characteristics of particular swaps. The Commission's approach should
also promote pre-trade price transparency in the swaps market by
allowing execution methods that maximize participation and concentrate
liquidity during times of episodic liquidity. The Commission believes
that providing flexibility in execution methods will allow the swaps
market to continue to naturally evolve and allow SEFs to innovate and
provide more efficient, transparent, and cost-effective means of
trading and execution. The Commission also proposes to eliminate the
minimum trading functionality requirement, which should reduce the
costs incurred by SEFs to operate and maintain order books that have
not attracted significant volumes. In lieu of specific execution method
requirements, the Commission is proposing general disclosure-based
trading and execution rules that would apply to any execution method
offered by a SEF.
In conjunction with allowing SEFs to offer more flexible execution
methods, the Commission is proposing new rules for certain SEF
personnel--``SEF trading specialists''--that constitute part of a SEF's
trading system or platform. The proposed rules require SEFs to adopt
minimum proficiency testing and ethics training requirements to ensure
that their trading specialists possess and maintain an adequate level
of technical knowledge and understand their ethical responsibilities in
customer trading or execution and fostering liquidity formation. The
proposed rules would also require SEFs to adopt trading conduct
standards and a duty of supervision. With the ability to offer more
flexible execution methods for all swaps, in particular those that
involve discretion by trading specialists in handling trading or
execution, the Commission believes that these proposed requirements are
necessary to enhance professionalism in the swaps market and to promote
market integrity and fairness. Further, the proposed requirements would
mandate requisite levels of knowledge and competence that are
commensurate to other similar requirements established for personnel in
major trading markets, such as futures and equities.\43\
---------------------------------------------------------------------------
\43\ See infra note 355.
---------------------------------------------------------------------------
The Commission is also proposing a series of amendments to
additional part 37 regulations that implement the SEF core principles.
These proposed amendments would allow a SEF to better tailor its
compliance and regulatory oversight programs to its trading operations
and markets. The Commission believes that these proposed revisions are
critical to the ability of SEFs to offer the diverse types of execution
methods that would be available to them under this proposal. Further,
the proposed rules would streamline and refine some of the existing
prescriptive requirements applicable to SEFs to better reflect
technological capabilities and existing market practices in the swaps
market. The proposed rules would also seek to reduce unnecessary
compliance costs while still maintaining robust
[[Page 61953]]
compliance programs and consistency with the SEF core principles. The
ability to tailor compliance and oversight programs is consistent with
the ``reasonable discretion'' that Core Principle 1 provides SEFs to
comply with the core principles and mitigates compliance challenges
that SEFs have encountered in implementing part 37.\44\
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\44\ Core Principle 1 states that, unless otherwise determined
by the Commission by rule or regulation, a SEF shall have reasonable
discretion in establishing the manner in which it complies with the
SEF core principles.'' 7 U.S.C. 7b-3(f)(1)(B).
---------------------------------------------------------------------------
With respect to existing staff guidance and staff no-action relief,
the Commission would adopt or codify such guidance or relief where
appropriate. Providing a simple, but more comprehensive regulatory
approach would help mitigate barriers for market participants to trade
and execute further on SEFs, which would in turn better promote the
statutory SEF goals.
Finally, the proposed rules include non-substantive amendments and
various conforming changes to relevant provisions in the Commission's
regulations.
The Commission believes that the proposed revisions to the part 37
framework are consistent with the statutory SEF provisions and should
serve to advance swaps trading on SEFs. The proposed rules are designed
to more appropriately account for swaps market characteristics,
especially with respect to the use of a wider array of different
execution methods to trade and execute a broad scope of swaps with
varying liquidity characteristics. Accordingly, the proposed rules are
expected to better promote the development, innovation, and growth of
the swaps market, with the intent of attracting liquidity formation
onto SEFs.
D. Summary of Proposed Revisions
As a general overview of the major changes described in this
notice, the Commission is proposing:
Registration: A proposed interpretation to apply the
statutory SEF registration requirement and the definition of ``swap
execution facility'' in CEA sections 5h(a)(1) and 1a(50),
respectively, to certain swaps broking entities, including
interdealer brokers, as well as aggregators of single-dealer
platforms. The proposed rules also include revisions to simplify the
registration process by streamlining Form SEF.
Trade Execution Requirement: A revised interpretation
of the trade execution requirement in CEA section 2(h)(8) and new
rules based upon that interpretation that (i) broaden the scope of
the trade execution requirement; (ii) create a compliance schedule
for the expanded requirement; and (iii) provide exemptions from the
requirement for certain types of swap transactions pursuant to CEA
section 4(c). Further, the Commission is proposing to require each
SEF to submit a Form TER that specifies those swaps that it lists
for trading that are subject to the clearing requirement.
Execution Methods: New general, disclosure-based
trading and execution rules under Core Principle 2 that apply to any
execution method offered by a SEF. These proposed rules would
replace the Sec. 37.3(a)(2) minimum trading functionality
requirement and the execution methods prescribed under Sec. 37.9
for Required Transactions, thereby allowing a SEF to offer flexible
methods of execution for swaps subject to the trade execution
requirement. Further, the Commission is also proposing to limit the
scope of trading-related communications that SEF participants may
conduct away from a SEF's trading system or platform.
Proficiency: In conjunction with allowing SEFs to offer
more flexible methods of execution for swaps subject to the trade
execution requirement, the Commission is also proposing new rules
under Core Principle 2 for SEF trading specialists. The proposed
rules would benefit SEF participants by strengthening market
integrity and fairness through requirements for SEFs to establish
proficiency testing and ethics training, trading conduct standards,
and a duty of supervision.
Swap Documentation: Amendments to the existing Sec.
37.6(b) confirmation requirement that would allow a SEF to provide a
``trade evidence'' record for an uncleared swap that serves as
evidence of a legally binding swap transaction, but may be
supplemented by counterparties with additional terms based on
previously negotiated underlying agreements.
Impartial Access: Modifications to the existing
impartial access rules under Sec. 37.202 that would allow a SEF to
structure participation criteria and trading practices in a manner
that aligns with the current swaps market structure.
Self-Regulatory Oversight: Amendments to Sec. Sec.
37.203-206 under Core Principle 2 that provide a SEF with the
ability to, among other things, (i) tailor its rule enforcement
program and disciplinary procedures and sanctions to the
characteristics of its trading operations and market; (ii) develop
an audit trail surveillance system that is appropriate to the types
of available execution methods it offers; and (iii) choose other
additional types of regulatory service providers to assist with
fulfilling its oversight duties.
Product Guidance: Additional guidance, pursuant to Core
Principle 3, for a SEF to demonstrate that the swaps that it lists
for trading are not readily susceptible to manipulation.
Straight-Through Processing: Amendments and
clarifications to the SEF straight-through processing requirements
that better reflect existing swaps market practices.
Financial Resources: Amendments to apply the existing
Core Principle 13 financial resource requirements in a more
practical manner to SEF operations. The proposed rule changes
include amendments to the existing six-month liquidity requirement
and the addition of new acceptable practices that provide further
guidelines to SEFs for making a reasonable calculation of their
projected operating costs.
Chief Compliance Officer: Amendments to Core Principle
15 regulations that streamline existing requirements for the chief
compliance officer (``CCO'') position; allow SEF management to
exercise discretion in CCO oversight; and simplify the preparation
and submission of the required annual compliance report.
E. Consultation With Other U.S. Financial Regulators
In developing these rules, the Commission has consulted with the
Securities and Exchange Commission, pursuant to section 712(a)(1) of
the Dodd-Frank Act.\45\
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\45\ Dodd-Frank Act, Public Law 111-203, tit. VII, Sec.
712(a)(1), 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
II. Part 9--Rules Relating To Review of Exchange Disciplinary, Access
Denial or Other Adverse Actions
The Commission is proposing non-substantive amendments to part 9 of
the Commission's regulations that conform to proposed amendments to
Sec. 37.206--Disciplinary procedures and sanctions. Accordingly, the
Commission discusses those proposed amendments to part 9 in Section
VII.F. of this notice in conjunction with its discussion of the
proposed amendments to Sec. 37.206.
III. Part 36--Trade Execution Requirement
The Commission is proposing new rules under part 36 of the
Commission's regulations to implement a proposed revised interpretation
of the trade execution requirement in CEA section 2(h)(8), which would
broaden the scope of the requirement to include additional swaps. The
Commission discusses the proposed implementing rules in Section
IV.I.4.a. of this notice in conjunction with its discussion of (i) the
proposed adoption of flexible means of execution and elimination of the
minimum trading functionality under Sec. 37.3(a)(2); (ii) the
prescribed execution methods under Sec. 37.9; and (iii) the MAT
process (and corresponding trade execution compliance schedule) under
Sec. 37.10, Sec. 37.12, and Sec. Sec. 38.11-12.\46\ Further, the
Commission discusses the proposed Form TER submission, the proposed
compliance schedule for the expanded requirement, and proposed
exemptions from the requirement in Section XXI. of this notice.
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\46\ See infra Section IV.I.4.a.--Sec. 36.1(a)--Trade Execution
Requirement.
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[[Page 61954]]
IV. Part 37--Subpart A: General Provisions
A. Sec. 37.1--Scope
Section 37.1 currently clarifies that part 37 applies to every SEF
that is registered or is applying to become registered as a SEF with
the Commission. Section 37.1 also clarifies that part 37's
applicability does not affect the eligibility of a registered SEF or a
SEF applicant to operate as either a DCM under part 38 of the
Commission regulations or a swap data repository (``SDR'') under part
49 of the Commission's regulations.
The Commission proposes a non-substantive amendment to Sec. 37.1.
The Commission has not identified any provisions in part 37 that would
preclude a registered SEF from being eligible to operate as a DCM or an
SDR; accordingly, the clarifying language may create unnecessary
ambiguity. Therefore, the Commission proposes a non-substantive
amendment to eliminate the existing language to avoid any potential
confusion.
B. Sec. 37.2--Applicable Provisions and Definitions \47\
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\47\ The Commission proposes to retitle Sec. 37.2 to
``Applicable provisions and definitions'' from ``Applicable
provisions'' based on the proposed addition of Sec. 37.2(b)
described below.
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1. Sec. 37.2(a)--Applicable Provisions
Section 37.2 states that a SEF must comply with part 37 and all
other applicable Commission regulations, including any related
definitions and cross-referenced sections. Section 37.2 also identifies
certain specific pre-Dodd-Frank Act provisions whose applicability to
SEFs may otherwise not be apparent--in particular, Sec. 1.60 and part
9 of the Commission's regulations.\48\ The Commission proposes to adopt
a non-substantive amendment to eliminate the reference to part 9; the
Commission notes that it has since adopted amendments to part 9 to
conform to the relevant part 37 regulations.\49\
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\48\ Section 1.60 sets forth requirements for futures commission
merchants (``FCMs'') and DCMs to submit documents requested by the
Commission that have been filed in any material legal proceeding in
which the FCM or DCM is a party. 17 CFR 1.60. For a description of
the Commission's part 9 regulations, see infra Section VII.F.--Part
9--Rules Relating to Review of Exchange Disciplinary, Access Denial
or Other Adverse Actions.
\49\ Technical Amendments to Rules on Registration and Review of
Exchange Disciplinary, Access Denial, or Other Adverse Actions, 83
FR 1538 (Jan. 12, 2018). The Commission notes that it is also
proposing additional amendments to part 9 in this notice that
conform to the proposed amendments to the Core Principle 2
regulations discussed herein. The Commission also proposes to
renumber this provision to subsection (a) based on the proposed
addition of Sec. 37.2(b) described below.
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2. Sec. 37.2(b)--Definition of ``Market Participant''
The Commission proposes a new provision under Sec. 37.2(b) to
define ``market participant,'' as the term is currently used in part
37, to clarify a SEF's jurisdiction over the various participants that
may be involved in trading or executing swaps on its facility. In the
preamble to the SEF Core Principles Final Rule, the Commission
specified that a ``market participant'' includes any ``person that
directly or indirectly effects transactions on the SEF. [The
definition] includes persons with trading privileges on the SEF and
persons whose trades are intermediated.'' \50\ This term applies to
several part 37 rules and triggers certain obligations under the Core
Principle 2 regulations, which set forth a SEF's self-regulatory
responsibilities. For example, Sec. 37.206 requires a SEF to establish
participation rules that broadly impose a SEF's disciplinary authority
across different categories of participants, including market
participants.\51\
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\50\ SEF Core Principles Final Rule at 33506. See also Division
of Market Oversight Guidance on Swap Execution Facility Jurisdiction
(Feb. 10, 2014) (``2014 Staff Jurisdiction Guidance'').
\51\ 17 CFR 37.206.
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In practice, SEFs have created various participation categories,
including ``direct access,'' ``direct market access,'' and ``sponsored
access'' to describe how persons connect to their trading systems or
platforms. For example, the Commission understands that ``direct
access'' generally refers to participants who have been granted trading
privileges by a SEF and utilize their own proprietary means, e.g.,
trading credentials and/or front-end interface, to participate directly
on the SEF.\52\ In contrast, ``direct market access'' or ``sponsored
access'' generally describe arrangements in which a person uses a SEF
participant's means, including trading credentials and/or front-end
systems, to participate directly on the SEF. For example, many SEFs
allow persons to access their systems or platforms by using the
credentials and/or front-end functionality provided by a SEF
participant, such as a futures commission merchant (``FCM'') serving as
a clearing member on the SEF or an IB.\53\ Finally, some persons may
participate on a SEF via an agency execution model by directing an
intermediary, e.g., an FCM or an IB, to submit orders or request quotes
on their behalf.
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\52\ The Commission notes that ``direct access'' also refers to
participants who may onboard and utilize a SEF's own front-end
application to trade swaps on the SEF's systems or platforms.
\53\ The Commission notes that some SEFs refer to such persons
as ``customers'' of a SEF trading participant.
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Notwithstanding these categories, SEFs have generally relied on the
existing description of ``market participant'' in the SEF Core
Principles Final Rule preamble to establish jurisdiction over all of
these participants that access the SEF and trade swaps on a direct or
indirect basis. Given this established reliance and the continued use
of this term under the proposed rules, the Commission seeks to codify
the definition of ``market participant'' in part 37. The Commission
proposes to define ``market participant'' as any person who accesses a
SEF (i) through direct access provided by a SEF; (ii) through access or
functionality provided by a third-party; or (iii) through directing an
intermediary that accesses a SEF on behalf of such person to trade on
its behalf. As a threshold matter, the Commission notes that since
these persons are currently considered ``market participants,'' they
are already subject to a SEF's jurisdiction. The Commission believes
that persons accessing a SEF through the various means described above
interact with other market participants on the SEF and have the ability
to engage in abusive trading practices. Therefore, they should continue
to be subject to a SEF's jurisdiction, including disciplinary
procedures and recordkeeping obligations.\54\
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\54\ Although a person who directs an intermediary to trade on
its behalf does not interact with other market participants in the
same manner, the Commission believes that such a person could engage
in abusive trading activity by using more than one intermediary to
place orders that result in an abusive trading practice. For
example, a person seeking to achieve a wash result could structure a
transaction or a series of transactions through separate
intermediaries, which may give the appearance of bona fide purchases
and sales, but where the trades have been entered into without the
intent to take a bona fide market position. While persons do not
typically access a SEF in this manner, the Commission is mindful
that the part 37 rules do not preclude this access method and notes
that some SEFs currently facilitate agency-based trading.
Accordingly, the Commission believes that a SEF must continue to
have jurisdiction and disciplinary authority over these persons in
order to effectively investigate misconduct and prosecute rule
violations that occur on the SEF.
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a. Applicability of Sec. 37.404(b) to Market Participants
The Commission notes in particular that this proposed definition of
``market participant'' would apply to the recordkeeping requirements
under Sec. 37.404(b). Section 37.404(b) requires a SEF to adopt rules
that require its market participants to keep records of their trading,
including records of their activity in any index or instrument used as
a reference price, the underlying
[[Page 61955]]
commodity, and related derivatives markets.\55\ Participants who trade
on a SEF via direct access and participants who use the access or
functionality of another participant to trade on a SEF have primary
access to these types of records of their own trading. Further, the
Commission believes persons who direct an intermediary to trade on
their behalf are best situated to maintain the records required by
Sec. 37.404(b). The Commission understands that such intermediaries
would likely only have access to records of swaps activity occurring on
the SEF, not necessarily activity by their customers in the index or
instruments used as a reference price, the underlying commodity, and
related derivatives markets. Consequently, the Commission believes that
as ``market participants'' under the proposed definition, they should
be subject to the recordkeeping requirements under Sec. 37.404(b).\56\
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\55\ 17 CFR 37.404(b).
\56\ The Commission notes that the proposed ``market
participant'' definition, or the discussion herein, does not alter
any person's obligations under Sec. 1.35. 17 CFR 1.35.
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b. SEF Jurisdiction Over Clients of Market Participants
The proposed ``market participant'' definition would not capture
clients of asset managers who, as market participants of a SEF, trade
on a SEF on their clients' behalf.\57\ The Commission recognizes that
based on general industry practice, these clients have given their
respective asset managers broad discretion to execute transactions in
various financial products in different markets, including swaps. When
asset managers trade on a client's behalf based on that discretion,
such trading typically occurs without specific knowledge by the client
as to whether such transactions are occurring on a SEF or the identity
of the SEFs involved. While the clients themselves ultimately are the
named counterparties to any transactions executed on their behalf, the
asset managers are the participants accessing the SEF, and as such, are
subject to the ``market participant'' definition and the obligations
thereunder, including the SEF's jurisdiction. The Commission notes that
asset managers--not their clients--access the SEF and sign onboarding
documentation subjecting them to the SEF's jurisdiction. Since clients
of asset managers would not be captured under the proposed market
participant definition, a SEF would not be required to subject these
clients to jurisdiction under proposed Sec. 37.202(d).
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\57\ The Commission notes that in the SEF Core Principles Final
Rule, one commenter expressed concern that the vague use of the term
``market participant'' could potentially subject dealers' customers,
and thus asset managers and their clients, to onerous requirements.
SEF Core Principles Final Rule at 33506.
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Given that these clients give broad trading discretion to their
asset managers, the Commission believes that requiring an asset manager
who accesses and conducts actual trading on a SEF to submit to the
SEF's jurisdiction is sufficient. This approach ensures that SEFs have
the ability to take disciplinary action against the individual or
entity--the asset manager--that could actually engage in potentially
abusive trading practices on the SEF. The Commission notes that this
logic would apply in other circumstances where a client gives broad
trading discretion to another person to trade and execute swap
transactions on the client's behalf. Therefore, these situations would
not fall within the third prong of the ``market participant''
definition as described above because the client is not ``directing''
the intermediary to trade on its behalf.
With respect to recordkeeping, the Commission understands that
asset managers typically maintain records of swap transactions on SEFs
to which their clients are named counterparties. Although asset
managers would likely not have complete records of their clients'
trading activity in the index or instruments used as a reference price,
the underlying commodity, and related derivatives markets under Sec.
37.404(b), the Commission does not believe that SEFs would need these
client records for regulatory purposes to the extent that the client is
not directing the asset manager to trade on its behalf, but rather
allowing the asset manager to exercise discretion in trading swaps.
Therefore, the potential risks of manipulation, price distortion, and
disruptions of the delivery or cash settlement process, which a SEF is
required to prevent through trade monitoring under Core Principle 4,
may be less attributable to such clients. To the extent that such risks
may exist, however, the Commission believes it is sufficient for SEFs
to have access to records that relate to the asset manager, who is
conducting the actual swaps trading activity.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.2(b). The Commission is particularly interested in the impact of the
scope of the proposed ``market participant'' definition on various
constituencies and, therefore, requests comment on the following
questions:
(1) Is the Commission's proposed definition of ``market
participant'' clear and complete? Please comment on any aspect of the
definition that you believe is not clear or adequately addressed.
(2) Should the proposed definition of ``market participant''
distinguish between clients that give up complete trading discretion to
an asset manager or another SEF participant and clients that do not so
give up discretion or only give up partial discretion? If so, on what
basis should the definition establish such a distinction?
(3) Do customers currently access a SEF through an intermediary,
e.g., an FCM or IB, and direct that intermediary to trade on their
behalf through an agency-based approach? If this is not common, could
this method of accessing a SEF become more common in the future? If so,
under what circumstances would this occur? Is the third prong of the
proposed ``market participant'' definition appropriate, which would
include a person who directs an intermediary that accesses a SEF to
trade on its behalf? If not, then why?
(4) Are there any other methods that are either currently being
used or could be used to access a SEF? Are there any other examples of
how a person could access a SEF through access or functionality
provided by a third party? What type of abusive trading practices, if
any, could a customer attempt to conduct if the customer directs its
trading through an intermediary such as an FCM or an IB? Please provide
examples.
(5) What type of abusive trading practices, if any, could a client
of an asset manager conduct if the client gives up complete trading
discretion to the asset manager? Please provide examples. If the client
allows an asset manager to exercise discretion in trading swaps, what
are the risks of manipulation, price distortion, and disruptions of the
delivery or cash settlement process that may be attributable to the
client?
(6) Does a SEF's ability to monitor trading to prevent such risks
require it to have access to client trading records that include
activity in the index or instrument used as a reference price, the
underlying commodity, and related derivatives markets? Are there any
trading records that are currently created and maintained by clients of
asset managers that would not also be retained by the asset managers?
If so, please describe such records. Should SEFs receive such records
for regulatory purposes?
[[Page 61956]]
C. Sec. 37.3--Requirements and Procedures for Registration
1. Sec. 37.3(a)--Requirements for Registration \58\
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\58\ The Commission proposes to renumber paragraph (a)(1) to
subsection (a) based on the proposed elimination of the minimum
trading functionality requirement under Sec. 37.3(a)(2) and the
Order Book definition under Sec. 37.3(a)(3) described below.
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CEA section 5h(a)(1) establishes the SEF registration requirement
and specifies that no person may operate a facility for the trading or
processing of swaps unless the facility is registered as a SEF or as a
DCM.\59\ In adopting the SEF Core Principles Final Rule, the Commission
affirmed its view under existing Sec. 37.3(a)(1) that the broad
registration requirement in CEA section 5h(a)(1) applies only to
facilities that meet the SEF definition in CEA section 1a(50).\60\ In
furtherance of CEA section 5h(a)(1), existing Sec. 37.3(a)(1) states
that any person operating a facility that offers a trading system or
platform in which more than one market participant has the ability to
execute or trade swaps with more than one other market participant on
the system or platform shall register the facility as a SEF or as a
DCM.\61\ The Commission believed that this interpretation of the
statutory SEF registration requirement would help further the statutory
SEF goals of promoting swaps trading on SEFs and promoting pre-trade
price transparency in the swaps market.\62\
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\59\ CEA section 5h(a)(1) states that no person may operate a
facility for the trading or processing of swaps unless the facility
is registered as a swap execution facility or as a designated
contract market. 7 U.S.C. 7b-3(a)(1).
\60\ SEF Core Principles Final Rule at 33481. The statutory SEF
definition in CEA section 1a(50) provides that a SEF is a trading
system or platform in which multiple participants have the ability
to execute or trade swaps by accepting bids and offers made by
multiple participants in the facility or system, through any means
of interstate commerce, including any trading facility, that
facilitates the execution of swaps between persons; and is not a
designated contract market. 7 U.S.C. 1a(50).
\61\ 17 CFR 37.3(a)(1). In addition to SEFs, existing Sec.
37.3(a)(1) also references registration as a DCM. While the trading
of swaps may occur through either a SEF or a DCM, CEA section 2(e)
limits the trading of swaps on SEFs to ECPs. Both ECPs and non-ECPs
may trade swaps through a DCM. 7 U.S.C. 2(e).
\62\ SEF Core Principles Final Rule at 33481.
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As discussed further below, the Commission is proposing to apply
the SEF registration requirement to several types of entities. The
Commission does not intend for the discussion in this notice to
exhaustively address which entities must register as a SEF. Rather, a
determination of whether an entity must register as a SEF pursuant to
CEA section 5h(a)(1) would depend on an evaluation of the operations of
the entity, in particular whether it meets the SEF definition under CEA
section 1a(50).\63\
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\63\ The Commission notes that the preamble to the SEF Core
Principles Final Rule addresses the applicability of the SEF
registration requirement in CEA section 5h(a)(1) to several types of
entities that facilitate swaps activity. SEF Core Principles Final
Rule at 33479-84. The Commission maintains its approach to these
types of entities with respect to the registration requirement,
except as discussed herein. See infra Section IV.C.1.b.--Single-
Dealer Aggregator Platforms (addressing the SEF registration
requirement with respect to single-dealer aggregator platforms).
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a. Footnote 88
As noted above, the Commission has stated that the SEF registration
requirement in CEA section 5h(a)(1) \64\ only applies to facilities
that meet the statutory SEF definition in CEA section 1a(50).\65\ In
footnote 88 of the preamble to the SEF Core Principles Final Rule, the
Commission specifically stated that the SEF registration requirement is
not limited by the trade execution requirement in CEA section 2(h)(8),
``such that only facilities trading swaps subject to the trade
execution requirement would be required to register as a SEF.\66\
Therefore, a facility is required to register as a SEF if it operates
in a manner that meets the statutory SEF definition even though it only
executes or trades swaps that are not subject to the trade execution
[requirement].'' \67\ The Commission adopted this approach despite
several comments to the proposed part 37 regulations, stating that
registration as a SEF should only be required if an entity both met the
SEF definition and offered swaps subject to the trade execution
requirement.\68\ The Commission stated that its approach to this issue
is consistent with the statutory SEF registration requirement, the
statutory SEF definition, and the trade execution requirement; the
Commission also held that its approach promotes the statutory SEF
goals.\69\
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\64\ 7 U.S.C. 5h(a)(1).
\65\ 7 U.S.C. 1a(50).
\66\ SEF Core Principles Final Rule at 33481 n.88.
\67\ Id.
\68\ Id. at 33479-80.
\69\ Id. at 33481-82.
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The Commission proposes to codify this existing approach to the SEF
registration requirement by amending Sec. 37.3(a)(1) to state that a
person operating a facility that meets the statutory SEF definition
must register as a SEF without regard to whether the swaps that it
lists for trading are subject to the trade execution requirement. This
proposed amendment is intended to clarify that the trade execution
requirement is not a determinant of whether an entity must register as
a SEF by codifying the requirement that an entity must register as a
SEF if it permits trading or execution of any swap, including swaps
that are not subject to the trade execution requirement, in a manner
consistent with the statutory SEF definition, i.e., trading or
execution on a ``multiple-to-multiple'' basis among market
participants.
Request for Comment
The Commission requests comment on all aspects of the proposed
amendment to Sec. 37.3(a).
b. Single-Dealer Aggregator Platforms
In the preamble to the SEF Core Principles Final Rule, the
Commission evaluated the application of the statutory SEF registration
requirement to various swaps market entities, including ``aggregation
services or portals'' (``SEF Aggregator Portals'') and ``one-to-many
systems or platforms'' (``Single-Dealer Platforms'').\70\ The
Commission generally determined that SEF Aggregator Portals and Single-
Dealer Platforms do not meet the statutory SEF definition and therefore
are not required to register as SEFs.\71\
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\70\ SEF Core Principles Final Rule at 33481-83.
\71\ See id.
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As the Commission has gained greater knowledge and experience with
the swaps market, however, it has become aware of a different type of a
trading system or platform that implicates the SEF registration
requirement--trading systems or platforms that aggregate Single-Dealer
Platforms (``Single-Dealer Aggregator Platforms''). Specifically, a
Single-Dealer Aggregator Platform typically operates a trading system
or platform that aggregates multiple Single-Dealer Platforms and, thus,
enables multiple dealer participants to provide executable bids and
offers, often via two-way quotes, to multiple non-dealer participants
on the system or platform. Those non-dealer participants are thus able
to view, execute, or trade swaps posted to the Single-Dealer Aggregator
Platform's system or platform from multiple dealer participants. These
types of systems or platforms, however, have not registered their
operations as SEFs.
The Commission believes that the type of trading system or platform
provided by Single-Dealer Aggregator Platforms should be subject to the
SEF registration requirement because it meets the SEF definition in CEA
section 1a(50) by allowing multiple participants to trade swaps by
accepting bids and offers made by multiple participants in the facility
or system.\72\
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\72\ 7 U.S.C. 1a(50).
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[[Page 61957]]
While a Single-Dealer Aggregator Platform has elements that
resemble a Single-Dealer Platform, which is a type of entity that does
not trigger the SEF registration requirement,\73\ the Commission
believes that both types of platforms are distinguishable from one
another. In the preamble to the SEF Core Principles Final Rule, the
Commission characterized Single-Dealer Platforms as systems or
platforms in which a single dealer serves as a single liquidity
provider by exclusively providing all bids and offers against which its
customers, i.e., participants, trade or execute swaps.\74\ Accordingly,
the dealer serves as the counterparty to all swaps executed on its
trading system or platform.\75\ Unlike the ``one-to-many'' nature of a
Single-Dealer Platform, however, a Single-Dealer Aggregator Platform
comports with the SEF definition in CEA section 1a(50) by providing a
trading system or platform where multiple dealers send or stream bids
and offers to multiple participants, thereby subjecting them to SEF
registration.
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\73\ SEF Core Principles Final Rule at 33482.
\74\ Id.
\75\ See id.
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The Commission also believes that Single-Dealer Aggregator
Platforms are distinguishable from SEF Aggregator Portals. SEF
Aggregator Portals are services or portals that enable market
participants to access multiple SEFs, each of which provides a trading
system or platform that facilitates the trading or execution of swaps
between multiple participants. In the preamble to the SEF Core
Principles Final Rule, the Commission stated that a SEF Aggregator
Portal does not meet the statutory SEF definition because it merely
provides a portal through which its users may access multiple SEFs,
rather than providing a venue for the trading or execution of
swaps.\76\ A SEF Aggregator Portal does not provide a trading system or
platform where multiple participants have the ability to execute or
trade swaps with multiple participants within its facility; rather, the
multiple-to-multiple participant execution or trading occurs on the SEF
and not the SEF Aggregator Portal. A Single-Dealer Aggregator Platform,
in contrast, acts as more than a mere portal because it provides a
system or platform for multiple-to-multiple participant swaps trading
or execution, thereby subjecting it to the SEF registration
requirement.
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\76\ Although the Commission maintains that a SEF Aggregator
Portal is generally not required to register as a SEF, such a system
or platform may be subject to the Act and Commission regulations as
an IB, as defined in CEA section 1a(31), given that its activity may
constitute soliciting or accepting orders to be routed to SEFs. 7
U.S.C. 1a(31).
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Request for Comment
The Commission requests comment on all aspects of the proposed
application of the SEF registration requirement to Single-Dealer
Aggregator Platforms. The Commission may consider alternatives to the
proposed application of the registration requirement to Single-Dealer
Aggregator Platforms and requests comment on the following questions:
(7) Is the Commission's position that Single-Dealer Aggregator
Platforms meet the SEF definition appropriate? Please explain.
(8) Should the Commission apply the SEF registration requirement to
any other type of entity or activity? If so, please describe the type
of entity and/or activity at issue.
(9) What factors, if any, would prevent a Single-Dealer Aggregator
Platform from complying with the SEF registration requirement?
(10) Is the Commission's existing position that SEF Aggregator
Portals and Single-Dealer Platforms do not satisfy the statutory SEF
definition appropriate? Please explain.
c. Swaps Broking Entities, Including Interdealer Brokers
In the preamble to SEF Core Principles Final Rule, the Commission
specified whether the SEF registration requirement would apply to
several specific types of entities,\77\ but did not address whether the
requirement would apply to swaps broking entities, i.e., interdealer
brokers, most of whom are registered with the Commission as IBs and
traditionally facilitate swaps trading in the over-the-counter
(``OTC'') markets.\78\ As discussed below, the Commission believes that
the activities of these entities--firms operating trading systems or
platforms that facilitate swaps trading primarily between swap
dealers--trigger the SEF registration requirement because they allow
multiple participants to trade swaps with multiple participants in a
manner consistent with the language of CEA sections 5h(a)(1) and 1a(50)
(emphasis added). In light of existing market practices, the Commission
believes that it is necessary to apply the SEF registration requirement
to ensure that the multiple-to-multiple ``trading'' that occurs on such
trading systems or platforms is subject to the Act and Commission's
regulations as regulated SEFs. This application is consistent with
Congressional intent, as evidenced by the statutory SEF registration
requirement and SEF definition, and is further consistent with the
statutory SEF goals.
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\77\ As noted in the preamble to the SEF Core Principles Final
Rule, the Commission received comments characterizing the SEF
registration requirement as ambiguous and requesting that the
Commission provide clarification with respect to certain entities.
SEF Core Principles Final Rule at 33479-81. In response, the
Commission provided examples of how the SEF registration requirement
would or would not apply to ``certain categories of better
understood facilities.'' Id. at 33482-84. These categories included
(i) one-to-many systems or platforms; (ii) blind auction systems or
platforms; (iii) aggregation services or portals; (iv) services
facilitating portfolio compression and risk mitigation transactions;
and (v) swap processing services. The Commission, however,
emphasized that these examples do not ``comprehensively'' address
all entities that are subject to SEF registration and urged
participants to seek clarification from the Commission as to how the
registration requirement applied to their particular operations. Id.
at 33482.
\78\ ``Interdealer broker,'' as used in this notice, refers to
an interdealer broker entity or operation in the aggregate and not
to a particular individual, i.e., an associated person, who works as
a broker within the entity or operation. The Commission, however,
considers such individuals to constitute part of the interdealer
broker's trading system or platform. See infra Section VI.A.1.--
Sec. 37.201(a)--Required Swap Execution Facility Rules (specifying
proposed rules for SEF execution methods that apply to activities of
SEF trading specialists who facilitate swaps trading or execution
by, among other things, conducting broking-like functions).
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The Commission understands that the proposed interpretation may
require certain non-domestic operations--in particular, foreign swaps
broking entities, such as foreign interdealer broker operations--to
seek SEF registration or an exemption from SEF registration pursuant to
CEA section 5h(g), provided that they fall within the Commission's
jurisdiction.\79\ Given the potentially complex issues that may arise
for these entities from the Commission's proposed application of the
SEF registration requirement, the Commission proposes below to delay
the compliance date of the requirement with respect to such entities
and their operations. This proposed delay would allow the Commission to
further develop its cross-border regulatory regime, including the
achievement of additional comparability determinations with foreign
regulators regarding their respective regulatory frameworks for swap
trading venues located within their respective jurisdictions, i.e.,
foreign multilateral swaps trading
[[Page 61958]]
facilities, which would include foreign swaps broking entities as
described below. Such a determination would allow such operations to
seek an exemption from SEF registration. A delay would also provide
time to foreign swaps broking entities to determine an appropriate
course of action for their respective operations.\80\
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\79\ Pursuant to CEA section 5h(g), the Commission may exempt a
facility from SEF registration upon a finding that it is subject to
``comparable, comprehensive supervision and regulation'' under the
rules and regulations of the facility's home country. 7 U.S.C. 7b-
3(g). See infra Section IV.C.1.d.--Foreign Swaps Broking Entities
and Other Foreign Multilateral Swaps Trading Facilities.
\80\ The Commission notes that potential courses of action for
such entities may include seeking SEF or DCM registration;
reorganizing into an existing affiliated SEF; working with the
appropriate regulator within their home country to seek an exemption
from registration pursuant to CEA section 5h(g); or adjusting their
activity to avoid the Commission's jurisdiction.
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(1) Structure and Operations of Swaps Broking Entities, Including
Interdealer Brokers
Since adopting part 37, the Commission has developed a deeper
understanding of the swaps market and has observed how swaps broking
entities, including interdealer brokers, have structured themselves in
relation to the current SEF regulatory framework. Interdealer broker
trading systems or platforms facilitate swaps trading between multiple
customers by negotiating or arranging swaps through voice-based or
voice-assisted systems that combine voice functionalities with
electronic systems such as order books. Swap dealers currently use
these trading systems or platforms for several purposes, including
obtaining market color or maintaining pre-trade anonymity in the course
of trading. Specifically, an interdealer broker typically ``works''
customer orders by issuing RFQs-to-all among other customers and
negotiating or arranging any resultant bids or offers. Once the
interdealer broker arranges a reciprocating bid and reciprocating
offer, it sets a price for a specific swap transaction for a particular
product, which in many cases enables a subsequent ``trade work-up''
session.\81\ Finally, the interdealer broker will either facilitate the
execution of the transaction(s) if the broker is part of a SEF's
trading system or platform \82\ or will otherwise route the pre-
arranged transaction(s) to a SEF for execution if the broker is not a
part of the registered SEF.
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\81\ For a description of a ``trade work-up'' session, see infra
note 269.
\82\ As discussed below, persons operating within these SEFs
that facilitate swaps trading are commonly referred to as ``trading
specialists'' or ``execution specialists.'' See infra Section
VI.A.3.--Sec. 37.201(c)--SEF Trading Specialists.
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The Commission notes that interdealer brokers have adopted varying
approaches to structuring themselves in relation to the SEF regulatory
framework. Some interdealer brokers have registered components of their
trading systems or platforms as SEFs. Other interdealer brokers have
operated very similar trading systems or platforms outside of the
structure of a SEF, often through registered IB entities, and have
interacted with a SEF solely as participants of the SEF.\83\ As SEF
participants, they submit transactions, which have already been
arranged on those trading systems or platforms, to the SEF for
execution. Notably, many interdealer brokers have maintained the latter
approach by operating both a SEF platform and a non-SEF trading system
or platform simultaneously, using the latter to facilitate the
interaction of bids and offers and bringing the resulting arranged
swaps to the SEF for execution.
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\83\ In becoming participants on a SEF, interdealer brokers
typically meet the SEF's access criteria prior to onboarding, which
provides them with trading privileges on the SEF. As SEF
participants, they are subject to the SEF's jurisdiction, including
all applicable disciplinary rules, similar to any other SEF
participant. Where the SEF offers its participants the ability to
submit pre-arranged or pre-negotiated transactions for execution, an
interdealer broker SEF participant will route transactions it has
arranged between its customers or clients, who are also SEF
participants, for execution on the SEF.
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This bifurcated approach has existed despite the close similarities
among interdealer broker trading systems or platforms, whether they are
registered or not as SEFs--they offer trading systems or platforms that
facilitate the trading of swaps between multiple participants. This
approach, however, has been justified by the execution of the swap on a
SEF; as noted, the interdealer brokers that conduct activity on non-SEF
platforms ultimately route the pre-arranged transactions to a SEF where
they are executed. This approach seems premised on the view that
because the execution occurs on a registered SEF, the facilitating
interdealer broker does not need to register as a SEF, notwithstanding
its role in negotiating or arranging the transaction(s).
To facilitate trading in Required Transactions outside the SEF,
these interdealer broker trading systems or platforms typically operate
outside of SEFs pursuant to the time delay requirement for Required
Transactions under Sec. 37.9(b).\84\ Under Sec. 37.9(b), the
Commission implemented a fifteen-second time-delay requirement for
Required Transactions that are pre-arranged or pre-negotiated by a
broker and submitted as cross trades for execution through the SEF's
Order Book. This requirement allows a broker or dealer to execute a
Required Transaction by trading against a customer's order or executing
two customers' orders against each other through pre-negotiation or
pre-arrangement, provided that one side of the transaction is exposed
to the Order Book for fifteen seconds before the other side of the
transaction is submitted for execution. The time delay is intended to
provide other market participants with an opportunity to execute
against the first order.\85\ In practice, however, the time delay
requirement has enabled interdealer brokers to facilitate ``trading''
of swaps i.e., the negotiating or arranging of swaps transactions
outside the SEF, through the interdealer brokers' multiple-to-multiple
trading systems or platforms. Negotiating or arranging consists of
facilitating the interaction of bids and offers.\86\ Once the
transaction is pre-negotiated or pre-arranged through the interdealer
broker's multiple-to-multiple trading system or platform, the
interdealer broker routes the pre-arranged transaction to the SEF,
where one side of the transaction is exposed for fifteen seconds on the
Order Book prior to the entry of the other side for execution.
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\84\ 17 CFR 37.9(b).
\85\ SEF Core Principles Final Rule at 33503. See infra note 322
and accompanying discussion (describing the policy reason for the
Sec. 37.9(b) time delay requirement).
\86\ See infra Section VI.A.2.a.--Sec. 37.201(b)--Pre-Execution
Communications (discussion of how pre-execution communications
between market participants constitute ``trading'').
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For swaps that are not subject to the trade execution requirement,
i.e., Permitted Transactions, SEFs have allowed their market
participants to conduct trading via pre-execution communications away
from their respective facilities and then submit the resulting
transaction, with the price, terms, and conditions already agreed upon
between the participants, to the SEF's trade capture functionality for
execution.\87\ The Commission notes that several SEFs affiliated with
interdealer brokers offer this type of functionality based in part on
the execution flexibility allowed under Sec. 37.9(c)(2) for Permitted
Transactions, i.e., a SEF may offer any method of execution for such
swaps. Accordingly, interdealer brokers submit Permitted Transactions
that have been negotiated or arranged through their trading systems or
platforms to an affiliated SEF without being subject to any
corresponding order exposure (e.g., a fifteen-second time-delay).\88\
Coupled
[[Page 61959]]
with the ability to submit Required Transactions in accordance with the
time delay requirement, these arrangements essentially enable the
operation of multiple-to-multiple trading systems or platforms for a
broad range of swaps outside of the SEF regulatory framework.
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\87\ For further discussion of this execution method, see infra
Section VI.A.2.--Sec. 37.203(a)--Pre-Arranged Trading Prohibition;
Sec. 37.9--Time Delay Requirement.
\88\ The Commission has also observed that other swaps broking
entities that are not affiliated with a SEF similarly negotiate or
arrange transactions away from a registered SEF and subsequently
submit those transactions to a registered SEF for execution. These
types of transactions, however, are less common and constitute a
smaller portion of the overall volume of relevant transactions
discussed herein.
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(2) SEF Registration Requirement for Swaps Broking Entities, Including
Interdealer Brokers
Based on the statutory SEF registration requirement and SEF
definition, the associated SEF goals, the Commission's experience and
knowledge from implementing part 37, and its evaluation of trading
practices that have developed under the current SEF regulatory
framework with respect to swaps broking entities that include
interdealer brokers, the Commission proposes that a trading system or
platform operated by such an entity must register as a SEF pursuant to
CEA section 5h(a)(1) and Sec. 37.3(a).\89\ The Commission believes
that such trading systems or platforms conform to the statutory SEF
definition because they allow multiple participants to trade swaps by
accepting bids and offers made by multiple participants in that
facility or system (emphasis added). As described above, these trading
systems or platforms facilitate the negotiation or arrangement of swap
transactions through the interaction of bids and offers. The Commission
believes that this ``trading'' activity should occur within a SEF,
regardless of whether the product is subject to the trade execution
requirement.\90\ Accordingly, entities operating these types of trading
systems or platforms should be subject to the SEF registration
requirement.\91\
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\89\ Although the Commission's description of swaps broking
entities above focuses on the dealer-to-dealer market, the
Commission clarifies that any person operating a system or platform
for multiple-to-multiple participant swaps trading as described
herein must register as a SEF consistent with CEA section 5h(a)(1)
and Sec. 37.3(a) (emphasis added).
\90\ The Commission notes that this view is consistent with the
proposed amendment to Sec. 37.3(a) to clarify that a person
operating a facility that meets the statutory SEF definition must
register as a SEF without regard to whether the swaps that it lists
for trading are subject to the trade execution requirement. See
supra Section IV.C.1.a.--Footnote 88. As part of the proposed
elimination of the prescriptive execution methods under Sec. 37.9
for Required Transactions, the Commission is proposing to eliminate
the time delay requirement under Sec. 37.9(b). See infra Section
VI.A.2.--Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec.
37.9(b)--Time Delay Requirement. Based on this proposed elimination
and the adoption of a flexible approach to SEF execution methods,
the Commission notes that rules permitting the pre-arrangement or
pre-negotiation of a swap transaction subject to a time delay
requirement would no longer be needed or allowed.
\91\ In addition to negotiation or arrangement that occurs
through a swaps broking entity, the Commission believes that
negotiation or arrangement that occurs directly between participants
should also occur within a SEF. The Commission is proposing to
require SEFs to have rules that prohibit market participants from
engaging in pre-execution communications, i.e., negotiation or
arrangement of swaps, away from a SEF's trading system or platform,
subject to certain exceptions. See infra Section VI.A.2.a.--Sec.
37.201(b)--Pre-Execution Communications.
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In addition to the statutory basis for this application, the
Commission's proposed approach would advance the Dodd-Frank goals of
promoting swaps trading on SEFs and pre-trade price transparency.\92\
The Commission believes that the operation of multiple-to-multiple
swaps trading systems or platforms by swaps broking entities, including
interdealer brokers outside of SEFs has frustrated these statutory
goals and moved liquidity formation away from SEFs. To promote both
trading on SEFs and pre-trade price transparency, the Commission
believes that the activities associated with swaps trading should occur
on SEFs consistent with the SEF registration requirement. Allowing such
activities to occur away from a SEF and submitting any resulting
transactions to a SEF for execution effectively makes the SEF a trade-
booking or post-trade processing engine, which is inconsistent with the
statutory language and goals of the CEA related to SEFs.
---------------------------------------------------------------------------
\92\ 7 U.S.C. 7b-3(e).
---------------------------------------------------------------------------
The Commission also believes that requiring these types of swaps
broking entities to register as SEFs would help to consistently apply
the SEF regulatory framework over a segment of swaps trading activity
that is very similar to registered SEF activity. Interdealer brokers
currently operate trading systems or platforms outside of the SEF
regulatory framework, yet act as participants on SEFs, resulting in
multiple-to-multiple trading that is opaque not only to the SEF where
the negotiated or arranged trade is eventually routed to for execution,
but also to the Commission and the general marketplace. Although many
interdealer brokers are registered as IBs pursuant to CEA section 4f
and are subject to the Commission's rules and regulations,\93\ the
Commission believes that these requirements are neither intended nor
sufficient for the regulation and oversight of such interdealer
brokers' multiple-to-multiple trading activity. The Commission believes
that Congress would not have created SEFs and added the word
``trading'' in the statutory SEF registration requirement and SEF
definition if it intended that an IB framework would be sufficient for
swaps ``trading.'' Given that these interdealer brokers operate trading
systems or platforms outside of the SEF regulatory framework that are
very similar to the activity that occurs on trading systems or
platforms that are located within interdealer brokers' registered
affiliated SEFs,\94\ the Commission believes such activity would be
more appropriately subject to a SEF-specific regulatory framework. This
approach would achieve the policy goal of applying more consistent
regulatory treatment to very similar swaps market activity.
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\93\ 7 U.S.C. 6f(a). Part 3 sets forth the registration and
regulatory requirements for IBs, among other registered entities. 17
CFR part 3. Among those requirements, IBs are required to register
with the National Futures Association (``NFA'') and therefore are
also subject to the NFA rules and regulations. 17 CFR 3.2. The
Commission further notes that Sec. 155.4 sets forth trading
standards for IBs. 17 CFR 155.4. For a description of additional IB-
related Commission requirements, see infra note 341.
\94\ The Commission emphasizes that an interdealer broker that
solely solicits or accepts individual or single bids or offers and
introduces them to an exchange, such as a SEF, would not be required
to register as a SEF because it would not be facilitating the
``trading,'' i.e., negotiating or arranging of swaps between
multiple market participants consistent with the SEF registration
requirement. Such brokers would be able to continue to engage in
such solicitation or acceptance in conformance with the IB
definition. 7 U.S.C. 1a(31).
---------------------------------------------------------------------------
Requiring interdealer brokers to either register as SEFs or carry
out their multiple-to-multiple trading activities within a SEF would
also enhance market integrity and monitoring because such activities
would become subject to the SEF core principles and regulations, as
well as direct regulatory oversight of a SEF in its capacity as a self-
regulatory organization (``SRO'').\95\ For example, Core Principle 2
requires SEFs to establish and enforce trading, trade processing, and
participation rules that will deter abuses and have the capacity to
detect, investigate, and enforce those rules, including means to
capture information that may be used in establishing whether rule
violations have occurred.\96\ These requirements enable SEFs to more
comprehensively monitor for, among other things, potential abusive
trading practices such as fraud and manipulation.\97\ The
[[Page 61960]]
Commission notes that establishing SEF monitoring and surveillance
requirements over activity in the interdealer broker market is
especially beneficial based on the role of interdealer brokers in the
manipulation of ISDAFIX, a benchmark for swap rates and spreads for
IRS; and the London Interbank Offered Rate (``LIBOR''), an average
benchmark for short-term interest rates used to determine floating
rates for IRS.\98\
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\95\ 17 CFR 1.3 (definition of ``self-regulatory
organization'').
\96\ 7 U.S.C. 7b-3(f)(2)(B).
\97\ Given that the interdealer brokers are participants of the
SEFs to which they submit negotiated or arranged transactions for
execution, the Commission notes that SEFs still have jurisdiction
over that activity and could investigate suspected prohibited
activity and issue sanctions where appropriate, pursuant to the
SEF's self-regulatory obligations.
\98\ See, e.g., Enforcement Order re: Soci[eacute]t[eacute]
G[eacute]n[eacute]rale S.A. Attempted Manipulation and False
Reporting of LIBOR and Euribor, CFTC Docket No. 18-14 (June 4,
2018); see also Enforcement Order re: JP Morgan Chase Bank, N.A.
Attempted Manipulation of U.S. Dollar ISDAFIX Benchmark, CFTC Docket
No. 18-15 (June 18, 2018).
---------------------------------------------------------------------------
Accordingly, the Commission proposes that swaps broking entities,
including interdealer brokers, that offer a trading system or platform
in which more than one market participant has the ability to trade any
swap with more than one other market participant on the system or
platform, shall register as a SEF or seek an exemption from
registration pursuant to CEA section 5h(g) (emphasis added). Where an
entity operates both a registered SEF and an affiliated swaps broking
entity--such as an interdealer broker--that negotiates or arranges
trades via a non-SEF trading system or platform and participates on the
affiliated SEF as a market participant, the swaps broking entity could
also comply with the SEF registration requirement by integrating its
non-SEF trading system or platform into its affiliated SEF. The
Commission believes that this proposed application of the SEF
registration provision in CEA section 5h(a)(1), which the Commission
continues to interpret in conjunction with the SEF definition in CEA
section 1a(50), is consistent with the statute and helps further the
statutory SEF goals provided in CEA section 5h.
The Commission proposes to delay the application of the SEF
registration requirement with respect to swaps broking entities,
including interdealer brokers, for a period of six months, subject to
certain conditions and starting from the compliance date of any final
rule adopted from this proposed rulemaking. Swaps broking entities,
including interdealer brokers, that meet the conditions set forth below
would be able to continue to maintain their current practice of
facilitating the negotiating or arranging of swaps transactions between
multiple participants and routing those swaps transactions to SEFs for
execution.\99\ Without the six-month delay period, the Commission
believes that applying the SEF registration requirement to these
entities would disrupt their operations and further fragment swaps
liquidity.
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\99\ As discussed below, the Commission is proposing Sec.
37.201(b) to prohibit the use of pre-execution communications by
market participants away from a SEF's trading system or platform.
See infra Section VI.A.2.a.--Sec. 37.201(b)--Pre-Execution
Communications. The Commission notes that to the extent swaps
broking entities, including interdealer brokers, engage in such
communications in the course of negotiating or arranging
transactions and submitting them to a SEF for execution, the
prohibition--if adopted via a final rule--would not apply during the
six-month period.
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As applied to swaps broking entities, including interdealer
brokers--most of whom are registered with the Commission as IBs--the
Commission proposes that the six-month delay from the SEF registration
requirement would be subject to the following conditions:
(i) All swap transactions that are traded on a swaps broking
entity, including an interdealer broker, must be routed for execution
to a SEF; and
(ii) The swaps broking entity, including an interdealer broker,
must provide electronically the following information with respect to
itself to the Secretary of the Commission at [email protected] and
the Commission's Division of Market Oversight (``Division'' or ``DMO'')
at [email protected]: (i) Entity name as it appears in the
entity's charter; (ii) name and address of the entity's ultimate parent
company; (iii) any names under which the entity does business; (iv)
address of principal executive office; (v) a contact person's name,
address, phone number, and email address; (vi) asset classes and swap
products for which the entity facilitates trading; and (vii) any
registrations, authorizations, or licenses held.\100\
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\100\ The Commission anticipates that the effective date of any
final rule would be established ninety days from the publication of
the rule in the Federal Register. The Commission believes that the
proposed ninety-day period would provide swaps broking entities,
including interdealer brokers seeking to avail themselves of the
six-month compliance date delay with a sufficient opportunity to
compile and submit this information to the Commission.
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Upon a DMO determination that a swaps broking entity's notice is
complete, the Commission proposes to post these notices on the
Commission's website under the ``Industry Filings'' page. This proposed
approach would effectively maintain the status quo for these swaps
broking entities for the proposed six-month delay period.
The Commission notes that the proposed six-month delay for swaps
broking entities, including interdealer brokers, does not affect any
other requirements under the CEA or the Commission's regulations. In
particular, this delayed compliance date would not affect the
application of CEA section 2(e) and its requirement that only ECPs be
permitted to trade swaps on SEFs.\101\
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\101\ 7 U.S.C. 2(e). See supra note 61.
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As part of this proposed transition period, swaps broking entities,
including interdealer brokers, would be able to route their
transactions to a SEF for execution. Furthermore, during this period,
counterparties subject to the trade execution requirement would be able
to satisfy that requirement by trading via a swaps broking entity,
including an interdealer broker, that routes the transactions to a SEF
for execution.
Request for Comment
The Commission requests comment on all aspects of the proposed
application of the SEF registration requirement to swaps broking
entities. The Commission may consider alternatives to the proposed
application of the requirement and requests comment on the following
questions:
(11) Is the Commission's view that swap broking entities, including
interdealer brokers, meet the SEF definition appropriate? Please
explain why or why not. Is it clear what activity falls within the SEF
registration requirement and SEF definition, including the meaning of
``trading''? If not, please explain.
(12) Should the Commission apply the SEF registration requirement
to any other type of entity or activity?
(13) What factors, if any, would prevent a swaps broking entity,
including an interdealer broker, from complying with the SEF
registration requirement or from seeking an exemption from registration
pursuant to CEA section 5h(g)?
(14) Is the proposed six-month delay period sufficient to allow
swaps broking entities, including interdealer brokers, time to seek
registration or alter their operations in compliance with the SEF
registration requirements? Why or why not?
(15) Should the Commission allow swaps broking entities, including
interdealer brokers, to route swap transactions to exempt SEFs during
this six-month delay period? Why or why not?
d. Foreign Swaps Broking Entities and Other Foreign Multilateral Swaps
Trading Facilities
As discussed above, the Commission has observed that swaps broking
[[Page 61961]]
entities, including interdealer brokers, have utilized various business
structures to operate in a bifurcated manner, i.e., a SEF and a non-SEF
trading system or platform. One common structure consists of an entity
that serves as a parent to a registered SEF entity and several
affiliated broker entities that negotiate or arrange trades and
participate exclusively on the affiliated SEF as market participants.
While many of those broker entities are domestically domiciled, a
significant number of them are also located in numerous foreign
jurisdictions.\102\ Similar to domestic swaps broking entities, these
foreign swaps broking entities are not currently registered as SEFs,
but are typically registered with the Commission as IBs.\103\ These
entities often serve as hubs for liquidity within their particular
jurisdiction during non-U.S. trading hours--operating trading systems
or platforms that facilitate the negotiating or arranging of
transactions for multiple U.S. persons with local customers and the
routing of those transactions to an affiliated SEF for execution.\104\
These foreign swaps broking entities' trading systems or platforms are
very similar to those operated by swaps broking entities within in the
U.S., such that they provide more than one market participant with the
ability to trade swaps with more than one other market participant
(emphasis added). Therefore, the Commission proposes that these foreign
swaps broking entities are ``foreign multilateral swaps trading
facilities,'' which are foreign facilities that operate a trading
system or platform where multiple participants have the ability to
execute or trade swaps with multiple market participants.
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\102\ Based on discussions with market participants, the
Commission is aware of foreign swaps broking entities that are
interdealer brokers located in numerous foreign jurisdictions,
including Australia, Brazil, Canada, Chile, Colombia, Hong Kong,
Japan, Mexico, Singapore, and South Korea, that participate on SEFs.
The Commission is also aware that interdealer brokers domiciled in
the European Union (``EU'') operate as investment firms that operate
Multilateral Trading Facilities (``MTFs'') and Organized Trading
Facilities (``OTFs''). The Commission notes that it has exempted
certain MTFs and OTFs located in the EU from registration as SEFs
pursuant to CEA section 5h(g). See infra note 109 (describing
December 2017 exemptive order issued by the Commission to certain
MTFs and OTFs based on comparability determination).
\103\ See supra note 93 (general description of Commission
requirements with respect to IBs).
\104\ For purposes of this discussion, the term ``U.S. person''
identifies those persons who, under the Commission's interpretation,
could be expected to satisfy the jurisdictional nexus set forth in
CEA section 2(i) based on their swap activities, either on an
individual or aggregate basis. See Interpretive Guidance and Policy
Statement Regarding Compliance With Certain Swap Regulations; Rule,
78 FR 45292, 45301 (Jul. 26, 2013) (``2013 Cross-Border Guidance'').
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Consistent with the proposal regarding the SEF registration
requirement above, such foreign multilateral swaps trading facilities,
including foreign swaps broking entities, would be required to register
as a SEF or seek an exemption from SEF registration if their activity
falls within the jurisdictional reach of the Commission pursuant to CEA
section 2(i). Pursuant to CEA section 2(i), activities outside of the
U.S. are not subject to the swap provisions of the CEA, including any
rules prescribed or regulations promulgated thereof, unless those
activities either have a ``direct and significant connection'' with
activities in, or effect on, commerce of the United States; or
contravene any rule or regulation established to prevent evasion of a
Dodd-Frank Act-enacted provision of the CEA.\105\ The Commission
expects that it will clarify the cross-border jurisdictional reach of
the SEF registration requirement in the future for foreign multilateral
swaps trading facilities, including foreign swaps broking entities,
pursuant to CEA section 2(i).\106\ To the extent that a foreign
multilateral swaps trading facility's activities are determined to fall
within the Commission's jurisdictional reach, the facility would be
required to register as a SEF or seek an exemption from SEF
registration.\107\
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\105\ 7 U.S.C. 2(i).
\106\ In November 2013, DMO issued guidance regarding the
application of the SEF registration requirement to foreign
multilateral swaps trading facilities. Division of Market Oversight
Guidance on Application of Certain Commission Regulations to Swap
Execution Facilities (Nov. 15, 2013). The guidance specified that a
foreign multilateral swaps trading platform that provides U.S.
persons or persons located in the United States (including personnel
and agents of non-U.S. persons located in the United States)
(``U.S.-located persons'') with the ability to trade or execute
swaps on or pursuant to the rules of the platform, either directly
or indirectly through an intermediary, would be expected to register
as a SEF or DCM. Id. at 2. The guidance listed two non-exhaustive
factors to determine whether a foreign platform met this
registration requirement: (i) Whether a foreign multilateral swaps
trading facility directly solicits or markets its services to U.S.
persons or U.S.-located persons; or (ii) whether a significant
portion of the market participants who a foreign multilateral swaps
trading facility permits to effect transactions are U.S. persons or
U.S.-located persons. Id. at 2 n.8. The guidance further specified
DMO's belief that U.S. persons and U.S.-located persons generally
comprise those persons whose activities have the requisite ``direct
and significant'' connection with activities in, or effect on,
commerce of the United States within the meaning of CEA section
2(i). Id. at 2. The guidance also stated DMO's view that a
multilateral swaps trading facility's provision of the ability to
trade or execute swaps on or through the platform to U.S. persons or
U.S.-located persons may create the requisite connection under CEA
section 2(i) for purposes of the SEF/DCM registration requirement.
Id. Subsequently, the Commission learned that many foreign
multilateral swaps trading facilities prohibited U.S. persons and
U.S-located persons from accessing their facilities due to the
uncertainty that the guidance created with respect to SEF
registration. The Commission understands that these prohibitions
reflect concerns that U.S. persons and U.S.-located persons
accessing their facilities would trigger the SEF registration
requirement. As noted above, the Commission expects to address the
application of CEA section 2(i) to foreign multilateral swaps
trading facilities, including foreign swaps broking entities, in the
future.
\107\ The Commission discusses further below the potential
implications for foreign multilateral swaps trading facilities
offering swaps that are subject to the trade execution requirement
to applicable counterparties.
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Such facilities that do not wish to register as a SEF and prefer to
comply with the regulatory requirements of their home country may seek
an exemption from SEF registration pursuant to CEA section 5h(g) either
directly or via the auspices of their home country regulator. Pursuant
to CEA section 5h(g), the Commission may exempt facilities from SEF
registration if the facility is subject to comparable, comprehensive
supervision and regulation on a consolidated basis by the appropriate
governmental authorities in the home country of the facility.\108\
Based on this provision, the Commission issued an order in December
2017 that exempts certain MTFs and OTFs authorized within the EU from
the SEF registration requirement based on a finding that their
respective regulatory frameworks satisfy the standard for granting an
exemption from the SEF registration requirement pursuant to CEA section
5h(g).\109\ At this time, the Commission has neither adopted a formal
regulatory framework for granting an exemption pursuant to this
provision nor has it granted exemptive relief to facilities in other
jurisdictions beyond the 2017 order to EU-based MTFs and OTFs.
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\108\ 7 U.S.C. 7b-3(g).
\109\ Order Exempting MTFs and OTFs Authorized Within the EU
from SEF Registration Requirement (Dec. 8, 2017) (``2017 MTF and OTF
Exemptive Order''). The order established this finding with respect
to EU-wide legal requirements--including, in particular,
requirements under the EU's new Markets in Financial Instruments
Regulation (``MiFIR''), the EU's amended Markets in Financial
Instruments Directive (``MiFID II''), and the EU's Market Abuse
Regulation--that establish regulatory frameworks for MTFs and OTFs.
Pursuant to this finding, the Commission provided specific
exemptions to several MTFs and OTFs. Id. at app. A.
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(1) Proposed Delay of SEF Registration Requirement
Given that the Commission intends to address the cross-border
jurisdictional reach of the Commission's SEF registration requirement
in the future, the Commission proposes to delay the compliance date of
the registration
[[Page 61962]]
requirement only with respect to foreign swaps broking entities,
including foreign interdealer brokers, that currently facilitate
trading, i.e., negotiation or arrangement, of swaps transactions for
U.S. persons (``Eligible Foreign Swaps Broking Entities'') for a period
of two years, subject to certain conditions and starting from the
effective date of any final rule adopted from this notice.
The proposed delay period would not apply to foreign swaps broking
entities that do not currently facilitate trading, i.e., negotiation or
arrangement, of swaps transactions for U.S. persons, given that their
operations would not be materially affected by the proposed application
of the SEF registration requirement to swaps broking entities. Further,
the proposed delay period would not apply to foreign multilateral swaps
trading facilities, as described above, that are not foreign swaps
broking entities. Such facilities are not subject to the Commission's
proposed application of the SEF registration requirement, and
therefore, are already required to register as a SEF pursuant to the
SEF registration requirement or seek an exemption pursuant to CEA
section 5h(g). Similarly, the Commission notes that MTFs and OTFs
located in the EU may not rely on this delay and instead must seek an
exemption from SEF registration pursuant to the terms of the
Commission's 2017 exemptive order.\110\
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\110\ 2017 MTF and OTF Exemptive Order.
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Eligible Foreign Swaps Broking Entities that meet the conditions
set forth below would be able to continue to maintain the current
practice of facilitating the negotiation or arrangement of swaps
transactions between multiple participants and routing those swaps
transactions to SEFs or Exempt SEFs for execution.\111\ Without the
two-year period, the Commission believes that applying the SEF
registration requirement to these entities would disrupt their
operations and fragment swaps liquidity.
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\111\ As discussed below, the Commission is proposing Sec.
37.201(b) to prohibit the use of pre-execution communications by
market participants away from a SEF's trading system or platform.
See infra Section VI.A.2.a.--Sec. 37.201(b)--Pre-Execution
Communications. The Commission notes that to the extent Eligible
Foreign Swaps Broking Entities engage in such communications in the
course of negotiating or arranging transactions and submitting them
to a SEF for execution, the prohibition--if adopted via a final
rule--would not apply during the two-year period.
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During this period, the Commission anticipates that it will address
what constitutes a ``direct and significant connection with activities
in, or effect on, commerce of the United States'' for foreign
multilateral swaps trading facilities, including foreign swaps broking
entities, under CEA section 2(i).\112\ The proposed delay would also
provide the Commission with time to develop any threshold standards for
the application of CEA section 2(i) to the SEF registration requirement
in CEA section 5h(a)(1). While the Commission has yet to determine
standards in this area, the Commission notes that any such standard
could include a de minimis component, whereby the activity of U.S.
persons below some defined quantitative threshold on a particular
foreign multilateral swaps trading facility would not trigger a need
for SEF registration.
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\112\ 7 U.S.C. 2(i).
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The Commission notes that counterparties that are required to
comply with the trade execution requirement may only satisfy the
requirement by executing a swap on a SEF, a DCM, or an Exempt SEF.\113\
Accordingly, any foreign multilateral swaps trading facility that seeks
to offer such swaps to such counterparties for trading must be
registered as a SEF or DCM or obtain an exemption from SEF registration
pursuant to CEA section 5h(g), regardless of whether that trading
system or platform meets the standards (or any future standards the
Commission may develop) for CEA section 2(i), i.e., a ``direct and
significant connection,'' to trigger SEF registration. As noted above,
the proposed delay would not apply to these foreign multilateral swaps
trading facilities. Similarly, upon the expiration of the proposed two-
year delay, any Eligible Foreign Swaps Broking Entity that seeks to
offer such swaps to such counterparties for trading on its trading
system or platform must be registered as a SEF or DCM or obtain an
exemption from SEF registration pursuant to CEA section 5h(g).
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\113\ For a discussion of which counterparties must comply with
the Category A Transaction-Level Requirements, including the trade
execution requirement, see 2013 Cross-Border Guidance at 45350-59
app. D.
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During this time, the Commission could formalize a regulatory
framework for providing exemptions from the SEF registration
requirement for foreign multilateral swaps trading facilities,
including foreign swaps broking entities, that meet that CEA section
2(i) standard. The proposed two-year delay not only could provide the
Commission with sufficient time to formalize this framework, which
would require standards and processes for evaluating exemption
requests, but also give Eligible Foreign Swaps Broking Entities more
time to determine their best course of action, i.e., seek SEF
registration with the Commission or obtain a CEA section 5h(g)
exemption from registration. Accordingly, the proposed delay would
further provide the Commission and regulators in foreign jurisdictions
with additional time to evaluate such registration applications or
requests for exemption received from Eligible Foreign Swaps Broking
Entities.
With respect to exemptions, the Commission anticipates that most
foreign swaps broking entities and other foreign multilateral swaps
trading facilities would seek to comply with the rules and regulations
of their home countries, and thus, seek an exemption from SEF
registration. The Commission further anticipates that the issuance of
such exemptions may take some time based upon the large number of
jurisdictions in which these operations are currently located.\114\
Thus, the Commission believes that it would be beneficial to provide
more time for evaluation of exemption requests because exempting such
comparably-regulated foreign entities from SEF registration, similar to
other deference initiatives, should generally reduce market
fragmentation, regulatory arbitrage, and duplicative or conflicting
regulatory requirements, while increasing the potential for harmonized
regulatory standards on a global level. Further, the Commission
anticipates that any future determination process for granting
exemptions from SEF registration would ensure that foreign and domestic
multilateral swaps trading facilities, which operate in a similar
fashion to one another, are all held to comparable regulatory
standards.
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\114\ See supra note 102 (listing the foreign jurisdictions
where swaps broking entities operate).
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The Commission further believes that this proposal should create
strong incentives for foreign jurisdictions to establish or bolster
their own robust regulatory regimes for swaps trading. Such measures
would also be consistent with the commitment made among the G-20
countries in 2009 ``to take action at the national and international
level to raise standards together so that our national authorities
implement global standards consistently in a way that ensures a level
playing field and avoids fragmentation of markets, protectionism, and
regulatory arbitrage.'' \115\ To the extent that foreign swaps broking
entities and other foreign multilateral swaps trading facilities
operate in foreign jurisdictions that currently do not have or are not
expected to have
[[Page 61963]]
comparable and comprehensive supervision and regulation, such
facilities would be subject to the proposed SEF registration
requirement if their operations create a ``direct and significant''
connection to activities in, or effect on, commerce of the United
States under CEA section 2(i).
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\115\ Group of Twenty, ``G-20 Leaders' Statement: The Pittsburgh
Summit 7 (Sept. 24-25, 2009), https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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(2) Proposed Conditions for Delay of SEF Registration Requirement
As applied to Eligible Foreign Swaps Broking Entities--most of whom
are registered with the Commission as IBs--the Commission proposes that
the two-year delay from the SEF registration requirement be subject to
the following conditions:
(i) All swap transactions involving U.S. persons that are traded on
an Eligible Foreign Swaps Broking Entity must be routed for execution
to a SEF or an Exempt SEF; \116\ and
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\116\ For a current list of Exempt SEFs, see 2017 MTF and OTF
Exemptive Order at app. A.
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(ii) The Eligible Foreign Swaps Broking Entities must provide the
following information electronically to the Secretary of the Commission
at [email protected] and DMO at [email protected]: (i) Entity
name as it appears in the entity's charter; (ii) name and address of
the entity's ultimate parent company; (iii) any names under which the
entity does business; (iv) address of principal executive office; (v) a
contact person's name, address, phone number, and email address; (vi)
asset classes and swap products for which the entity facilitates
trading; (vii) certification that the entity currently arranges or
negotiates swap transactions for U.S. persons; (viii) the entity's home
country regulator or regulators; and (ix) any registrations,
authorizations, or licenses held by the entity in its home
country.\117\
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\117\ The Commission anticipates that the effective date of any
final rule would be established ninety days from the publication of
the rule in the Federal Register. The Commission believes that a
ninety-day effective date would provide Eligible Foreign Swaps
Broking Entities seeking a two-year compliance date delay with
sufficient opportunity to compile and submit the requisite
information to the Commission.
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Upon a DMO determination that an Eligible Foreign Swaps Broking
Entity's notice is complete, the Commission would post these notices on
the Commission's website under the ``Industry Filings'' page. This
proposed approach would effectively maintain the status quo for these
Eligible Foreign Swaps Broking Entities during the two-year compliance
date delay period. The Commission notes that the proposed two-year
delay for Eligible Foreign Swaps Broking Entities does not affect any
other requirements under the CEA or the Commission's regulations. In
particular, this delayed compliance date would not affect the
application of CEA section 2(e) and its limitation of SEF and Exempt
SEF trading to ECPs.\118\
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\118\ 7 U.S.C. 2(e). See supra note 61.
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As part of this proposed transition period, Eligible Foreign Swaps
Broking Entities would be able to route their transactions to either a
SEF or an Exempt SEF for execution. Furthermore, during this two-year
delay, counterparties subject to the trade execution requirement would
be able to satisfy that requirement by trading via an Eligible Foreign
Swaps Broking Entity that routes the transactions to either a SEF or an
Exempt SEF for execution.
In light of these considerations, the Commission notes that the
issue of whether an Eligible Foreign Swaps Broking Entity routes a
transaction to a SEF or an Exempt SEF during the proposed two-year time
delay period would have practical implications for the counterparties
involved in the transaction with respect to complying with Commission
reporting and clearing requirements. For swap transactions that are
routed to a SEF for execution, the SEF would be responsible for
compliance with (i) the real-time reporting requirements under part 43
of the Commission's regulations and (ii) the regulatory reporting
requirements under part 45 of the Commission's regulations.\119\
Counterparties to a swap transaction that is routed to an Exempt SEF
for execution would be responsible for the reporting requirements set
forth in both part 43 and part 45, unless there is a substituted
compliance determination by the Commission with respect to those
requirements.\120\
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\119\ In connection with swap transactions executed on a SEF,
the Commission notes that the part 45 regulations continue to apply
to counterparties that are subject to such reporting requirements.
17 CFR part 45.
\120\ Exempt SEFs may report transactions on behalf of
counterparties as a service provider; the counterparties, however,
retain ultimate responsibility for reporting.
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Further, for swap transactions routed to a SEF that are intended to
be cleared or subject to the clearing requirement, the SEF would be
responsible for routing the swap transaction to a Commission-registered
derivatives clearing organization (``DCO'') or a clearing organization
that has been exempted from DCO registration by the Commission pursuant
to CEA section 5b(h), i.e., Exempt DCO, for clearing.\121\ For swap
transactions routed to an Exempt SEF for execution that are intended to
be cleared or are subject to the clearing requirement, the Commission
notes that the following clearing-related requirements would to apply
to such swap transactions:
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\121\ See 17 CFR 37.700-702.
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(i) When a swap transaction executed by a U.S. person on such an
Exempt SEF is a ``customer'' position subject to CEA section 4d, the
transaction, if intended to be cleared, must be cleared through a
Commission-registered FCM at a Commission-registered DCO;
(ii) When a swap transaction executed by a U.S. person on such an
Exempt SEF is a ``proprietary'' position under Commission regulation
1.3(y), the transaction, if intended to be cleared, must be cleared
either through a Commission-registered DCO or an Exempt DCO; and
(iii) When a swap transaction is subject to the Commission's
clearing requirement, the transaction must be cleared either through a
Commission-registered DCO or an Exempt DCO, provided that consistent
with (i) above, the transaction must be cleared through a Commission-
registered FCM at a Commission-registered DCO and cannot be cleared
through an Exempt DCO if the transaction is a ``customer'' position
subject to CEA section 4d.
Request for Comment
The Commission requests comment on all aspects of its proposed
approach to SEF registration for Eligible Foreign Swaps Broking
Entities, in particular the proposed two-year delay in the compliance
date of any final rule. The Commission may consider alternatives to the
proposed two-year delay and requests comment on the following
questions:
(16) Is the delay of two years for Eligible Foreign Swaps Broking
Entities an adequate delay? If not, then how long of a delay should the
Commission consider and why?
(17) Are there additional considerations that the Commission should
take into account in establishing this delay?
(18) Are there additional conditions that the Commission should
consider imposing on Eligible Foreign Swaps Broking Entities during
this delay period?
2. Sec. Sec. 37.3(a)(2)-(3)--Minimum Trading Functionality and Order
Book Definition
In developing the regulatory framework for SEFs, the Commission
adopted a ``minimum trading functionality'' requirement under Sec.
37.3(a)(2) that requires a SEF to maintain and offer an Order Book for
all
[[Page 61964]]
of the swaps that it lists for trading.\122\ An Order Book is defined
under Sec. 37.3(a)(3) as (i) an electronic trading facility; \123\
(ii) a trading facility; \124\ or (iii) a trading system or platform in
which all market participants in the trading system or platform have
the ability to enter multiple bids and offers, observe or receive bids
and offers entered by other market participants, and transact on such
bids and offers.\125\ In the preamble to the SEF Core Principles Final
Rule, the Commission acknowledged that the Order Book functionality
does not have the requisite flexibility to serve as the ideal method of
execution for a variety of swaps, in particular those that feature
lower levels of liquidity.\126\ The Commission nevertheless believed
that an Order Book could establish a base level of pre-trade price
transparency to all market participants and, therefore, required that
each SEF offer an Order Book for all swaps that it lists for trading,
including both swaps subject to the trade execution requirement and
swaps not subject to the trade execution requirement.\127\
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\122\ 17 CFR 37.3(a)(2).
\123\ CEA section 1a(16) defines ``electronic trading facility''
as a trading facility that (i) operates by means of an electronic or
telecommunications network; and (ii) maintains an automated audit
trail of bids, offers, and the matching of orders or the execution
of transactions on the facility. 7 U.S.C. 1a(16).
\124\ CEA section 1a(51) defines ``trading facility'' as a
person or group of persons that constitutes, maintains, or provides
a physical or electronic facility or system in which multiple
participants have the ability to execute or trade agreements,
contracts, or transactions by accepting bids or offers made by other
participants that are open to multiple participants in the facility
or system; or through the interaction of multiple bids or multiple
offers within a system with a pre-determined non-discretionary
automated trade matching and execution algorithm. 7 U.S.C.
1a(51)(A).
\125\ 17 CFR 37.3(a)(3).
\126\ SEF Core Principles Final Rule at 33564-65. In the
preamble to the SEF Core Principles Final Rule, the Commission
stated its anticipation that an Order Book would typically work well
for liquid Required Transactions, i.e., transactions involving swaps
that are subject to the trade execution requirement. For less liquid
Required Transactions, however, it anticipated that RFQ systems
would help facilitate trading.'' Id.
\127\ SEF Core Principles Final Rule at 33564.
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The Commission has observed that market participants have rarely
used Order Books to trade swaps on SEFs despite their availability for
all swaps listed by SEFs. Depending on the product involved, for
example, order book trading typically ranges between ``less than [one
percent] to less than [three percent] of total CDS transactions'' on
SEFs, while order book trading constitutes between ``less than [one
percent] to approximately [twenty percent] of total IRS transactions. .
. .'' \128\ The Commission believes that this low level of swaps
trading on Order Books is attributable \129\ to an Order Book's
inability to support the broad and diverse range of products traded in
the swaps market that trade episodically, rather than on a continuous
basis.\130\ Given the broad array of liquid and illiquid swaps listed
on SEFs, mandating that a SEF offer an Order Book for all of these
products has imposed significant operational and financial costs and
burdens, particularly from a technological standpoint, with little
benefit to most market participants who choose not to utilize
them.\131\
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\128\ J. Christopher Giancarlo and Bruce Tuckman, Swaps
Regulation Version 2.0: An Assessment of the Current Implementation
of Reform and Proposals for Next Steps 49-50 (Apr. 26, 2018),
available at https://www.cftc.gov/sites/default/files/2018-05/oce_chairman_swapregversion2whitepaper_042618.pdf.
\129\ In addition to reasons stated above, the Commission
acknowledges that the lack of swaps trading on SEF Order Books may
also be attributed to other factors, such as concerns over ``name
give-up'' practices and the current lack of certain trading
features, such as the ability to calculate volume-weighted average
pricing.
\130\ In their study of the index CDS market, Pierre Collin-
Dufresne, Benjamin Junge, and Anders B. Trolle state that
``[p]roponents of bringing all market participants onto one limit
order book typically argue that it would (i) increase quote
competition among dealers and (ii) allow clients to occasionally
supply liquidity via limit orders thereby lowering overall
transaction costs (although at the cost of execution risk). However,
a limit order book arguably works best when trading is continuous
and it is not necessarily optimal when trading is more episodic as
is the case for index CDSs. For instance, Barclay, Hendershott, and
Kotz (2006) document a precipitous drop in electronic trading (via
limit order books) when Treasuries go off-the-run and trading
volumes decline.'' Pierre Collin-Dufresne, Benjamin Junge, & Anders
B. Trolle, Market Structure and Transaction Costs of Index CDSs 6
n.10 (Swiss Fin. Inst. Res. Paper No. 18-40, 2017) (``2017 Collin-
Dufresne Research Paper''), citing Michael J. Barclay, Terrence
Hendershott, & Kenneth Kotz, Automation Versus Intermediation:
Evidence from Treasuries Going Off the Run, 61 J. Fin. 2395, 2395-
2414 (2006).
\131\ The Commission understands that these costs include
regularly occurring software updates to electronic order book
systems and other ongoing technology-related maintenance.
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Therefore, based in part on its experience, the Commission proposes
to eliminate the minimum trading functionality requirement and the
regulatory Order Book definition. The Commission believes that
eliminating the minimum trading functionality would help reduce
operating costs for SEFs, as they would no longer be required to
operate and maintain order book systems that are poorly suited for
trading in less liquid swaps, and therefore, do not attract significant
trading activity. Instead of employing resources to build and support a
seldom-utilized trading system or platform, the proposed elimination
provides a SEF with the flexibility to determine how to allocate its
resources, particularly as it relates to developing methods of
execution that are better suited to trading the products that it lists.
As discussed below, other execution methods may be better suited to
maximizing participation and concentrating liquidity formation on SEFs
in episodically liquid swaps markets.\132\ Therefore, removing this
requirement may spur development and innovation in execution methods.
The Commission also believes that eliminating this requirement may
encourage SEFs to list new and different types of swaps, given that
they would no longer have to incur the costs of operating and
supporting Order Books. The Commission notes, however, that a SEF would
be free to continue to offer an order book if it so chooses.
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\132\ See infra Section IV.I.4.b.--Elimination of Required
Execution Methods.
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The Commission adopted the minimum trading functionality
requirement based in part on the goal of promoting pre-trade price
transparency,\133\ but acknowledges that the CEA does not explicitly
prescribe the Order Book as a SEF minimum trading functionality.
Accordingly, with the elimination of this requirement under Sec.
37.3(a)(2), the only trading functionality obligation that a SEF must
comply with on an ongoing basis is based upon the CEA section 1a(50)
definition of SEF.\134\ Therefore, the SEF must operate a trading
system or platform in which multiple participants have the ability to
execute or trade swaps by accepting bids and offers made by multiple
participants in the facility or system, through any means of interstate
commerce.\135\ To meet the SEF definition, a trading system or platform
must provide multiple participants with the ability to accept bids and
offers from other multiple participants within the facility or system.
As long as multiple participants have the ability to accept bids and
offers from other multiple participants within the facility or system,
the facility or system will meet the SEF definition, regardless of how
the multiple participants choose to interact with one another. Based on
this more straightforward approach, the Commission expects that
determining whether a particular system or platform
[[Page 61965]]
meets the SEF definition would generally be self-evident. Nevertheless,
the Commission will continue to work with entities that seek
interpretive guidance on the parameters of that definition.\136\
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\133\ 7 U.S.C. 7b-3(e).
\134\ The Commission emphasizes that while the SEF definition in
CEA section 1a(50) would serve as the baseline requirement for the
type of trading systems or platforms that a SEF must maintain, it
also provides the basic criterion to determine which types of
trading systems or platforms are subject to the SEF registration
requirement.
\135\ 7 U.S.C. 1a(50).
\136\ Based on the Commission's proposed elimination of the
Order Book as a minimum trading functionality requirement, the
Commission clarifies one particular issue regarding the scope of the
CEA section 1a(50) SEF definition. In the preamble to the SEF Core
Principles Final Rule, the Commission expressed doubt as to whether
an RFQ-to-one system met the multiple participant aspect of the SEF
definition. SEF Core Principles Final Rule at 33498, 33561, and
33563. This view, articulated in the context of the Commission's
discussion of RFQ Systems as a required method of execution, would
suggest that an ``RFQ-to-one'' trading system or platform may, on
its face, not meet the SEF definition. The Commission notes,
however, that this view does not appropriately give meaning to the
`ability' factor of the SEF definition. Therefore, the Commission
seeks to clarify the application of the `ability' factor as it
applies to RFQ-to-one transactions. The Commission believes that an
entity that permits its market participants to use its RFQ-to-one
functionality to issue concurrent or serial RFQs to multiple,
different recipients would fit within the SEF definition, as it
provides participants the ``ability'' to accept bids and offers from
multiple participants within the trading system or platform.
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3. Sec. 37.3(b)--Procedures for Registration \137\
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\137\ Based on the elimination of the temporary registration
requirements, the Commission proposes to retitle Sec. 37.3(b) to
``Procedures for registration'' from ``Procedures for full
registration.'' The Commission also proposes to add a title to Sec.
37.3(b)(1)--``Application for registration.''
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a. Elimination of Temporary Registration
To implement the SEF regulatory framework, the Commission
established a temporary SEF registration regime to help minimize
disruptions to incumbent platforms that had been operating prior to the
adoption of part 37 and to allow new entities to compete with those
incumbent platforms.\138\ Section 37.3(c) sets forth the process for
SEF applicants to apply for temporary SEF registration prior to the
Commission's review of an application for full SEF registration. The
temporary registration process, however, has expired pursuant to a two-
year sunset provision established under Sec. 37.3(c)(5).\139\ Since
the expiration of this process, the Commission has reviewed SEF
applications pursuant to a 180-day Commission review period.\140\
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\138\ SEF Core Principles Final Rule at 33487.
\139\ The Commission notes that the part 37 regulations became
effective on August 5, 2013. Accordingly, the temporary registration
provisions expired on August 5, 2015, subject to certain exceptions.
\140\ 17 CFR 37.3(b)(5).
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Based on the expiration of the temporary registration regime, the
Commission proposes to eliminate the provisions under existing Sec.
37.3(c) and adopt various conforming changes to other provisions in
proposed Sec. 37.3(b) and proposed Sec. 37.3(h), as discussed below.
b. Sec. 37.3(b)(1)--Application for Registration
To request registration as a SEF, Sec. 37.3(b)(1)(i) requires an
applicant to electronically file a complete Form SEF, as set forth in
Appendix A to part 37, with the Commission.\141\ The Commission uses
Form SEF, which is comprised of a series of different exhibits that
require an applicant to provide details of its operations, to determine
whether the applicant demonstrates compliance with the Act and
applicable Commission's regulations.\142\ Applicants must also use Form
SEF to amend a pending application or to seek an amended registration
order.\143\ As part of the SEF registration process, an applicant must
also request from the Commission a unique, extensible, alphanumeric
identifier code for the purpose of identifying the SEF in connection
with swap reporting requirements pursuant to part 45 of the
Commission's regulations.\144\
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\141\ 17 CFR 37.3(b)(1)(i).
\142\ The exhibits that comprise Form SEF concern the
applicant's business organization (Exhibits A-H); financial
information (Exhibits I-K); compliance (Exhibits L-U); and
operational capability (Exhibit V). 17 CFR part 37 app. A.
\143\ 17 CFR 37.3(b)(3); 17 CFR part 37 app. A.
\144\ 17 CFR 37.3(b)(1)(iii).
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Based on its experience with the SEF registration process, the
Commission believes that some of the information requested under Form
SEF has proven to be unnecessary to determine an applicant's compliance
with the Act and applicable Commission regulations. The Commission also
recognizes that some of the exhibit requirements are unclear in the
amount of information required to be provided, thereby causing
inconsistency across applications in the information received to
evaluate compliance. The proposed changes to the part 37 framework, as
discussed further herein, would also necessitate certain Form SEF
revisions. Therefore, the Commission is proposing several amendments to
Form SEF that would consolidate or eliminate several of the existing
exhibits and also request some additional information. Further, the
Commission is proposing several amendments to the Form SEF
instructions. The Commission intends for these proposed changes to
establish a clearer and more streamlined application process that would
still provide the Commission with sufficient and appropriate
information to determine compliance with the Act and Commission
regulations.
(1) Form SEF Exhibits--Business Organization
The Commission proposes several amendments to the ``Business
Organization'' exhibits--existing Exhibits A through H--of Form
SEF.\145\
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\145\ The Commission is not proposing any substantive changes to
Exhibit A, which requires an applicant to specify persons who own
ten percent or more of the applicant's stock or otherwise may
control or direct the applicant's management or policies; and
Exhibit B, which requires an applicant to provide a list of present
officers, directors and governors, or their equivalents. The
Commission is proposing non-substantive amendments to Exhibit A to
reorganize the existing requirements to paragraphs (a)-(b) and to
revise the existing language accordingly.
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First, the Commission proposes to consolidate certain existing
exhibits, in particular (i) existing Exhibit G, which requires an
applicant to submit various governance documents, into existing Exhibit
C, which requires information regarding the applicant's board of
directors; \146\ and (ii) existing Exhibit F, which requires an
analysis of the applicant's staffing, into existing Exhibit E, which
requires a description of the personnel qualifications for each
category of the applicant's professional employees.\147\ Under the
consolidated new Exhibit E, the Commission proposes to require more
specific detail about the applicant's personnel structure, including
personnel seconded to the applicant. As proposed, Exhibit E would
require information about the reporting lines among the applicant's
personnel; estimates of the number of non-management and non-
supervisory employees; and a description of the duties, background,
skills, and other qualifications for each officer, manager/supervisor,
and any other category of non-management and non-supervisory employees.
The Commission believes that amending Exhibit E to provide
[[Page 61966]]
greater specificity would promote consistency among applications and
further assist in evaluating the applicant's compliance with the Act
and the Commission's regulations, particularly with respect to self-
regulatory requirements.\148\
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\146\ Existing Exhibit C requires a narrative that describes the
composition and fitness standards for the applicant's board of
directors. Existing Exhibit G requires a copy of the applicant's
constitution, articles of incorporation, articles of formation, or
articles of association with all amendments thereto; partnership or
limited liability agreements; existing by-laws, operating agreement,
rules or instruments corresponding thereto; any governance fitness
information not included in existing Exhibit C; and a certificate of
good standing. As proposed, the existing Exhibit G requirements
would be re-designated as paragraphs (a) and (c) of a consolidated
new Exhibit C; existing Exhibit C would be re-designated as
paragraph (b) within new Exhibit C.
\147\ Existing Exhibit E requires a description of such
employees employed by the applicant or a division, subdivision, or
other separate entity within the applicant. Existing Exhibit F
requires the analysis of staffing requirements that are necessary to
operate the applicant as a SEF, including the staff names and
qualifications.
\148\ Based on the proposed consolidation of existing Exhibit F
and existing Exhibit G, existing Exhibit H would be re-designated as
a new Exhibit F with no additional substantive changes. This exhibit
requires a brief description of any material pending legal
proceeding(s), other than ordinary and routine litigation incidental
to the business, to which the applicant or any of its affiliates is
a party or to which any of its or their property is the subject.
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The Commission also proposes to narrow the scope of information
required by existing Exhibit D, which requires a description of the
applicant's organizational structure that includes a list and
description of affiliates and relevant divisions, subdivisions, or
other separate entities related to the applicant. As proposed, Exhibit
D would require an applicant to describe the nature of the business of
any affiliated entities which engage in financial services or market
activities, including but not limited to, the trading, clearing, or
reporting of swaps. The Commission believes that this amendment would
more appropriately focus the required information on entities related
to the applicant's swaps-trading business and minimize the submission
of information that is not related. Further, the Commission proposes
non-substantive amendments to the existing exhibit.
(2) Form SEF Exhibits--Financial Information
The Commission proposes several amendments to the ``Financial
Information'' exhibits--existing Exhibits I through K--of Form SEF.
The Commission proposes to adopt several changes to existing
Exhibit I.\149\ This exhibit requires applicants to submit financial
information to demonstrate compliance with the financial resources
requirements under Core Principle 13. Among other required information,
paragraph (a) requires applicants to submit their most recent fiscal-
year financial statements \150\ and paragraph (b) requires a narrative
of how the value of the applicant's financial resources is sufficient
to cover operating costs of at least one year, on a rolling basis, of
which six months' value of those resources are unencumbered and liquid.
Paragraph (c) requires an applicant to submit copies of any agreements
(i) establishing or amending a credit facility, (ii) insurance
coverage, or (iii) other arrangement that demonstrate compliance with
the liquidity requirement. Paragraph (d) requires an applicant to
submit representations regarding sources and estimates for future
ongoing operational resources.
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\149\ The Commission also proposes to re-designate existing
Exhibit I as a new Exhibit G based on the proposed changes described
above.
\150\ The financial information currently required under
paragraph (a) includes an applicant's balance sheet; income and
expense statement; cash flow statement; and statement of sources and
application revenues and all notes or schedules thereto.
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The Commission proposes to amend the requirements of paragraphs (a)
through (c) to conform to the proposed amendments to the SEF financial
resources requirements under Core Principle 13. In particular, the
proposed required documentation would demonstrate an applicant's
ability to maintain resources that exceed one year of operating costs
and the existence of resources to meet the liquidity requirement.\151\
The Commission also proposes to eliminate paragraph (d) because the
representation of an applicant's future ongoing operational resources
is not necessary to determine compliance with Core Principle 13.
Additionally, the Commission proposes to amend paragraph (a) to
incorporate the existing Form SEF instruction for newly-formed
applicants who cannot submit the requisite financial statements, but
who alternatively seek to provide pro forma financial statements for a
six-month period.
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\151\ See infra Section XVIII.--Part 37--Subpart N: Core
Principle 13 (Financial Resources) for a description of the
Commission's proposed changes to the Core Principle 13 regulations
upon which new Exhibit G is based.
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The Commission also proposes to adopt several changes to Exhibit
K.\152\ This exhibit requires an applicant to provide disclosures
related to fees that it would impose upon participants. Paragraph (a)
requires a complete list of all of the facility's dues, fees, and other
charges for its services; paragraph (b) requires a description of the
basis or methods used to determine those amounts; and paragraph (c)
requires a description of any differences in charges between different
customers or groups of customers for similar services. The Commission
proposes to amend paragraph (a) to require applicants to identify any
market maker programs, other incentive programs, or other discounts on
dues, fees, or other charges to be imposed. Based on the Commission's
experience, this information is beneficial in evaluating compliance
with access requirements pursuant to Core Principle 2.\153\ Given the
Commission's proposed revisions to the existing impartial access
requirements--in particular, the elimination of the ``comparable fees''
requirement under existing Sec. 37.202(a)(3)--the Commission further
proposes to eliminate the requirement for a description of fee
differentials under paragraph (c). The Commission also proposes several
streamlining changes to the existing language.
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\152\ The Commission also proposes to re-designate existing
Exhibit K as a new Exhibit H based on the proposed changes described
above.
\153\ The Commission notes that proposed Sec. 37.202(a)(2)
would require a SEF to establish and apply fee structures and fee
practices to its market participants in a fair and non-
discriminatory manner. See infra Section VII.A.1.b.--Sec.
37.202(a)(2)--Fees.
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In addition to the amendments to new Exhibit G (existing Exhibit I)
and new Exhibit H (existing Exhibit K), the Commission proposes to
eliminate existing Exhibit J, which requires an applicant to disclose
the financial resources information for any SEF, DCM, or other swap
trading platform affiliates. Based on its experience with Exhibit J,
the Commission recognizes that this information related to an
applicant's affiliates is not particularly useful in demonstrating an
applicant's compliance with Core Principle 13 or the conflicts of
interest requirements under Core Principle 12.
(3) Form SEF Exhibits--Compliance
The Commission proposes several amendments to the ``Compliance''
exhibits--existing Exhibits L through U--of Form SEF.
First, the Commission proposes to eliminate several exhibits
including (i) existing Exhibit P, which requires the applicant to
provide information on disciplinary and enforcement protocols, tools,
and procedures that is generally duplicative to the details contained
in an applicant's rulebook and compliance manual; \154\ (ii) existing
Exhibit R, which requires a list of the applicant's prohibited trade
practice violations that is duplicative to the rules that an applicant
must include in its rulebook pursuant to Core Principle 2 requirements;
\155\ and (iii) existing Exhibit U, which requires a list of items
subject to a request for confidential
[[Page 61967]]
treatment under Sec. 145.9 of the Commission's regulations--as
described further below, the Commission proposes to instead require
SEFs to identify these documents within the Table of Contents to Form
SEF.
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\154\ An applicant is currently required to submit a copy of its
rules under existing Exhibit M and a copy of its compliance manual
under existing Exhibit O, as currently designated. The Commission is
maintaining those requirements under the proposed revisions to Form
SEF as a new Exhibit J and a new Exhibit K, respectively. The
Commission notes that it proposes to move ``arrangements for
alternative dispute resolution'' under existing Exhibit P to a new
Exhibit L described below. See infra note 159.
\155\ Section 37.203 requires a SEF to establish and enforce
trading rules that will deter abuses, including prohibitions on
abusive trading practices in its markets. 17 CFR 37.203.
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Second, the Commission proposes to streamline the requirements of
existing Exhibit L.\156\ This exhibit currently requires a narrative
and documentation that describe the manner in which the applicant
complies with each SEF core principle. This documentation includes a
regulatory compliance chart that sets forth each core principle and
cites the relevant rules, policies, and procedures that describe the
manner in which the applicant is able to comply with each core
principle. For issues that are novel or for which compliance with a
core principle is not evident, this exhibit also requires an applicant
to explain how that item and the application satisfy the SEF core
principles. The Commission proposes to streamline this exhibit to
require that the applicant only submit the regulatory compliance chart
and an explanation of novel issues, as is currently required. Based on
its experience, the Commission believes that the regulatory compliance
chart with citations to relevant rules, policies, and procedures is
sufficient to determine an applicant's compliance with the Act and the
Commission's regulations. The Commission has found that the additional
narrative and documentation that describe the manner in which the
applicant complies with each SEF core principle creates unnecessary
paperwork and does not further the Commission's review of an
application in this regard. The Commission further proposes certain
non-substantive amendments to the existing language of Exhibit L.
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\156\ The Commission also proposes to re-designate existing
Exhibit L as a new Exhibit I based on the proposed changes described
above.
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Third, the Commission proposes to simplify the requirements of
existing Exhibit M.\157\ This exhibit currently requires a copy of the
applicant's rules, and any technical manuals, other guides, or
instruction for SEF users, including minimum financial standards for
members or market participants. The Commission proposes to eliminate
the existing requirement to cite position limits and aggregation
standards in part 151 of the Commission's regulations and any position
limit rules set by the facility. As discussed below with respect to
Core Principle 6, the Commission intends to address the position limit
issue in a separate rulemaking; \158\ the Commission also notes that
this requirement is redundant to the applicant's requirement to submit
a copy of its rules. Further, the Commission proposes several non-
substantive amendments to streamline Exhibit M's existing language.
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\157\ The Commission also proposes to re-designate existing
Exhibit M as a new Exhibit J based on the proposed changes described
above.
\158\ See infra Section XI.--Part 37--Subpart G: Core Principle
6 (Position Limits or Accountability).
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Fourth, the Commission proposes to eliminate the requirements under
existing Exhibit N. The exhibit currently requires an applicant to
provide executed or executable copies of any agreements or contracts
that facilitate the applicant's compliance with the SEF core
principles, including third-party regulatory service provider or member
or user agreements. To streamline Form SEF, the Commission would
require instead that applicants submit these documents pursuant to
other relevant exhibits, as described below.
Fifth, the Commission proposes a new Exhibit L, which would
continue to require an applicant to submit user agreements. As
proposed, the new exhibit would specify that the required agreements
would include, but not be limited to, on-boarding documentation,
regulatory data use consent agreements, intermediary documentation, and
arrangements for alternative dispute resolution.\159\ The new Exhibit L
would also require a narrative of the legal, operational, and technical
requirements for users to directly or indirectly access the SEF. This
requirement reflects some documents that applicants have previously
submitted under existing Exhibit N. The additional specificity,
however, reflects the Commission's experience with different
participant-related agreements that implicate (i) a SEF participant's
ability to access the facility's trading system or platform pursuant to
Core Principle 2; and (ii) the facility's use of a SEF participant's
proprietary data or personal information under existing Sec.
37.7.\160\
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\159\ The Commission notes that ``arrangements for alternative
dispute resolution'' are included based on the requirements of
existing Exhibit P, which the Commission proposes to eliminate from
Form SEF. See supra note 154.
\160\ The Commission notes that it proposes to move the language
of existing Sec. 37.7, which generally prohibits a SEF from using a
participant's proprietary data or personal information that it
collects or receives for regulatory purposes for business or
marketing purposes, to a new Sec. 37.504. See infra Section X.D.--
Sec. 37.504--Prohibited Use of Data Collected for Regulatory
Purposes.
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Sixth, the Commission proposes a new Exhibit M to establish
requirements related to an applicant's swaps reporting capabilities.
The new Exhibit M would require the applicant to submit (i) a list of
the SDRs to which the applicant will report swaps data, including the
respective asset classes; \161\ (ii) an executed copy of all agreements
between the applicant and those SDRs; and (iii) a representation from
each of those SDRs stating that the applicant has satisfactorily
completed all requirements, including all necessary testing, that
enables the SDR to reliably accept data from the applicant. These
requirements reflect some of the documents that the Commission has
required applicants to submit under existing Exhibit N and would enable
the Commission to determine the applicant's ability to comply with
Sec. 37.901, which requires a SEF to report swap data pursuant to
parts 43 and 45 of the Commission's regulations.\162\
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\161\ The Commission notes that the reference to a Commission-
registered SDR in Exhibit M also includes a provisionally-registered
SDR.
\162\ 17 CFR 37.901.
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Seventh, the Commission proposes a new Exhibit N to incorporate the
requirements in existing Exhibit T related to an applicant's ability to
submit swaps to a DCO for clearing. New Exhibit N would require the
applicant to submit (i) a list of DCOs and exempt DCOs to which the
applicant will submit swaps for clearing, including the respective
asset classes; (ii) a representation that the clearing members of those
DCOs and exempt DCOs will guarantee all trades submitted by the swap
execution facility for clearing; (iii) an executed copy of the clearing
agreement and any related documentation for each of those DCOs or
exempt DCOs; and (iv) a representation from each of those DCOs or
exempt DCOs stating that the applicant has satisfactorily completed all
requirements, including all necessary testing, that enable its
acceptance of swap transactions submitted by the applicant for
clearing. These requirements reflect some of the documents that the
Commission has required applicants to submit under existing Exhibit N
and would enable the Commission to determine an applicant's ability to
comply with proposed Sec. 37.702(b)(1) under Core Principle 7, which
requires a SEF to coordinate with each DCO to facilitate ``prompt,
efficient, and accurate'' processing and routing of transactions to the
DCO for clearing.\163\
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\163\ For a discussion of the relevant proposed amendments to
the Core Principle 7 regulations, see infra Section XII.B.--Sec.
37.702--General Financial Integrity.
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Eighth, the Commission proposes a new Exhibit O to require an
applicant to submit all other agreements or contracts that enable the
applicant to comply with the applicable SEF core principles and are not
already required to be submitted
[[Page 61968]]
under new Exhibits L, M, N, or Q.\164\ In conjunction with these other
exhibits, new Exhibit O matches the scope of documents that an
applicant is currently required to submit under existing Exhibit
N.\165\
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\164\ Exhibit Q requires an applicant to complete and submit the
Program of Risk Analysis and Oversight Technology Questionnaire.
Among other things, the questionnaire requires an applicant to
provide any agreements with third-party IT providers. See infra
Section XIX.B.--Sec. 37.1401(g)--Program of Risk Analysis and
Oversight Technology Questionnaire.
\165\ Given this new proposed exhibit, the Commission proposes
to re-designate existing Exhibit O as a new Exhibit K. The content
of the exhibit would remain the same and require an applicant to
submit a copy of a compliance manual and documents that describe how
the applicant will conduct trade practice, market, and financial
surveillance.
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Ninth, the Commission proposes to adopt several changes to existing
Exhibit Q.\166\ This exhibit currently requires an applicant to provide
an explanation of how its trading system(s) or platform(s) satisfy the
Commission's rules, interpretations, and guidelines concerning SEF
execution methods. Where applicable, paragraphs (a) and (b) of Exhibit
Q specify that the explanation should include various details related
to the minimum trade functionality requirement under Sec. 37.3(a)(2),
i.e., an Order Book, and the prescribed execution methods for Required
Transactions under Sec. 37.9, i.e., an Order Book or an RFQ System. As
discussed below, the Commission is proposing to eliminate these
requirements and to allow SEFs to offer flexible means of
execution,\167\ subject to certain trading-related rules under proposed
Sec. 37.201(a).\168\ Accordingly, the Commission proposes conforming
changes to Exhibit Q. In addition to the explanation of the applicant's
trading system(s) or platform(s), the Commission also proposes to
require an applicant to provide screenshots of any of its trading
system(s) or platform(s). Based on the Commission's experience, these
screenshots provide a useful supplement to evaluate any explanation
provided under this exhibit.
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\166\ The Commission also proposes to re-designate existing
Exhibit Q as a new Exhibit P based on the proposed changes described
above.
\167\ See infra Section IV.I.--Sec. 37.9--Methods of Execution
for Required and Permitted Transactions; Sec. 37.10--Process for a
Swap Execution Facility to Make a Swap Available to Trade; Sec.
37.12--Trade Execution Compliance Schedule; Sec. 38.11--Trade
Execution Compliance Schedule; Sec. 38.12--Process for a Designated
Contract Market to Make a Swap Available to Trade.
\168\ Proposed Sec. 37.201(a) would require a SEF to establish
rules that govern the operation of the SEF, including rules that
specify (i) the protocols and procedures for trading and execution;
(ii) the use of discretion in facilitating trading and execution;
and (iii) the sources and methodology for generating any market
pricing information. See infra Section VI.A.1.--Sec. 37.201(a)--
Required Swap Execution Facility Rules.
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Finally, the Commission proposes to consolidate existing Exhibit S,
which currently requires a discussion of how the applicant will
maintain trading data, into new Exhibit K (re-designated from existing
Exhibit O). Exhibit K would require an applicant to submit a copy of
its compliance manual and documents that describe how the applicant
will conduct trade practice, market, and financial surveillance.
(4) Form SEF Exhibits--Operational Capability
The Commission proposes to re-designate existing Exhibit V, which
requires the applicant to provide information pertaining to its program
of risk analysis and oversight via the Technology Questionnaire, as a
new Exhibit Q and to adopt non-substantive amendments to the exhibit's
existing language.\169\ Additionally, the Commission is making certain
amendments to update the questionnaire, as described below.\170\
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\169\ As discussed below, the Commission is proposing Sec.
37.1401(g) to require a SEF to annually prepare and submit an up-to-
date Technology Questionnaire to Commission staff. See infra Section
XIX.B.--Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire.
\170\ See infra Section XIX.B.--Sec. 37.1401(g)--Program of
Risk Analysis and Oversight Technology Questionnaire.
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(5) Other Form SEF Amendments
In addition to the proposed amendments to the existing exhibits,
the Commission is proposing several changes to the Form SEF
instructions. Form SEF currently requires applicants to include a Table
of Contents that lists each exhibit submitted as part of the
application. In lieu of a separate list provided via existing Exhibit
U, the Commission proposes to require that applicants designate, in the
Table of Contents, the exhibits that are subject to a request for
confidential treatment. The Commission also proposes to require that
any such confidential treatment be reflected by some type of
identifying number and code on the appropriate exhibit(s), similar to
the approach followed for DCO applications and Form DCO.\171\ Further,
the Commission proposes to eliminate the existing instruction for
newly-formed applicants regarding pro forma financial statements, which
the Commission proposes to incorporate in paragraph (a) of new Exhibit
G.
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\171\ The Commission also proposes to specify in the Form SEF
instructions that an applicant must file a confidentiality request
in accordance with Sec. 145.9 of the Commission's regulations.
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The Commission also proposes two minor amendments related to the
Form SEF cover sheet. First, to enable the Commission to evaluate a
SEF's compliance with ongoing filing requirements more readily, the
Commission proposes to require an applicant to specify its fiscal year-
end date.\172\ Second, the Commission proposes to eliminate the
reference to the use of Form SEF to amend an existing order or
registration, in conformance with the proposed amendment to Sec.
37.3(b)(3) discussed further below.\173\
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\172\ The Commission notes that these ongoing filing
requirements include (i) a fiscal year-end financial report that a
SEF would be required to file within ninety days after the end of
its fourth fiscal quarter under proposed Sec. 37.1306(d), see infra
Section XVIII.F.4.--Sec. 37.1306(d); (ii) proposed Exhibit Q of
Form SEF, i.e., the Program of Risk Analysis and Oversight
Technology Questionnaire that a SEF would be required to file within
ninety days after the end of its fiscal year under proposed Sec.
37.1401(g), see infra Section XIX.B.--Sec. 37.1401(g)--Program of
Risk Analysis and Oversight Technology Questionnaire; and (iii) an
annual compliance report that a SEF would be required to file within
ninety days after the end of its fiscal year under proposed Sec.
37.1501(e)(2), see infra Section XX.A.5.--Sec. 37.1501(e)--
Submission of Annual Compliance Report and Related Matters.
\173\ See infra Section IV.C.3.d.--Sec. 37.3(b)(3)--Amendment
of Application for Registration.
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(6) Request for Legal Entity Identifier
The Commission proposes to eliminate the requirement that an
applicant request a ``unique, extensible, alphanumeric code'' from the
Commission under Sec. 37.3(b)(1)(iii) and to require instead that the
applicant obtain a legal entity identifier (``LEI''). The Commission
adopted part 37 prior to the establishment of the technical
specification and governance mechanism for a global entity identifier.
Since that adoption, a 20-digit alphanumeric LEI has been developed and
adopted by many regulatory authorities in other jurisdictions, as well
as the Commission, for use in identifying counterparties and other
entities pursuant to various regulatory reporting requirements,
including part 45 of the Commission's regulations.\174\
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\174\ The Commission notes that applicants may obtain an LEI
from an LEI-issuing organization that has been accredited by the
Global Legal Entity Identifier Foundation (``GLEIF''). GLEIF, About
LEI--Get an LEI: Find LEI Issuing Organizations, https://www.gleif.org/en/about-lei/get-an-lei-find-lei-issuing-organizations.
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Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.3(b)(1) and Appendix A to part 37.
[[Page 61969]]
c. Sec. 37.3(b)(2)--Request for Confidential Treatment
The Commission is not proposing any amendments to Sec. 37.3(b)(2).
d. Sec. 37.3(b)(3)--Amendment of Application for Registration \175\
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\175\ The Commission proposes to retitle Sec. 37.3(b)(3) to
``Amendment of application for registration'' from ``Amendment of
application prior or subsequent to full registration'' based on the
proposed changes described below.
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Section 37.3(b)(3) specifies that an applicant amending a pending
application or requesting an amendment to a registration order must
file an amended application with the Secretary of the Commission in the
manner specified by the Commission. The Form SEF instructions
correspond to this requirement and currently specify that requests for
amending a registration order and any associated exhibits must be
submitted via Form SEF. Section 37.3(b)(3) otherwise specifies that a
SEF must file any amendment to its application subsequent to
registration as a submission under part 40 of the Commission's
regulations, or as specified by the Commission.\176\ In the preamble to
SEF Core Principles Final Rule, the Commission also stated that if any
information provided in a Form SEF is or becomes inaccurate for any
reason, even after registration, the SEF ``must promptly make the
appropriate corrections with the Commission.'' \177\
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\176\ 17 CFR 37.3(b)(3). Part 40 governs the submission of new
products, rules and rule amendments for registered entities,
including a process for the voluntary submission of rules for
Commission review and approval under Sec. 40.5 and a process for
the self-certification of rules under Sec. 40.6. 17 CFR 40.5-6.
\177\ SEF Core Principles Final Rule at 33485.
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The Commission proposes to clarify and amend the requirements
regarding post-registration amendments to both Form SEF exhibits and
registration orders. First, the Commission proposes to amend Sec.
37.3(b)(3) and Form SEF to eliminate the required use of Form SEF to
request an amended order of registration from the Commission.\178\
Under current practice, SEFs file a request for an amended order with
the Commission rather than submitting Form SEF. Commission staff
typically will review the request, obtain additional information from
the SEF where necessary, and subsequently recommend to the Commission
whether to grant or deny the amended order. Given current practice, the
Commission believes that an updated Form SEF is not needed to request
an amended order of registration.
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\178\ See infra Section IV.C.4.--Sec. 37.3(c)--Amendment to an
Order of Registration.
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Second, the Commission proposes to eliminate the existing language
that specifies the use of part 40 to file application amendments
subsequent to registration. The Commission emphasizes that not all of
the information from the Form SEF exhibits need to be updated pursuant
to part 40 subsequent to registration; certain part 37 provisions
already require SEFs to update their information on an ongoing basis.
For example, under Sec. 37.1306, a SEF is required to file updated
financial reports, including fiscal year-end reports, which precludes
the need to amend and file new Exhibit G (existing Exhibit I) through
part 40. The Commission clarifies that part 40 only applies to
information from application exhibits that constitute a ``rule,'' as
defined under Sec. 40.1(i).\179\ Therefore, registered SEFs have
already been submitting changes to these types of documentation
pursuant to the part 40 rule filing procedures. Given that part 40
defines ``rule,'' the existing language is not required to be included
under proposed Sec. 37.3(b)(3). If certain information from the Form
SEF exhibits are not required to be updated through other part 37
provisions or part 40, then a SEF does not have to file those
amendments subsequent to registration. The Commission notes, however,
that it may otherwise request information related to a SEF's business
pursuant to Sec. 37.5(a).\180\
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\179\ ``Rule'' is defined under Sec. 40.1(i) as any
constitutional provision, article of incorporation, bylaw, rule,
regulation, resolution, interpretation, stated policy, advisory,
terms and conditions, trading protocol, agreement or instrument
corresponding thereto, including those that authorize a response or
establish standards for responding to a specific emergency, and any
amendment or addition thereto or repeal thereof, made or issued by a
registered entity or by the governing board thereof or any committee
thereof, in whatever form adopted. 17 CFR 40.1(i). The Commission
generally interprets the Sec. 40.1(i) rule definition broadly to
encompass governance documentation (proposed Exhibit C); fees
(proposed Exhibit H); rulebooks (proposed Exhibit J); compliance
manuals (proposed Exhibit K); participant agreements (proposed
Exhibit L); SDR-related agreements (proposed Exhibit M); clearing-
related agreements (proposed Exhibit N); other third-party
agreements (proposed Exhibit O); and information related to
execution methods (proposed Exhibit P).
\180\ 17 CFR 37.5(a).
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Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.3(b)(3).
e. Sec. 37.3(b)(4)--Effect of Incomplete Application
The Commission is not proposing any amendments to Sec. 37.3(b)(4).
f. Sec. 37.3(b)(5)--Commission Review Period
Based on the elimination of the temporary registration regime under
existing Sec. 37.3(c), the Commission proposes to amend the existing
provision to eliminate related language and specify that the Commission
reviews a SEF registration application pursuant to a 180-day timeframe
and the procedures specified in CEA section 6(a).
g. Sec. 37.3(b)(6)--Commission Determination
The Commission is not proposing any amendments to Sec. 37.3(b)(6).
4. Sec. 37.3(c)--Amendment to an Order of Registration
Consistent with existing Commission practice and the proposal to
eliminate the use of Form SEF to request an amended registration order,
the Commission proposes a new Sec. 37.3(c)--``Amendment to an order of
registration''--to establish a separate process for such requests.\181\
A SEF would be required to submit its request electronically in the
form and manner specified by the Commission.\182\ Similar to the
procedures set forth for the registration application process, a SEF
would be required to provide the Commission with any additional
information and documentation necessary to review a request. The
Commission would issue an amended order if the SEF would continue to
maintain compliance with the Act and the Commission's regulations after
such amendment. Further, the Commission may also issue an amended order
subject to conditions. The Commission also proposes to specify that it
may decline to issue an amended order based upon a determination that
the SEF would not continue to maintain compliance with the Act and the
Commission's regulations upon such amendment.
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\181\ See supra Section IV.C.3.d.--Sec. 37.3(b)(3)--Amendment
of Application for Registration.
\182\ The Commission proposes to eliminate existing Sec.
37.3(c), which establishes the temporary SEF registration process
that is no longer available to applicants, as described above. See
supra Section IV.C.3.a.--Elimination of Temporary Registration.
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Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.3(c).
5. Sec. 37.3(d)--Reinstatement of Dormant Registration
The Commission is not proposing any amendments to Sec. 37.3(d).
[[Page 61970]]
6. Sec. 37.3(e)--Request for Transfer of Registration
Section 37.3(e) establishes requirements that a SEF must follow
when seeking to transfer its registration from its current legal entity
to a new legal entity as a result of a corporate change.\183\ Among
these requirements, Sec. 37.3(e)(2) requires a SEF to file a transfer
request no later than three months prior to the anticipated corporate
change, or if not possible, as soon as it knows of the change.\184\
Section 37.3(e)(3) requires a transfer request to include certain
information, such as the transferee's governing documents under Sec.
37.3(e)(3)(iv).\185\ Under Sec. 37.3(e)(3)(vi), the request must also
include certain representations from a transferee, including
representations that it will (i) retain and assume, without limitation,
all of the assets and liabilities of the transferor; (ii) assume
responsibility for complying with the Act and the Commission's
regulations; (iii) assume, maintain, and enforce all of the
transferor's rules that are applicable to SEFs, including the
transferor's rulebook and any amendments; (iv) comply with all self-
regulatory responsibilities, including maintaining and enforcing all
self-regulatory programs; and (v) notify market participants of all
changes to the rulebook prior to the transfer, as well as the transfer
and issuance of a corresponding order by the Commission.\186\ Under
Sec. 37.3(e)(3)(vii), the transfer request must also include a
representation from the transferee that upon the transfer, it will
assume responsibility for and maintain compliance with the SEF core
principles for all swaps previously made available for trading through
the transferor; and that none of the proposed rule changes will affect
the rights and obligations of any market participant.\187\
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\183\ 17 CFR 37.3(e).
\184\ 17 CFR 37.3(e)(2).
\185\ 17 CFR 37.3(e)(3).
\186\ 17 CFR 37.3(e)(3)(vi).
\187\ 17 CFR 37.3(e)(3)(vii).
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The Commission proposes several non-substantive amendments to
streamline the existing requirements under Sec. 37.3(e) for filing a
transfer request. First, the Commission proposes to simplify the
timeline for filing a request by requiring that a SEF file the request
``as soon as practicable,'' rather than no later than three months
prior to the anticipated corporate change or as soon as it knows of
such a change, if less than three months prior to the change.\188\
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\188\ The Commission proposes to adopt this amendment under
Sec. 37.3(e)(2).
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Second, with respect to the required information in a transfer
request, the Commission also proposes to specifically reference other
types of governing documents that would be adopted by transferees, such
as a limited liability agreement or an operating agreement.\189\ This
proposed change acknowledges that a transferee of a SEF's registration
may be a non-corporate entity, such as a limited liability company or
partnership.
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\189\ The Commission proposes to adopt this amendment under
Sec. 37.3(e)(3)(iv). The Commission recognizes that different types
of entities are established and governed by different types of
documentation. For example, a corporation is formed based on
articles of incorporation and operates pursuant to bylaws; a limited
liability company is generally established pursuant to articles of
organization and operates pursuant to an operating agreement; and a
limited partnership is generally formed based on a limited
partnership agreement. Based on the proposed amendments to Sec.
37.3(e)(iv), the Commission also proposes to amend Sec.
37.3(e)(3)(i) by changing the word ``agreement'' to
``documentation.''
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Third, the Commission proposes to simplify a transferee's
compliance-related representations under Sec. 37.3(e)(3)(vi). The
Commission proposes to consolidate and eliminate unnecessary language;
\190\ and eliminate the existing requirement that the transferee attest
that it will assume, maintain, and enforce compliance with the SEF core
principles, as well as maintain and enforce self-regulatory
programs.\191\ The Commission notes that the language that it proposes
to delete is otherwise duplicative to Sec. 37.3(e)(3)(vi)(B), which
generally requires the transferee to represent that it will assume
responsibility for compliance with all applicable provisions of the Act
and the Commission's regulations. Further, the Commission proposes to
eliminate the existing requirement under Sec. 37.3(e)(3)(vii)(A) that
a transferee represent that it will continue to comply with the SEF
core principles for all swaps made available for trading through the
transferor. The Commission notes that all SEFs, whether or not a
transferee, must comply with the Act and Commission regulations,
including all requirements applicable to a SEF's listed swaps.
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\190\ The Commission proposes to consolidate existing clauses
(B) and (D) into a new proposed clause (B).
\191\ The Commission proposes to eliminate this requirement
under existing clause (C) and renumber existing clause (E) as clause
(C).
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Fourth, the Commission proposes to amend Sec. 37.3(e) to better
reflect the practical realities of the transfer process. Rather than
require a transferee to represent that it will retain and assume all
the assets and liabilities of the transferor without limitation, the
Commission proposes to instead require that the transferee state in the
request when it would not do so.\192\ In addition, rather than require
a transferee to represent that none of a transferee's proposed rule
changes will affect the rights and obligations of any market
participant, the Commission proposes instead to require that the
transferee represent that it will notify market participants of changes
that may affect their rights and obligations.\193\ These amendments
would eliminate certain pre-emptive restrictions upon business-related
changes associated with the transfer, but also allow the Commission to
continue reviewing whether such changes may be inconsistent with the
Act or the Commission's regulations.
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\192\ The Commission proposes to adopt this amendment under
subparagraph (3)(vi)(A).
\193\ The Commission proposes to amend the language of existing
subparagraph (3)(vii)(B) and renumber the provision to subparagraph
(3)(vii)(C) based on the proposed changes described above. The
Commission notes that the transferee's notification obligations
would not be limited to those that may affect a market participant's
rights and obligations; the proposed rule would maintain the
existing requirement that a transferee represent that it will notify
market participants of all changes to the transferor's rulebook
prior to the transfer.
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7. Sec. 37.3(f)--Request for Withdrawal of Application for
Registration
The Commission is not proposing any amendments to Sec. 37.3(f).
8. Sec. 37.3(g)--Request for Vacation of Registration
The Commission is not proposing any amendments to Sec. 37.3(g).
9. Sec. 37.3(h)--Delegation of Authority
Given the deletion of the phrase relating to temporary registration
in the existing paragraph, the Commission proposes a conforming non-
substantive amendment.
D. Sec. 37.4--Procedures for Implementing Rules 194
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\194\ The Commission proposes to retitle Sec. 37.4 to
``Procedures for implementing rules'' from ``Procedures for listing
products and implementing rules'' based on the proposed changes
described below.
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Section 37.4 currently sets forth rules related to the listing of
swap products and the submission of rules on a pre- and post-
registration basis. Section 37.4(a) specifies that a SEF applicant may
submit the terms and conditions of swaps that it intends to list for
trading as part of its registration application.\195\ Section 37.4(b)
specifies that any swap
[[Page 61971]]
terms and conditions or rules submitted as part of the SEF's
application shall be considered for approval by the Commission at the
time it issues the SEF's registration order.\196\ Section 37.4(c)
specifies that after the Commission issues a registration order, the
SEF shall submit any proposed swap terms and conditions, including
amendments to such terms and conditions, proposed new rules, or
proposed rule amendments, pursuant to part 40 of the Commission's
regulations.\197\ Section 37.4(d) specifies that any swap terms and
conditions or rules submitted as part of an application to reinstate a
dormant SEF shall be considered for approval at the time that the
Commission approves the dormant SEF's reinstatement of
registration.\198\
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\195\ 17 CFR 37.4(a).
\196\ 17 CFR 37.4(b).
\197\ 17 CFR 37.4(c).
\198\ 17 CFR 37.4(d).
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The Commission proposes to eliminate Sec. 37.4(a) and to adopt
conforming amendments to Sec. 37.4(b) to establish that the
Commission's process of reviewing the terms and conditions of a swap
product that the applicant intends to list for trading upon
registration is separate from the review process of a SEF's application
for registration.\199\ As amended, Sec. 37.4(b) would specify that
rules, except swap product terms and conditions, submitted by the SEF
applicant as part of a registration application would be considered for
approval at the time the Commission issues an order of registration.
Upon obtaining an order of registration, a registered SEF may formally
submit product terms and conditions under Sec. 40.2 or Sec. 40.3,
which controls the submission of new product terms and conditions by
registered entities.\200\ Given that the submission procedures for
rules, including product terms and conditions, are established under
part 40, the Commission also proposes to eliminate unnecessary language
by deleting Sec. 37.4(c). The Commission believes that separating
these two processes would promote efficiency for both Commission staff
and SEF applicants. For example, a SEF applicant's registration order
could otherwise be unnecessarily delayed or stayed if the SEF applicant
submits for Commission approval, along with its application for
registration, a novel or complex product that would require additional
consideration or analysis by Commission staff.
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\199\ The Commission proposes to renumber subsection (b) to
subsection (a) based on the proposed amendment as described above.
\200\ 17 CFR part 40. Although an applicant may not submit swap
product terms and conditions for approval as part of the
registration process, the Commission notes that SEF applicants may
informally discuss any proposed products with Commission staff for
informal feedback as part of the registration process.
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To conform to the proposed approach for reviewing swap product
terms and conditions from SEF applicants described above, the
Commission also proposes to amend Sec. 37.4(d) to delete the reference
to any ``swap terms and conditions'' submitted by a dormant SEF that is
applying for reinstatement of registration.\201\ Accordingly, dormant
SEFs would not be able to provide proposed swap product terms and
conditions for approval as part of the dormant SEF registration
reinstatement process. Upon obtaining a reinstatement of registration,
a SEF may formally submit product terms and conditions under Sec. 40.2
or Sec. 40.3, which controls the submission of new product terms and
conditions by registered entities.
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\201\ The Commission proposes to renumber subsection (d) to
subsection (b) based on the proposed amendments as described above.
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Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.4.
E. Sec. 37.5--Provision of Information Relating to a Swap Execution
Facility 202
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\202\ The Commission proposes to retitle Sec. 37.5 to
``Provision of information relating to a swap execution facility''
from ``Information relating to swap execution facility compliance''
based on the proposed changes described below.
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1. Sec. 37.5(a)--Request for Information
The Commission is not proposing any amendments to Sec. 37.5(a).
2. Sec. 37.5(b)--Demonstration of Compliance
The Commission is proposing certain non-substantive amendments to
Sec. 37.5(b).
3. Sec. 37.5(c)--Equity Interest Transfer
Section 37.5(c) sets forth notification requirements related to
transfers of equity interest in a SEF. Section 37.5(c)(1) requires a
SEF to notify the Commission if the SEF enters into a transaction
involving the transfer of fifty percent or more of the equity interest
in the SEF.\203\ Section 37.5(c)(2) requires the SEF to file the notice
at the earliest possible time, but no later than the open of business
ten business days following the date upon which the SEF enters into a
firm obligation to transfer the equity interest.\204\ Upon such a
notification, the Commission may request supporting documentation of
the transaction.\205\ Where any aspect of the transfer constitutes a
rule as defined under part 40, Sec. 37.5(c)(3) requires a SEF to
comply with the requirements of CEA section 5c(c) and part 40.\206\
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\203\ 17 CFR 37.5(c)(1).
\204\ 17 CFR 37.5(c)(2).
\205\ 17 CFR 37.5(c)(1). In the SEF Core Principles Final Rule,
the Commission specified the types of documentation to include, but
not be limited to, (i) relevant agreement(s); (ii) associated
changes to relevant corporate documents; (iii) a chart outlining any
new ownership or corporate or organization structure, if available;
and (iv) a brief description of the purpose and any impact of the
equity interest transfer. SEF Core Principles Final Rule at 33490.
The final rule also stated that a SEF must file a certification
regarding its compliance with CEA section 5h and the Commission's
regulations thereunder, as set forth in existing Sec. 37.5(c)(4).
Id.
\206\ 17 CFR 37.5(c)(3).
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The Commission has previously stated that in situations where such
an equity transfer occurs, the Commission has an interest in reviewing
and considering the implications of the changes in ownership.\207\ In
particular, the Commission seeks to determine whether the change in
ownership will adversely impact the operations of the SEF or the SEF's
ability to comply with the core principles and the Commission's
regulations thereunder.\208\ Further, the Commission intended for Sec.
37.5(c) to enable Commission staff to consider whether any term or
condition contained in an equity transfer agreement(s) is inconsistent
with the self-regulatory responsibilities of a SEF or with any of the
core principles.\209\
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\207\ Core Principles and Other Requirements for Swap Execution
Facilities, 76 FR 1214, 1217 (Jan. 7, 2011) (``SEF Core Principles
Proposed Rule'').
\208\ Id.
\209\ Id. In the SEF Core Principles Final Rule, the Commission
raised the provision to 50 percent from 10 percent and maintained a
similar policy rationale, SEF Core Principles Final Rule at 33490,
i.e., to ``ensure that SEFs remain mindful of their self-regulatory
responsibilities when negotiating the terms of significant equity
interest transfers.'' SEF Core Principles Proposed Rule at 1217.
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The Commission proposes to amend Sec. 37.5(c)(1) to require a SEF
to file a notice with the Commission in the event of any transaction
that results in the transfer of direct or indirect ownership of fifty
percent or more of the equity interest in the SEF. The Commission notes
that indirect ownership may transpire, for example, through a
transaction involving a direct or indirect parent company of the SEF.
Section 37.5(c), however, only requires a SEF to file a notice where
the SEF is a party to a transaction involving a transfer of direct
ownership of fifty percent or more of the equity interest in the SEF,
but not where the SEF is not a party to the transaction, or where the
transaction results in a transfer of indirect ownership of the SEF. The
Commission believes that such transfers implicate the same regulatory
policies underlying the existing rule and therefore proposes
[[Page 61972]]
amendments to broaden the requirement. Based on the proposed changes
described above, the Commission further proposes conforming non-
substantive amendments to Sec. 37.5(c)(2)--``Timing of
notification''--and Sec. 37.5(c)(4)--``Certification.'' \210\
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\210\ The Commission also proposes to renumber paragraph (c)(4)
to paragraph (c)(3) based on the proposed elimination of the
existing language in paragraph (c)(3) described below.
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The Commission further proposes to streamline Sec. 37.5(c) by
deleting Sec. 37.5(c)(3)--the Commission notes that part 40 already
applies to SEFs with respect to rule filings, and therefore, a separate
provision is not necessary to apply part 40 to SEFs.
Request for Comment
The Commission requests comments on all aspects of the proposed
amendments to Sec. 37.5(c).
4. Sec. 37.5(d)--Delegation of Authority
The Commission is not proposing any amendments to Sec. 37.5(d).
F. Sec. 37.6--Enforceability
1. Sec. 37.6(a)--Enforceability of Transactions
Section 37.6(a) is intended to provide market participants with
legal certainty with respect to swap transactions on a SEF and
generally clarifies that a swap transaction entered into on or pursuant
to the rules of a SEF cannot be void, voidable, subject to recession,
otherwise invalidated, or rendered unenforceable due to a violation by
the SEF of the Act or applicable Commission regulations or any
proceeding that alters or supplements a rule, term or condition that
governs such swap or swap transaction.\211\
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\211\ 17 CFR 37.6(a).
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The Commission proposes non-substantive amendments to Sec.
37.6(a).\212\ These amendments include (i) amending the phrase
``entered into'' to ``executed'' to provide greater clarity; and (ii)
eliminating the reference to swaps executed ``pursuant to the rules
of'' a SEF, which conforms to the proposed amendment to the ``block
trade'' definition under Sec. 43.2, discussed further below.\213\
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\212\ The Commission also proposes to add a new title to Sec.
37.6(a)--``Enforceability of transactions.''
\213\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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2. Sec. 37.6(b)--Swap Documentation
Section 37.6(b) requires a SEF to provide each counterparty to a
transaction with a written ``confirmation'' that contains all of the
terms of a swap transaction at the time of the swap's execution for
both cleared and uncleared swap transactions, including (i) ``economic
terms'' that are specific to a transaction, e.g., swap product, price,
and notional amount; and (ii) non-specific ``relationship terms'' that
generally govern all transactions between two counterparties, e.g.,
default provisions, margin requirements, and governing law.\214\
``Confirmation'' is defined under parts 43 and 45 of the Commission's
regulations as the consummation (electronically or otherwise) of
legally binding documentation that memorializes the agreement of the
counterparties to all terms of the swap (emphasis added).\215\ The
definition also states that a confirmation shall be in writing
(electronic or otherwise) and legally supersede any previous agreement
(electronic or otherwise) relating to the swap.\216\ The Commission
adopted Sec. 37.6(b), in part, to facilitate this process for swaps
transactions--both cleared and uncleared--executed on or pursuant to
the rules of a SEF.\217\
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\214\ 17 CFR 37.6(b).
\215\ 17 CFR 43.2; 17 CFR 45.1. See also 17 CFR 23.500 (similar
definition of ``confirmation'' that applies to swap dealers
(``SDs'') and major swap participants (``MSPs'')).
\216\ 17 CFR 43.2; 17 CFR 45.1.
\217\ SEF Core Principles Final Rule at 33491.
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For uncleared swap transactions, the Commission is aware that many
relationship terms that may govern certain aspects of an uncleared swap
transaction are often negotiated and executed between potential
counterparties prior to execution.\218\ The Commission previously
provided that SEFs may satisfy Sec. 37.6(b) for uncleared swap
transactions by incorporating by reference the relevant terms set forth
in such agreements, as long as those agreements have been submitted to
the SEF prior to execution.\219\ As applied, Sec. 37.6(b) requires
that the SEF obtain and incorporate this documentation into the issued
confirmation, which is intended in part to provide SEF participants
with legal certainty with respect to uncleared swap transactions.\220\
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\218\ SEF Core Principles Final Rule at 33491 n.195. Swap
counterparties have typically relied on the use of industry-standard
legal documentation, including master netting agreements,
definitions, schedules, and confirmations, to document their swap
trading relationships. This documentation, such as the ISDA Master
Agreement and related Schedule and Credit Support Annex (``ISDA
Agreements''), as well as related documentation specific to
particular asset classes, offers a framework for documenting
uncleared swap transactions between counterparties. See
Confirmation, Portfolio Reconciliation, Portfolio Compression, and
Swap Trading Relationship Documentation Requirements for Swap
Dealers and Major Swap Participants, 77 FR 55904, 55906 (Sept. 11,
2012). For uncleared swap transactions, Sec. 23.504(b) requires
written documentation of all the terms governing the trading
relationship between an SD or MSP and its counterparty. 17 CFR
23.504(b).
\219\ SEF Core Principles Final Rule at 33491 n.195.
\220\ To ensure that the SEF confirmation provides legal
certainty, the Commission stated that counterparties choosing to
execute a swap transaction on or pursuant to the rules of a SEF must
have all terms, including possible long-term credit support
arrangements, agreed to no later than execution, such that the SEF
can provide a written confirmation inclusive of those terms at the
time of execution. SEF Core Principles Final Rule at 33491.
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This requirement, however, has created impractical burdens for
SEFs. Based upon feedback from SEFs, the Commission understands that
SEFs have encountered many issues in trying to comply with the
requirement for uncleared swaps, including high financial,
administrative, and logistical burdens to collect and maintain
bilateral transaction agreements from many individual counterparties.
SEFs have stated that they are unable to develop a cost-effective
method to request, accept, and maintain a library of every previous
agreement between counterparties.\221\ SEFs have also noted that the
potential number of previous agreements is considerable, given that SEF
counterparties enter into agreements with many other parties and have
multiple agreements for different asset classes.\222\
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\221\ Many of these agreements are maintained in paper form or
scanned PDF files that are difficult to quickly digitize in a cost-
effective manner. See WMBAA, Request for Extended Relief from
Certain Requirements under Parts 37 and 45 Related to Confirmations
and Recordkeeping for Swaps Not Required or Intended to be Cleared
at 3 (Mar. 1, 2016). Further, some SEFs have cited the considerable
resource cost of obtaining the number of different agreements that
exist to accommodate the different parties and different asset
classes. Id.
\222\ Id.
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Commission staff has acknowledged these technological and
operational challenges and has accordingly granted time-limited no-
action relief.\223\ Based on this relief, SEFs have incorporated
[[Page 61973]]
applicable relationship terms from previous agreements by reference in
the confirmation without obtaining copies of these agreements prior to
the execution of a swap.\224\ SEFs, however, still must memorialize the
relationship terms contained in separate, previously-negotiated
agreements that the SEF has not reviewed at the time of incorporation,
and would likely not review post-execution. One industry participant,
however, noted that a SEF would not be familiar with the terms of the
agreements that it is required to incorporate by reference into a
confirmation.\225\
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\223\ Commission staff provided initial no-action relief in
2014. CFTC Letter No. 14-108, Re: Staff No-Action Position Regarding
SEF Confirmations and Recordkeeping Requirements under Certain
Provisions Included in Regulations 37.6(b) and 45.2 (Aug. 18, 2014).
Commission staff has since extended this no-action relief on several
occasions. See CFTC Letter No. 17-17, Re: Extension of No-Action
Relief for Swap Execution Facility Confirmation and Recordkeeping
Requirements under Commodity Futures Trading Commission Regulations
37.6(b), 37.1000, 37.1001, 45.2, and 45.3(a) (Mar. 24, 2017); CFTC
Letter No. 16-25, Re: Extension of No-Action Relief for Swap
Execution Facility Confirmation and Recordkeeping Requirements under
Commodity Futures Trading Commission Regulations 37.6(b), 37.1000,
37.1001, 45.2, and 45.3(a) (Mar. 14, 2016); CFTC Letter 15-25, Re:
Extension of No-Action Relief for SEF Confirmation and Recordkeeping
Requirements under Commission Regulations 37.6(b), 37.1000, 37.1001,
and 45.2, and Additional Relief for Confirmation Data Reporting
Requirements under Commission Regulation 45.3(a) (Apr. 22, 2015).
\224\ Id.
\225\ See SIFMA Asset Management Group, Re: Straight-Through
Processing, Swap Execution Facility Implementation and Relief
Relating to the Aggregation Provision in Final Block Trade Rule at 6
n.14 (Oct. 25, 2013) (stating that ``it is highly impractical for a
SEF to familiarize itself with the often complex, bespoke master
agreement and trade terms (and the various documents that may be
incorporated by reference) in order to produce a customized,
potentially complex confirmation on a trade by trade basis.'').
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Based on its experience with the part 37 implementation, the
Commission acknowledges that cleared and uncleared swaps raise
different issues with respect to confirmation requirements and the
current SEF requirements create difficulties for the latter type of
swap transaction. Therefore, the Commission is proposing a revised
approach to Sec. 37.6(b) as described below.
a. Sec. 37.6(b)(1)--Legally Binding Documentation
The Commission proposes Sec. Sec. 37.6(b)(1)(i)-(ii) to establish
separate swap transaction documentation requirements for cleared and
uncleared swaps. Proposed Sec. 37.6(b)(1)(i)(A) would apply the
existing confirmation requirement--that a SEF must issue a written
confirmation that includes all of the terms of the transaction--to
cleared swap transactions. The Commission further proposes to define
``confirmation document'' under Sec. 37.6(b)(1)(i)(B) as a legally
binding written documentation that memorializes the agreement to all
terms of a swap transaction and legally supersedes any previous
agreement that relates to the swap transaction between the
counterparties.
With respect to uncleared swap transactions the Commission proposes
a revised approach under Sec. 37.6(b)(1)(ii) that would require a SEF
to provide the counterparties to an uncleared swap transaction with a
``trade evidence record'' that memorializes the terms of the swap
transaction agreed upon between the counterparties on the SEF. In
contrast to a cleared swap confirmation, the trade evidence record
would not be required to include all of the terms of the swap
transaction, including relationship terms contained in underlying
documentation between the counterparties. As defined under proposed
Sec. 37.6(b)(1)(ii)(B), a trade evidence record means a legally
binding written documentation that memorializes the terms of a swap
transaction agreed upon by the counterparties and legally supersedes
any conflicting term in any previous agreement that relates to the swap
transaction between the counterparties. The Commission anticipates that
these terms would include, at a minimum, the ``economic terms'' that
are agreed upon between the counterparties to a specific SEF
transaction, e.g., trade date, notional amount, settlement date, and
price.
The Commission believes that the proposed rule would provide SEFs
with a simplified approach to comply with the legal documentation
requirement, but also continue to promote the policy objective of Sec.
37.6(b) by providing SEF participants with legal certainty with respect
to both cleared and uncleared swap transactions. Further, the proposed
approach accommodates existing counterparty trading practices for
uncleared swaps, particularly the use of separate, previously-
negotiated underlying agreements to establish relationship terms that
generally govern the trading relationship, as opposed to a specific
transaction, between two counterparties. To the extent that such terms
either are agreed upon between the counterparties in underlying
documentation established away from the SEF and continue to govern the
transaction post-execution or are not required to establish legal
certainty for a specific transaction, a SEF would not be required to
incorporate those terms into a trade evidence record. The proposed
approach should address the challenges that have prevented SEFs from
fully complying with Sec. 37.6(b) by reducing the administrative
burdens for SEFs, who would not be required to obtain, incorporate, or
reference those previous agreements, and for counterparties, who would
not be required to submit all of their relevant documentation with
other potential counterparties to the SEF.\226\
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\226\ The Commission acknowledges that the issuance of a trade
evidence record would not alter the other obligations of a SEF or
the counterparties under the CEA and the Commission's regulations.
For example, a SEF would still be required to report all required
swap creation data under Sec. 45.3(a), as applicable. 17 CFR
45.3(a). Further, a counterparty that is a swap dealer or major swap
participant would also still be required to transmit a confirmation
pursuant to Sec. 23.501, as applicable. 17 CFR 23.501.
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Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.6(b)(1). In particular, the Commission is particularly interested in
the prescribed contents and legal import of a trade evidence record and
requests comment on the following questions:
(19) Should the Commission allow a SEF to issue a trade evidence
record that does not include all the terms of a swap transaction agreed
to on the SEF?
(20) Should the Commission require a SEF to include a minimum set
of terms in a trade evidence record, e.g., material economic terms?
Should the Commission specify those terms in the proposed regulation?
(21) Should the Commission require a SEF to include any of the
``primary economic terms,'' as defined under Sec. 45.1, in a trade
evidence record? If so, which terms should be included?
(22) Should the Commission specify that a trade evidence record (i)
serves as evidence of a legally binding agreement upon the
counterparties; and (ii) legally supersedes any previous agreement,
rather than any conflicting term in any previous agreement, as
proposed? With respect to (i), are there terms that are generally
contained within previously-negotiated, underlying agreements between
the counterparties that are necessary to make a transaction legally
binding, and therefore must be submitted to the SEF?
(23) Should the Commission specify in its regulations that
notwithstanding the trade evidence record requirement, a SEF is allowed
to incorporate by reference underlying, previous agreements containing
terms governing a swap transaction into any trade evidence record
associated with the transaction?
(24) Do proposed Sec. Sec. 37.6(b)(1)(i)-(ii) provide sufficient
legal certainty with respect to any contradictory terms that may be
contained within the previous agreements?
b. Sec. 37.6(b)(2)--Requirements for Swap Documentation
Section 37.6(b) requires that the confirmation take place at the
same time as execution, except for a limited exception for certain
information for bunched orders.\227\ The Commission proposes Sec.
37.6(b)(2)(i) to amend this requirement and instead require a SEF to
provide a confirmation document or trade evidence record to the
counterparties to a transaction ``as soon as technologically
practicable'' after the
[[Page 61974]]
execution of the swap transaction on the SEF.\228\
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\227\ 17 CFR 37.6(b).
\228\ The Commission notes that in the context of real-time
public reporting, it has defined ``as soon as technologically
practicable'' to mean as soon as possible, taking into consideration
the prevalence, implementation and use of technology by comparable
market participants. 17 CFR 43.2. The meaning of this term, as
proposed in Sec. 37.6(b)(2)(i) herein, would be consistent with
this definition.
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The Commission recognizes that a strict implementation of the
existing requirement is not practical from a temporal standpoint, given
that a SEF's issuance of a written confirmation document or trade
evidence record would only occur upon execution by counterparties.\229\
Further, the required issuance of a written confirmation document or
trade evidence record simultaneous with execution may become further
impracticable for some SEFs from an operational and technological
standpoint based on the different trading systems or platforms that
SEFs may offer under a more flexible approach to execution methods
proposed by the Commission.\230\ Therefore, proposed Sec.
37.6(b)(2)(i) is intended to establish a more practical approach that
accommodates different types of SEF operations. The Commission believes
that the proposed standard--``as soon as technologically
practicable''--would also continue to promote the Commission's goals of
providing the swap counterparties with legal certainty in a prompt
manner. Based on this proposed amendment to the existing language of
Sec. 37.6(b), the Commission also proposes to renumber the existing
requirement regarding bunched orders to proposed Sec. 37.6(b)(2)(ii)
and adopt non-substantive amendments.
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\229\ The Commission notes that a public commenter previously
cited execution and confirmation as two separate processes in the
swap transaction process. SEF Core Principles Final Rule at 33491
(comment from the Energy Working Group that execution and
confirmation are ``distinct steps'' in the swap transaction
process).
\230\ See infra Section IV.I.--Sec. 37.9--Methods of Execution
for Required and Permitted Transactions; Sec. 37.10--Process for a
Swap Execution Facility to Make a Swap Available to Trade; Sec.
37.12--Trade Execution Compliance Schedule; Sec. 38.11--Trade
Execution Compliance Schedule; Sec. 38.12--Process for a Designated
Contract Market to Make a Swap Available to Trade.
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As noted, Sec. 37.6(b) requires a SEF to provide the written
confirmation of a transaction executed on or pursuant to the SEF's
rules to ``each counterparty to [the] transaction.'' The Commission
proposes to add Sec. 37.6(b)(2)(iii) to provide that a SEF may issue a
confirmation document or trade evidence record to the intermediary
trading on behalf of a counterparty, provided that the SEF establish
and enforce rules to require any intermediary to transmit any such
document or record to the counterparty as soon as technologically
practicable. Based on industry practice, the Commission notes that to
the extent that intermediaries, acting on behalf of swap participants,
facilitate swap execution on a SEF, the SEF transmits the written
confirmation to the intermediary and then requires the intermediary to
forward the confirmation to its customer. The Commission understands
that participants using intermediaries to trade on a SEF may not
establish the appropriate connectivity necessary to receive written
confirmations directly from the SEF. Requiring the intermediary to
transmit the document or record as soon as technologically practicable
would further accommodate current market practices, as discussed above.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.6(b)(2). In particular, the Commission requests comment on the
following questions:
(25) Is the Commission's proposal, to require a SEF to transmit
confirmation documents or trade evidence records to counterparties ``as
soon as technologically practicable'' after the execution of the swap
transaction on the SEF an appropriate time frame? Should the Commission
require that the SEF issue the confirmation document or trade evidence
record within a specified time limit?
(26) Is the Commission's proposal to require a SEF to establish and
enforce rules that require an intermediary acting on behalf of a
counterparty to transmit a confirmation document or trade evidence
record to such counterparty ``as soon as technologically practicable''
an appropriate time frame? Should the Commission require that the SEF
issue the confirmation document or trade evidence record within a
specified time limit?
(27) Should the Commission define ``as soon as technologically
practicable'' in a similar manner to the definition in part 43?
G. Sec. 37.7--Prohibited Use of Data Collected for Regulatory Purposes
The Commission proposes to move and amend Sec. 37.7, which
prohibits a SEF from using proprietary or personal information that it
collects or receives to fulfill regulatory obligations for business or
marketing purposes, as a new Sec. 37.504 under the Core Principle 5
(Ability to Obtain Information) regulations. The Commission discusses
the proposed amendments to the existing requirements further
below.\231\
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\231\ See infra Section X.D.--Sec. 37.504--Prohibited Use of
Data Collected for Regulatory Purposes.
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H. Sec. 37.8--Boards of Trade Operating Both a Designated Contract
Market and a Swap Execution Facility 232
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\232\ The Commission proposes to renumber Sec. 37.8 to Sec.
37.7 based on the proposed changes described above.
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Section 37.8(a) requires an entity that operates as both a DCM and
a SEF to separately register with the Commission in accordance with the
procedures set forth under part 38 and part 37 of the Commission's
regulations, respectively. Section 37.8(a) further requires that a
dually-registered entity comply with the respective DCM and SEF core
principles and regulations on an ongoing basis.
The Commission notes that the language is superfluous to the
similar requirements that already exist under Sec. 38.2 and Sec. 37.2
for DCMs and SEFs, respectively, and therefore proposes to delete this
latter requirement. The Commission notes, however, that this is not a
substantive change and DCMs and SEFs must otherwise comply with the Act
and applicable regulations.
I. Sec. 37.9--Methods of Execution for Required and Permitted
Transactions; Sec. 37.10--Process for a Swap Execution Facility To
Make a Swap Available to Trade; Sec. 37.12--Trade Execution Compliance
Schedule; Sec. 38.11--Trade Execution Compliance Schedule; Sec.
38.12--Process for a Designated Contract Market To Make a Swap
Available To Trade
The CEA, as amended by the Dodd-Frank Act, requires the Commission
to develop and implement a regulatory framework for trading swaps on
registered SEFs and establishes a corresponding trade execution
requirement that requires certain swaps to be executed on DCMs, SEFs,
or Exempt SEFs.\233\ The regulatory framework that the Commission
developed to implement these provisions prescribes, among other things,
(i) a process that allows SEFs and DCMs to initiate determinations of
which swaps should be subject to the CEA section 2(h)(8) trade
execution requirement, i.e., the MAT process; and (ii) the methods of
execution that must be used for swaps that are subject to the trade
execution requirement. In addition, the framework permits SEFs to offer
any method of execution for swaps
[[Page 61975]]
that are not subject to the trade execution requirement.
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\233\ 7 U.S.C. 2(h)(8). Although the trade execution requirement
may be satisfied through DCMs, the Commission's discussion of the
trade execution requirement in this proposed rulemaking will
generally pertain to SEFs, unless otherwise noted.
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The Commission adopted this framework in part to achieve the SEF
statutory goals in CEA section 5h(e) of promoting trading on SEFs and
promoting pre-trade transparency in the swaps market. The Commission
acknowledges that the existing framework has transitioned some swaps
trading and market participants to SEFs. Since 2013, however, the
Commission has gained considerable knowledge and experience with swaps
trading dynamics through implementing part 37, particularly with
respect to the required use of certain execution methods. Based on that
knowledge and experience, the Commission believes that certain aspects
of the current SEF regulatory framework should be enhanced to further
promote the statutory SEF goals and better maximize the role of SEFs as
vibrant and liquid marketplaces for swaps trading.
Accordingly, the Commission is proposing two revisions to the
current framework. First, the Commission proposes to adopt a revised
interpretation of CEA section 2(h)(8) to set the applicability of the
trade execution requirement, i.e., swaps subject to the clearing
requirement and listed for trading by a SEF or DCM would be subject to
the requirement. Instead of maintaining the current MAT determination
process, the Commission believes that this proposed approach would be
better aligned with the intent of CEA section 2(h)(8) and further the
statutory goal of promoting swaps trading on SEFs. As applied to the
current scope of swaps that are subject to the clearing requirement and
listed for trading by SEFs and DCMs, the Commission anticipates that
this approach would significantly expand the scope of swaps that are
subject to the trade execution requirement. Second, based on its
understanding of swaps trading dynamics and the increased scope of
swaps that would become subject to the trade execution requirement, the
Commission also proposes to allow greater flexibility in the trading of
such swaps by eliminating the prescribed execution methods for swaps
subject to the requirement.
1. Trade Execution Requirement and MAT Process
The trade execution requirement mandates counterparties to execute
swap transactions subject to the clearing requirement on a SEF or DCM,
unless no SEF or DCM ``makes the swap available to trade.'' \234\ The
Commission adopted Sec. 37.10 and Sec. 38.12 to establish a ``MAT
determination'' process that allows SEFs and DCMs, respectively, to
make swaps ``available to trade,'' and therefore, subject to the trade
execution requirement.\235\ These processes enable a SEF or DCM to make
a swap ``available to trade'' by submitting a determination to the
Commission pursuant to the part 40 rule filing procedures.\236\ A SEF
or DCM that submits a MAT determination must include an assessment of
whether the subject swap has ``sufficient trading liquidity'' and must
address at least one of six factors that serve as indicia of the swap's
trading liquidity.\237\ Swaps that become subject to the trade
execution requirement pursuant to the approval or certification of a
MAT determination must, with the limited exception of block
transactions, be executed by counterparties on a SEF or DCM.\238\
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\234\ 7 U.S.C. 2(h)(8). CEA section 2(h)(8) also specifies that
swaps that are subject to a clearing exception under section 2(h)(7)
are not subject to the trade execution requirement. See infra
Section XXI.A.3.--Sec. 36.1(c)--Exemption for Swap Transactions
Excepted or Exempted from the Clearing Requirement under Part 50.
The Commission interprets ``swap execution facility'' in CEA section
2(h)(8)(B) to include a swap execution facility that is exempt from
registration pursuant to CEA section 5h(g). See supra note 10.
\235\ 17 CFR 37.10; 17 CFR 38.12.
\236\ The Commission notes that a SEF or DCM may submit a MAT
determination pursuant to the rule approval process under Sec. 40.5
or through the rule certification process under Sec. 40.6. 17 CFR
37.10(a)(1) and 38.12(a)(1).
\237\ 17 CFR 37.10(b), 38.12(b). Parts 37 and 38 respectively
specify the same six factors: (i) Whether there are ready and
willing buyers and sellers for the swap; (ii) the frequency or size
of transactions in the swap; (iii) the swap's trading volume; (iv)
the number and types of market participants trading the swap; (v)
the swap's bid/ask spread; and (vi) the usual number of resting firm
or indicative bids and offers in the swap. 17 CFR 37.10(b),
38.12(b). The Commission explained in the preamble to the MAT Final
Rule that with respect to factors (ii)-(iii), the submitting DCM or
SEF could look to DCM, SEF, or bilateral transactions. MAT Final
Rule at 3360.
\238\ Based on part 40, a MAT determination filing applies the
trade execution requirement to a particular swap either upon
Commission approval (in the case of a filing submitted for approval
under Sec. 40.5) or upon the lack of Commission objection (in the
case of a filing submitted on a self-certified basis under Sec.
40.6).
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2. Execution Method Requirements
Section 37.9 defines swaps that are subject to the trade execution
requirement, i.e., those swaps that must be executed on a SEF or DCM,
as ``Required Transactions'' \239\ and specifies that a SEF may only
offer two methods for executing such swaps. Specifically, Required
Transactions must be executed on (i) an Order Book, as defined under
Sec. 37.3(a)(3) and discussed above; \240\ or (ii) an RFQ System, as
defined under Sec. 37.9(a)(3).\241\ An RFQ System is defined, among
other requirements, as a trading system or platform where a market
participant transmits a request for a bid or offer to no less than
three market participants who are not affiliates of, or controlled by,
the requester or each other (``RFQ-to-3 requirement'').\242\ To the
extent that a SEF offers an RFQ System for Required Transactions, that
system must operate in conjunction with an Order Book, which a SEF is
currently required to establish and maintain as a minimum trading
functionality.\243\ Pursuant to the statutory SEF definition, SEFs have
been able to offer these methods through ``any means of interstate
commerce,'' \244\ which the Commission has interpreted to mean ``a
variety of means of execution or communication, including, but not
limited to, telephones, internet communications, and electronic
transmissions.'' \245\ Accordingly, SEFs have been able to develop and
offer an Order Book or RFQ System through various forms, including
voice-based systems.
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\239\ 17 CFR 37.9(a)(1).
\240\ See supra notes 123-125 and accompanying discussion
(definition of ``Order Book'' under Sec. 37.3(a)(3)).
\241\ 17 CFR 37.9(a)(2).
\242\ 17 CFR 37.9(a)(3). The RFQ System definition additionally
specifies that the three requesters may not be affiliates or
controlled by one another; and the system must provide each of its
market participants with equal priority in receiving RFQs and
transmitting and displaying for execution responsive orders. 17 CFR
37.9(a)(3); 17 CFR 37.9(a)(3)(iii).
\243\ 17 CFR 37.9(a)(2)(i)(B). In operating an RFQ System in
conjunction with an Order Book, a SEF must communicate to a
requester any firm bid or offer pertaining to the same instrument
resting on any of the SEF's Order Books; and provide the requester
with the ability to execute against such firm resting bids or offers
along with any responsive RFQ orders. 17 CFR 37.9(a)(3)(i)-(ii). As
discussed above, the Commission is proposing to eliminate the
minimum trading functionality under Sec. 37.3(a)(2) and the Order
Book definition under Sec. 37.3(a)(3). See supra Section IV.C.2.--
Sec. Sec. 37.3(a)(2)-(3)--Minimum Trading Functionality and Order
Book Definition.
\244\ 7 U.S.C. 1a(50).
\245\ SEF Core Principles Final Rule at 33501 n.328.
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In establishing the Order Book and RFQ System requirements, the
Commission sought in part to transition swaps trading onto SEFs and
achieve the statutory SEF goal of promoting pre-trade price
transparency in the swaps market. In addition to establishing the Order
Book as a minimum trading functionality for all swaps listed for
trading by a SEF, the Commission intended for the Order Book
requirement to promote such transparency for swaps subject to the trade
execution requirement. The Commission did acknowledge, however, that an
Order Book lacks the appropriate
[[Page 61976]]
flexibility to be suitable for trading many types of swaps, in
particular those lacking liquidity.\246\ The lack of liquidity is a
characteristic of broad segments of the swaps market, which trade
episodically among a limited number of market participants in large
average notional amounts.
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\246\ SEF Core Principles Final Rule at 33564-65. In the
preamble to the SEF Core Principles Final Rule, the Commission
expressed its anticipation that ``the order book method will
typically work well for liquid Required Transactions (i.e.,
transactions involving swaps that are subject to the trade execution
requirement in CEA section 2(h)(8)), but for less liquid Required
Transactions, RFQ systems are expected to help facilitate trading.''
Id.
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To address this lack of suitability even within the scope of
Required Transactions, the Commission prescribed the RFQ System as an
alternative execution method for these transactions.\247\ At the time,
the Commission observed that RFQ systems provide market participants
with a certain level of trading flexibility, in particular by allowing
them to balance the risks of information leakage and front-running
associated with disclosing trading interests against the price
competition benefits derived by disseminating a request to a larger
number of participants.\248\ The Commission recognizes that most SEFs
currently offer an RFQ System for most of the respective products that
they list for trading; when trading swaps subject to the trade
execution requirement, market participants have mostly utilized an RFQ
System, transmitting RFQs to more than three unaffiliated market
participants in many instances.\249\
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\247\ 17 CFR 37.9(a)(2). The Commission adopted the RFQ System
requirement based upon its prevalence in the OTC swaps market. Id.
at 33564. The Commission stated that ``RFQ systems are currently
used by market participants in the OTC swap market, many in
conjunction with order book functionality.'' In adopting the
requirement, the Commission also stated it was ``leveraging best
practices from current swaps trading platforms.'' Id. at 33565.
\248\ SEF Core Principles Final Rule at 33476.
\249\ In discussing trading of CDX and iTraxx indices, Lynn
Riggs, Esen Onur, David Reiffen, and Haoxiang Zhu found that
``[c]ustomers most frequently request quotes from three dealers,
which happens in about 45% of the RFQ sessions, followed by five
dealers, which happens in just below 30% of the RFQ sessions. In
about 18% of the sessions the customer selects four dealers.'' Lynn
Riggs, Esen Onur, David Reiffen, & Haoxiang Zhu, Mechanism Selection
and Trade Formation on Swap Execution Facilities: Evidence from
Index CDS 10 (2017), https://www.cftc.gov/idc/groups/public/@economicanalysis/documents/file/oce_mechanism_selection.pdf (``2017
Riggs Study'').
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3. Implementation of Existing Requirements
While the Commission acknowledges that the existing approach has
transitioned some swaps trading to SEFs, this transition has stagnated
and will not likely increase further without changes to the existing
regulatory framework. This stagnation, as discussed further below, is
reflected by the limited set of swaps that have become subject to the
trade execution requirement, and therefore subject to mandatory trading
on SEFs, through the Commission's MAT process. The lack of additional
swaps becoming subject to the requirement over the last several years
has been attributable to market participants' concerns over the
Commission's Order Book and RFQ System requirements for Required
Transactions under Sec. 37.9; this concern, in turn, has dissuaded
SEFs from submitting additional MAT determinations.
Since the Commission's adoption of the MAT determination process, a
small number of swaps that are subject to the clearing requirement have
become subject to the trade execution requirement. In the fall of 2013,
four SEFs and one DCM submitted a limited number of swaps to the
Commission as ``available to trade'' via the Commission's Sec. 40.6
self-certification process.\250\ The swaps submitted consist of the
current ``on-the-run'' and most recent ``off-the-run'' index CDS with a
five-year tenor and fixed-to-floating IRS with benchmark tenors
denominated in U.S. dollars, euros, and pound sterling.\251\ The IRS
and CDS that are currently subject to the trade execution requirement
represent the most standardized and highly liquid swaps contracts
offered by SEFs,\252\ but also represent a very limited segment of the
potential universe of swaps eligible to become subject to the trade
execution requirement, i.e., those swaps that are both subject to the
clearing requirement and currently listed for trading on a SEF.\253\
Based on data evaluated by the International Swaps and Derivatives
Association (``ISDA''), approximately 85 percent of total reported IRS
traded notional volume (``traded notional'') in 2017 consisted of swaps
subject to the clearing requirement.\254\ This represents an increase
from the approximately 73 to 77 percent of total reported IRS traded
notional during 2015 to 2016 that was subject to the clearing
requirement.\255\ Data analysis conducted by Commission staff found
that the percentage of trading volume in IRS subject to the trade
execution requirement is far lower than the percentage subject to the
clearing requirement and has actually declined, from approximately 10
to 12 percent of total reported IRS traded notional in 2015 to
approximately 7 to 9 percent of the total reported IRS traded notional
in 2017 and the first half of 2018.\256\
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\250\ TW SEF LLC--Amendment to Self-Certification for Swaps to
be Made Available to Trade (Jan. 26, 2014) (third amended filing
from initial submission on October 28, 2013); Javelin SEF, LLC, No.
13-06R(3), Javelin Determination of Made Available to Trade of
Certain Interest Rate Swaps made Pursuant to Parts 37 of the Rules
of the Commodity Futures Trading Commission (Jan. 8, 2014) (third
amended filing from initial submission on October 18, 2013)
(``Javelin SEF MAT Determination''); Bloomberg SEF LLC, No. 2013-R-
9, Bloomberg SEF LLC--Made Available to Trade (``MAT'') Submission
of Certain Credit Default Swaps (``CDS'') and Interest Rate Swaps
(``IRS'') pursuant to Commodity Futures Trading Commission (the
``Commission'') Regulation 40.6 (submission #2013-R-9) (Dec. 5,
2013) (``Bloomberg SEF MAT Determination''); MarketAxess SEF
Corporation, Made Available to Trade (``MAT'') Submission of Certain
Credit Default Swaps (Oct. 30, 2013) (``MarketAxess SEF MAT
Determination''); trueEX, LLC, Submission 2013-14, Made Available to
Trade (``MAT'') Submission of Certain Interest Rate Swaps (``IRS'')
pursuant to CFTC Regulation 40.6 (Oct. 21, 2013) (``trueEX MAT
Determination'').
\251\ CFTC, Industry Filings--Swaps Made Available to Trade,
https://www.cftc.gov/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf.
\252\ See, e.g., TW SEF LLC--Self-Certification for Swaps to be
Made Available to Trade at 8 (Oct. 28, 2013) (describing the IRS
submitted as benchmark swaps with the most liquidity and the CDS
submitted as the most actively traded); Javelin SEF MAT
Determination at 11 (noting that the bid-offer spreads for the IRS
submitted is tight and characteristic of considerable liquidity);
Bloomberg SEF MAT Determination at 3 (stating that the scope of the
MAT determination represents IRS and CDS that are the most
standardized and liquid); MarketAxess SEF MAT Determination at 1
(stating that the MAT determination consists of the most liquid CDS
listed); trueEX MAT Determination at 4 (specifying that the trade
frequency of IRS with whole-year tenors is sufficient to support a
MAT determination).
\253\ The clearing requirement currently applies to various
categories of IRS, including fixed-to-floating swaps denominated in
U.S. dollars, pound sterling, and euros with whole- and partial-year
tenors that range from 28 days to 50 years; fixed-to-floating swaps
in additional currency denominations with whole and partial tenors
that range from 28 days up to 30 years; basis swaps, overnight index
swaps, and forward rate agreements in varying denominations and
tenors; and various CDX and iTraxx index CDS in the current on-the-
run series and a broad range of older series (prior to the most
recent off-the-run series) with whole-year benchmark tenors. 17 CFR
50.4.
\254\ ISDA, ISDA Research Note: Actual Cleared Volumes vs.
Mandated Cleared Volumes: Analyzing the US Derivatives Market 3
(July 2018), https://www.isda.org/a/6yYEE/Actual-Cleared-Volumes-vs-Mandated-Cleared-Volumes.pdf (``2018 ISDA Research Note'').
\255\ Id.
\256\ Commission staff conducted data analysis based on publicly
available data accessed via Clarus Financial Technology
(``Clarus''). In a separate analysis, ISDA found that only 5 percent
of trading volume in IRS during 2015 and the first three quarters of
2016 consisted of IRS subject to the trade execution requirement.
ISDA, ISDA Research Note: Trends in IRD Clearing and SEF Trading 1,
3, 11 (December 2016), https://www.isda.org/a/xVDDE/trends-in-ird-clearing-and-sef-trading1.pdf (``2016 ISDA Research Note'').
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Beyond this limited initial set of self-certified MAT
determinations, however,
[[Page 61977]]
the Commission has not received any additional MAT determinations for
the significantly large number of IRS and CDS that are subject to the
clearing requirement. This discrepancy has grown even larger as a
result of a subsequent expansion of the clearing requirement.\257\ The
Commission believes that the lack of further MAT determinations from
SEFs or DCMs is largely attributed to the influence of market
participants who believe that applying the trade execution requirement,
and therefore the required use of an Order Book or RFQ System, would
adversely impact their ability to utilize execution methods that are
best suited for the swap they are trading and their individual trading
needs.\258\
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\257\ The Commission expanded the list of swaps subject to the
clearing requirement in 2016 by adding several new classes of IRS
denominated in nine different currencies. See supra note 35. The
Commission believes that the expansion likely contributed to the
increase noted above in the percentage of total reported IRS traded
notional subject to the clearing requirement in 2017 relative to
prior years.
\258\ SIFMA AMG noted that these limited methods of execution
meant that a MAT determination ``could force the entire swap market
to change its practice, disrupting trading and upending the natural
evolution of market dynamics.'' See Letter from the Asset Management
Group of the Securities Industry and Financial Markets Association
(``SIFMA AMG''), In re Concerns Regarding the SEF Framework 3 (May
11, 2015) (``2015 SIFMA AMG Letter''). Further, SIFMA AMG argued
that the ``artificial limitation'' on execution methods for required
transactions ``has resulted in reduced liquidity and fewer options
for asset managers working to reduce portfolio risk in a cost-
effective manner. . . .'' Id. At a Commission roundtable discussion
on the MAT process, one participant noted that market participant
aversion to a broad MAT determination by Javelin SEF discouraged
other SEFs from submitting determinations, based on the fear that
market participants would cease trading or avoid their respective
platforms altogether. 2015 MAT Roundtable at 65-67. See also Joe
Rennison, Experts split on MAT determinations, Risk.net (Nov. 8,
2013), https://www.risk.net/infrastructure/trading-platforms/2305790/experts-split-mat-determinations (noting market participant
resistance to Javelin SEF's initial MAT submission).
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To establish which swaps would be sufficiently liquid to be traded
via an Order Book or RFQ System, the Commission relied upon the
expertise and experience of SEFs and DCMs in the MAT determination
process.\259\ The limited number of MAT determinations that has
resulted reflects these execution methods' lack of suitability in
facilitating a broad range of swaps trading. Market participants have
stated that the prescriptive requirements under Sec. 37.9 limit their
ability to otherwise utilize other execution methods that they believe
may be better suited to address their business needs, adapt to quickly-
changing market conditions, or achieve some combination thereof.\260\
Given that many of the swaps that are subject to the clearing
requirement are highly customizable and less liquid, continuing to
mandate the use of an Order Book and RFQ System is inconsistent with
transitioning a broader segment of the swaps market to the SEF
regulatory framework. Therefore, the Commission recognizes the need for
greater flexibility in execution methods to broaden the scope of the
trade execution requirement over additional swaps trading.\261\
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\259\ MAT Final Rule at 33609.
\260\ See 2015 SIFMA AMG Letter at 8 (In re the current approach
to required methods of execution: ``this prescriptive approach has
negatively impacted market conditions and has caused fragmentation
of the U.S. swap market. The unnecessary restriction on modes of
execution . . . limits a SEF's ability to foster liquidity and
diminishes the venues that asset managers may access for liquid,
competitive pricing.'').
\261\ The Commission notes that the current SEF regulatory
framework allows a SEF to offer flexible methods of execution for
swaps that are not subject to the trade execution requirement, i.e.,
Permitted Transactions; this approach would facilitate trading in
bespoke or less liquid swaps on a SEF. 17 CFR 37.9(c). As noted
above, only 7 to 9 percent of total reported IRS traded notional has
consisted of swaps subject to the trade execution requirement in
recent months; however, approximately 57 percent of total reported
IRS traded notional has occurred on SEFs in 2018. ISDA, ISDA
SwapsInfo Weekly Analysis: Week Ending October 19, 2018, https://analysis.swapsinfo.org/2018/10/interest-rate-and-credit-derivatives-weekly-trading-volume-week-ending-october-19-2018/ (``2018 ISDA
SwapsInfo Weekly Analysis''). Accordingly, the Commission believes
that adopting a more flexible approach to execution methods in the
SEF regulatory framework would better reflect the current swaps
market environment.
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The Commission acknowledges that the Order Book and RFQ System
requirements are too prescriptive and limiting to be applied over a
broader segment of the swaps market. Specifically, these methods do not
account for the swaps products that are highly customized and
episodically liquid by nature. The Commission previously acknowledged
that market participants take into account factors such as swap product
complexity, trade size, and liquidity in deciding how to trade swaps,
including the number of market participants to whom a request for quote
will be sent.\262\ Thus, even the RFQ-to-3 requirement, which the
Commission adopted to provide more execution flexibility, may hinder
market participants from determining the appropriate number of market
participants to disseminate an RFQ for the additional swaps that would
be subject to the trade execution requirement. Mandating the use of
limited methods of execution for swaps subject to the requirement
imposes the Commission's judgment regarding how best to execute
different swaps and ultimately inhibits market participants from
tailoring their own trading strategies and decisions based on the swaps
involved, their individual business needs, the desired transaction
size, and existing market conditions, among other factors.
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\262\ SEF Core Principles Final Rule at 33562.
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The required methods of execution has also limited SEFs from
developing more efficient, transparent, and cost-effective methods of
trading, as well as impeded their ability to compete with one another
using innovative and different methods of execution.\263\ For example,
a SEF may develop a new trading functionality that does not qualify as
an Order Book or RFQ System, but is effective and efficient in trading
both IRS that are and are not subject to the trade execution
requirement. Under the current regulatory framework, participants could
not use that new method for IRS that are subject to the trade execution
requirement or IRS that would become subject to the requirement in the
future. This scenario deprives market participants of a useful
execution method and deprives the SEF that developed the method of
benefitting from its innovative efforts.
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\263\ At the Commission's 2015 MAT Roundtable, one participant
expressed concern that a MAT determination would ``cut[ ]off
potential modes of execution,'' rather than promoting new innovative
execution methods. See 2015 MAT Roundtable at 165.
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The Commission notes that this scenario could occur with respect to
forward rate agreements (``FRAs''), many of which are economically
similar to IRS that are currently subject to the trade execution
requirement. In spite of this economic similarity, FRAs in several
different types of currency denominations and tenor ranges that are
currently subject to the clearing requirement, but have not been
submitted to the Commission as ``available to trade.'' \264\ Based on
an ISDA analysis, over 97 percent of total reported FRA traded notional
during the third quarter of 2016 was cleared and approximately 81
percent of which was traded on SEF and accounted for slightly less than
54 percent of total reported IRS traded notional occurring on
SEFs.\265\ The Commission has
[[Page 61978]]
observed that FRA trading on SEFs occurs through ``permitted''
execution methods, such as risk mitigation services,\266\ that assist
market participants with managing their exposures to market, credit,
and other sources of risk.\267\ Despite their utility, risk mitigation
services do not constitute an Order Book or RFQ System, and therefore,
are not available as an execution method for swaps subject to the trade
execution requirement under the current regulatory framework. Given
that many FRAs would become subject to the trade execution requirement
under the Commission's proposed regulatory framework, as discussed
further below, allowing SEF participants to continue executing these
types of swaps would require more flexible execution methods that are
appropriate for conducting risk mitigation exercises.
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\264\ 17 CFR 50.4 (specifying the FRAs that are subject to
mandatory clearing).
\265\ 2016 ISDA Research Note at 5. The Commission notes that
these statistics include both swaps subject to the clearing
requirement and swaps that are voluntarily cleared. In a subsequent
analysis, however, ISDA determined that 92 to 98 percent of total
reported FRA traded notional from 2014 to 2017 consisted of FRAs
subject to the clearing requirement. 2018 ISDA Research Note at 9.
Commission staff replicated ISDA's results and also found that in
2018, the share of total reported FRA traded notional that is
cleared has increased to 99 percent, with approximately 81 percent
of cleared FRAs continuing to trade on SEF. Commission staff also
found that during the first half of 2018, cleared FRAs accounted for
approximately 48 percent of IRS volume on SEFs, a somewhat smaller
share than the amount that ISDA found during its own review period.
\266\ The Commission notes that market participants have
contended that the required methods of execution are unsuitable for
allowing SEFs to conduct risk mitigation services for swaps that are
subject to the trade execution requirement. See CFTC Letter No. 13-
81, Time-Limited No-Action Relief from Required Transaction
Execution Methods for Transactions that Result from Basis Risk
Mitigation Services (Dec. 23, 2013). See also 2016 WMBAA Letter at
app. A (stating that ``[a]dditional methods of execution for
Required Transactions should include risk mitigation [platforms]'').
\267\ The Commission previously determined that risk mitigation
services that facilitate swap execution are subject to the SEF
registration requirement. SEF Core Principles Final Rule at 33482-
83.
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Further, the Commission believes that the current approach to
required methods of execution may have imposed barriers to entry for
entities that seek to offer swaps trading. As noted above, limiting the
execution methods that a SEF can provide limits their ability to offer
new and innovative trading solutions. As a result, new entrant SEFs
have been unable to differentiate themselves from incumbent SEFs on the
basis of innovation and development, given that both incumbent
platforms and newly-registered entities are otherwise limited to
offering an Order Book and an RFQ System. Accordingly, SEFs have been
forced to compete with one another on a more ancillary basis, rather
than on fundamental operating aspects that provide value to market
participants, in particular the available trading system and platform.
The Commission's current approach to required methods of execution
has also compelled SEFs to make unintended adjustments and alterations
to their execution methods, including auction platforms \268\ and work-
up trading protocols.\269\ Given the prescriptive requirements that a
SEF execution method must comply with to qualify as an Order Book under
Sec. 37.3(a)(3) or as an RFQ System under Sec. 37.9(a)(3), some SEFs
have expended time and effort to amend certain aspects of their trading
systems or platforms, including trading protocols, prior to allowing
participants to use those methods to execute swaps subject to the trade
execution requirement. The Commission acknowledges that SEFs have not
been able to employ and operate execution methods that are fully
developed to facilitate price discovery and more robust participation
on the SEF in periods of episodic liquidity. Rather, requiring SEFs to
adjust various aspects of their respective systems or platforms to
comply with the required methods of execution has likely introduced
operating inefficiencies that have not provided corresponding benefits
to SEF participants. Therefore, the Commission believes that the
prescriptive execution methods have inhibited the effectiveness of
execution methods designed and developed by SEFs to promote trading.
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\268\ For a description of auction-based platforms, see infra
note 313 and accompanying discussion.
\269\ In a trade work-up session associated with a SEF's trading
system or platform, two participants that execute a particular swap
transaction at a particular price have the opportunity to execute
additional volume of that swap at that price within a given time
period established by the SEF. When that period has lapsed, multiple
other buyers and sellers may then seek to execute that particular
swap at the established price set by the initial transaction.
Interested participants may continue to seek to execute that swap at
the established price until the buying and selling interest is
exhausted or the work-up session has expired, as set forth by the
SEF. The Commission has observed that SEFs offer these sessions
within a particular execution method, e.g., an electronic order
book, to encourage participants to provide liquidity to the market.
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4. Proposed Approach
To further promote the SEF statutory goals, the Commission proposes
a SEF regulatory framework that would facilitate a more robust
application of the trade execution requirement and allow more
flexibility in the execution methods that may be offered and used for
trading swaps that are subject to the requirement. The Commission
believes that this approach would better establish SEFs as vibrant and
liquid marketplaces for swaps trading that foster price discovery and
liquidity formation. The Commission believes that its proposed approach
is consistent with the statutory SEF provisions and would also further
the statutory SEF goals, while helping to alleviate the challenges of
the existing approach described above.
The Commission proposes to adopt a new interpretation of the trade
execution requirement that would greatly expand the scope of swaps that
are subject to the requirement. Considering the market characteristics
and episodic liquidity profiles of these additional swaps, the
Commission's proposed approach would provide needed flexibility to SEFs
and market participants to support more trading through SEF trading
systems or platforms. In conjunction with an expansion of the trade
execution requirement, the Commission also proposes to eliminate the
prescriptive execution methods for swaps subject to the requirement.
Rather than impose execution method requirements that are limited to an
Order Book or RFQ System, the Commission's proposed approach would
allow SEFs to develop and offer--and therefore enable--market
participants to choose execution methods that are appropriate to their
trading. Providing market participants with greater choice in execution
methods allows them to utilize trading systems or platforms that are
not constrained by prescriptive regulatory requirements and suit their
trading circumstances and the market conditions for those swaps at a
given time. This flexibility is necessary to facilitate trading in the
broad scope of swaps that would become subject to the trade execution
requirement. This flexibility should also allow the swaps market and
SEFs to continue to naturally evolve and innovate to more efficient,
transparent, and cost effective means of trading, even for swaps
currently subject to the trade execution requirement. The Commission
believes that this flexibility, in concert with the concentration of
trading activity in episodically liquid swaps on SEFs, should help
foster price discovery and allow market participants to pursue more
appropriate, counterparty and swap-specific levels of pre-trade price
transparency through additional methods of execution.\270\ Accordingly,
[[Page 61979]]
the Commission believes that more execution flexibility also reduces
certain complexity, costs, and burdens that have impeded SEF
development and innovation, particularly with more swaps that would be
subject to mandatory trading on SEFs. Ultimately, this approach is
intended to attract greater liquidity that would promote more trading
on SEFs.
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\270\ As discussed above, the Commission acknowledges that
market participants take into account factors such as swap product
complexity, trade size, liquidity, and the associated desire to
minimize potential information leakage and front-running risks in
deciding how to trade swaps, including the number of market
participants to whom a request for quote will be sent. In selecting
that number of market participants to whom a request for quote will
be sent, the market participant is determining the appropriate level
of pre-trade transparency necessary to efficiently and effectively
execute that swap transaction based on the above factors and its
individual trading needs. See supra Section I.B.1.b.--Swaps Market
Characteristics.
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a. Sec. 36.1(a)--Trade Execution Requirement
The Commission has interpreted the trade execution requirement in
CEA Section 2(h)(8)--in particular, the phrase ``makes the swap
available to trade''--in a manner that has limited the scope of swaps
that must be traded on a SEF.\271\ Initially designed to ensure that
the Order Book and RFQ System requirements could support swaps that are
sufficiently liquid for trading, the MAT determination process has
resulted in a small number of swaps that are currently subject to the
trade execution requirement. As noted above, Commission staff has
determined that only a small and declining percentage of total reported
IRS traded notional over a recent time period is subject to the trade
execution requirement, with only part of overall IRS trading volume
occurring on SEFs.\272\
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\271\ MAT Final Rule at 33606.
\272\ See supra notes 256 and 261 and accompanying discussion.
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Given the current regulatory framework's limited ability in
promoting swaps trading on SEFs, which limits the statutory SEF goals,
the Commission is proposing to adopt a revised interpretation of CEA
section 2(h)(8). The Commission believes that the phrase ``makes the
swap available to trade'' should be interpreted to mean that once the
clearing requirement applies to a swap, then the trade execution
requirement applies to that swap upon any single SEF or DCM listing the
swap for trading.\273\ As previously noted by some commenters to the
proposed MAT rule, CEA section 2(h)(8) does not mandate the MAT process
adopted by the Commission to implement the trade execution
requirement.\274\ The Commission believes that the most straightforward
reading of CEA section 2(h)(8) would specify that once the clearing
requirement applies to a swap, then the trade execution requirement
also applies to that swap unless no SEF or DCM ``makes the swap
available to trade.'' Accordingly, once any single DCM or SEF ``makes
available,'' i.e., lists, a swap that is subject to the clearing
requirement for trading on its facility, then the trade execution
requirement would apply to that swap, such that market participants may
only execute the swap on a SEF, a DCM, or an Exempt SEF.
---------------------------------------------------------------------------
\273\ In addition to DCMs and SEFs, CEA section 2(h)(8)
contemplates the ability of Exempt SEFs to list swaps subject to the
clearing requirement. As discussed below, the Commission proposes to
use its exemptive authority pursuant to CEA section 4(c) to exclude
swaps that are exclusively listed by Exempt SEFs from being subject
to the trade execution requirement. Accordingly, only a CFTC-
registered DCM or SEF would be able to trigger the CEA section
2(h)(8) trade execution requirement by listing a clearing
requirement swap. See infra Section XXI.A.2.--Sec. 36.1(b)--
Exemption For Certain Swaps Listed Only By Exempt SEFs.
\274\ MAT Final Rule at 33607. These commenters believed that
use of the clearing determination process in CEA section 2(h)(2)
``as the exclusive basis for finding that a swap is available to
trade would subject more swaps to the trade execution requirement
and further the objectives of the Dodd-Frank Act.'' SEF Core
Principles Final Rule at 33607-08. Some commenters pointed out that
the procedure for determining whether a swap was made available to
trade was ``duplicative of the mandatory clearing determination
process [in CEA section 2(h)(2)] and accordingly stated that the
Commission should rely on the clearing determination process to also
determine whether a swap is available to trade.'' MAT Final Rule at
33607.
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The Commission notes that Congress had the ability to delineate a
comprehensive statutory process for determining when a swap should be
subject to the trade execution requirement, but did not do so when
amending the CEA via the Dodd-Frank Act.\275\ In contrast, the clearing
requirement, established by Congress concurrently with the trade
execution requirement under the Dodd-Frank Act, sets forth a formal
statutory process for the Commission to follow in determining which
swaps must be submitted to a DCO for clearing.\276\ The Commission
notes that the statutory process in CEA section 2(h)(2) establishes
that submissions from a DCO for each swap, or any group, category,
type, or class of swap that it plans to accept for clearing is
automatically subject to a clearing determination by the
Commission.\277\ As part of a clearing requirement determination, the
CEA requires the Commission to evaluate submitted swaps based on a
prescribed set of factors that includes trading liquidity.\278\ Given
the absence of analogous CEA provisions governing the trade execution
requirement and based on its experience since implementing the swaps
trading framework, the Commission believes that the proposed
interpretation of CEA section 2(h)(8) is consistent both with that
statutory provision and with the statutory goal of promoting the
trading of swaps on SEFs.
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\275\ The Commission also observes that Congress specifically
placed the trade execution requirement within the CEA section 2(h)
heading of ``clearing requirement.'' The Commission believes that
this placement of the trade execution requirement within the
clearing requirement further supports the view that no additional
framework was intended by Congress beyond the processes already
enumerated within this section. 7 U.S.C. 2(h).
\276\ Specifically, CEA section 2(h)(2) delineates a structured
process that outlines a specific set of factors that the Commission
must consider in its clearing requirement determination and includes
a provision for public comment. Among other things, the Commission
must consider outstanding notional exposures; trading liquidity;
adequate pricing data; adequate clearing infrastructure; mitigation
of systematic risk; effects on competition; and legal certainty
surrounding solvency concerns. 7 U.S.C. 2(h)(2).
\277\ CEA section 2(h)(2)(B)(iii)(II).
\278\ As adopted under part 50 of the Commission's regulations,
the Commission has noted that this required analysis of a swap's
trading liquidity is intended for risk management purposes, i.e.,
pricing and margining of cleared swaps. In this connection, the
Commission has noted that higher trading liquidity in swaps would
assist DCOs in end-of-day settlement procedures, as well as in
managing the risk of CDS portfolios, particularly in mitigating the
liquidity risk associated with unwinding a portfolio of a defaulting
clearing member. 77 FR 47176.
---------------------------------------------------------------------------
As support for its view that the proposed interpretation of CEA
section 2(h)(8) would promote the trading of swaps on SEFs, the
Commission notes that more than 85 percent of IRS and index CDS trading
volume is currently subject to the clearing requirement; \279\ many,
but not all, of those swaps are currently listed for trading by SEFs.
Therefore, the proposed reading would both promote the statutory SEF
goal of swaps trading on SEFs and help to further swaps liquidity on
SEFs by requiring all counterparties to trade these swaps on a SEF,
which may promote increased pre-trade price transparency.\280\ A more
robust trade
[[Page 61980]]
execution requirement would help migrate and concentrate additional
trading interests to available trading systems or platforms on
SEFs.\281\ The Commission believes that all of these factors can
increase activity on SEFs, as well as help improve their efficiency and
effectiveness.
---------------------------------------------------------------------------
\279\ 2018 ISDA Research Note at 3, 15-16.
\280\ The Commission believes that further achieving both SEF
statutory goals--promoting trading on SEFs and promoting pre-trade
price transparency--requires both (i) increasing the number of swaps
that are subject to the trade execution requirement, thereby
increasing the amount of trading that must occur on SEF; and (ii)
concurrently providing flexible execution methods. The Commission
believes that requiring market participants to conduct a larger
portion of their swaps trading on SEFs would centralize liquidity,
foster additional competition among a more concentrated number of
market participants, and reduce information asymmetries that would
increase market efficiency and decrease transaction costs. While
offering flexible methods of execution alone could transition
additional swaps trading to SEFs, the Commission believes that
maximizing the potential benefits of the proposed approach
necessitates an approach that would also lessen fragmentation in
trading of swaps on SEFs versus the OTC environment.
Accordingly, the Commission's proposed approach would have a
profound impact on the amount of swaps trading that occurs on SEFs.
As noted above, Commission staff found that a small and declining
percentage of the reported IRS volume in recent months has consisted
of swaps subject to the trade execution requirement (currently less
than 10 percent). ISDA determined, however, that more than 55
percent of total reported IRS traded notional has been occurring on
SEFs since 2015. See supra note 261 (noting that SEFs have
facilitated trading of Permitted Transactions). Based on these
determinations, the Commission's proposed interpretation of the
trade execution requirement may result in a significantly larger
amount of additional IRS trading volume on SEFs, given that the
Commission believes that many, but not all, of that 85 percent of
IRS that is subject to clearing requirement is currently listed on
SEFs. Moreover, it is plausible that adopting this proposed
interpretation would induce SEFs to list additional swaps subject to
the clearing requirement, which would expand the amount of swaps
trading that is subject to the trade execution requirement.
\281\ As noted above, the Commission expects that the proposal
would greatly expand the scope of the trade execution requirement.
In particular, the Commission expects that the following swaps would
become subject to the trade execution requirement based on the fact
they are currently subject to the clearing requirement and also
listed by at least one SEF or DCM: (i) Various swaps in the interest
rate asset class including fixed-to floating swaps denominated in
U.S. dollars, pound sterling, and euros with non-benchmark tenors
(whole and partial) that range from 28 days to 50 years; fixed-to-
floating swaps in additional denominations with whole and partial
tenors ranging from 28 days up to 30 years; basis swaps, overnight
index swaps (``OIS''), and FRAs with different denominations and
tenors; and (ii) various CDX and iTraxx index CDSs in older series
(prior to the most recent off-the-run series) and additional tenors,
as well as new CDS indices.
---------------------------------------------------------------------------
Given the Commission's proposed approach to the trade execution
requirement, as described above, the Commission proposes to eliminate
(i) the MAT process for SEFs under Sec. 37.10; (ii) the associated
trade execution compliance schedule under Sec. 37.12; (iii) the MAT
process for DCMs under Sec. 38.12; and (iv) the associated trade
execution compliance schedule under Sec. 38.11.
The Commission further proposes to codify under Sec. 36.1(a) the
statutory language of the trade execution requirement in CEA section
2(h)(8), which requires counterparties to execute a swap that is
subject to the clearing requirement on a DCM, a SEF, or an exempt SEF
unless no such entity ``makes the swap available to trade'' or the swap
is subject to a clearing exception in CEA section 2(h)(7).\282\ As
proposed, Sec. 36.1(a) would specify that counterparties must execute
a transaction subject to the clearing requirement on a DCM, a SEF, or
an Exempt SEF that lists the swap for trading. As discussed above, the
Commission believes that the statutory phrase ``makes the swap
available to trade'' specifies the listing of a swap by a DCM, a SEF,
or an exempt SEF on its facility for trading. Accordingly, the trade
execution requirement would apply to a swap that is subject to the
clearing requirement upon the listing of that swap by any DCM or
SEF.\283\
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\282\ 7 U.S.C. 2(h)(8)(B). The Commission interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g). See supra note 10.
\283\ As discussed below, the Commission is proposing an
exemption from the requirement for swap transactions involving swaps
that are listed for trading only by an Exempt SEF. See infra Section
XXI.A.2.--Sec. 36.1(b)--Exemption For Certain Swaps Listed Only By
Exempt SEFs.
---------------------------------------------------------------------------
As discussed further below, the Commission is also proposing (i)
exemptions of various transactions from the trade execution requirement
under Sec. 36.1 pursuant to its exemptive authority in CEA section
4(c); (ii) a compliance schedule for market participants with respect
to the expanded application of the trade execution requirement to
additional swaps; (iii) a public registry with information as to which
swaps are subject to the trade execution requirement and the SEFs or
DCMs that list them for trading; and (iv) a standardized form to assist
the Commission in populating the public registry with relevant
information regarding the trade execution requirement.\284\
---------------------------------------------------------------------------
\284\ See infra Section XXI.A.--Sec. 36.1--Trade Execution
Requirement.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of its proposed
approach to the trade execution requirement, including Sec. 36.1(a) as
well as any alternative approaches to implementation of the trade
execution requirement.
b. Elimination of Required Execution Methods
To better foster trading on SEFs--particularly with respect to the
many episodically liquid swaps that will become subject to the trade
execution requirement--the Commission proposes to eliminate the
existing execution method requirements under Sec. 37.9. These
requirements include the (i) definition of and associated requirements
for Required Transactions under Sec. 37.9(a), including the RFQ System
definition under Sec. 37.9(a)(3); \285\ and (ii) the definition and
associated provision for Permitted Transactions under Sec. 37.9(c).
Therefore, a SEF would be permitted to offer any method of execution
that meets the SEF definition for any swap that it lists for trading,
irrespective of whether the particular swap is or is not subject to the
trade execution requirement. The Commission believes that this approach
is consistent with the statutory SEF definition in CEA section 1a(50),
which establishes that a SEF operates a trading system or platform
whereby multiple participants have the ability to execute or trade
swaps by accepting bids and offers made by multiple participants also
using the trading system or platform.\286\
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\285\ As discussed above, the Commission is also proposing to
eliminate the Order Book definition set forth under Sec.
37.3(a)(3). See supra Section IV.C.2.--Sec. Sec. 37.3(a)(2)-(3)--
Minimum Trading Functionality and Order Book Definition. As
discussed below, the Commission is also proposing to eliminate the
time delay requirement under Sec. 37.9(b), which applies to
Required Transactions executed on an Order Book. See infra Section
VI.A.2.--Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec.
37.9(b)--Time Delay Requirement.
\286\ 7 U.S.C. 1a(50).
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The Commission's proposed elimination of Sec. 37.9(a) also
includes the elimination of subparagraph (a)(2)(ii), which currently
specifies that with respect to offering an Order Book or RFQ System for
Required Transactions, a SEF may utilize ``any means of interstate
commerce'' for purposes of execution and communication, including, but
not limited to, the mail, internet, email and telephone.\287\ Given the
elimination of the Order Book and RFQ System requirements, the
Commission notes that this provision is no longer necessary.
---------------------------------------------------------------------------
\287\ 17 CFR 37.9(a)(2)(ii).
---------------------------------------------------------------------------
As noted above, implementing the proposed interpretation of the
trade execution requirement would increase the number of swaps that are
required to trade on a SEF. Many of these swaps, which are all
currently subject to the clearing requirement would have terms and
conditions, e.g., partial-year tenors and varying payment terms, that
counterparties customize to address idiosyncratic risks, such as larger
and longer duration risk exposures.\288\ Given
[[Page 61981]]
their variable and complex nature, trading in these types of swaps can
be punctuated by alternating periods of liquidity and illiquidity.\289\
The markets for many of these swaps may consist of only a few trades
per day or, in some cases, a few trades per month.\290\ Historically,
market participants have had discretion to utilize execution methods
tailored to their particular trading motives and needs, the liquidity
profile and characteristics of the swap being traded, and current
market conditions, among other considerations.\291\
---------------------------------------------------------------------------
\288\ Additionally, market participants may execute such swaps
as part of different transaction structures, including package
transactions composed of multiple risk-assuming or risk-hedging swap
and non-swap components that are priced together. In their review of
three months of OTC IRS trading, Federal Reserve Bank of New York
(``FRBNY'') staff found that the swaps traded were ``broad in scope
with a wide range of products, currencies, and maturities traded . .
. [including] transactions in eight different product types, 28
currencies and maturities ranging from less than one month to 55
years.'' Michael Fleming, John Jackson, Ada Li, Asani Sarkar, &
Patricia Zobel, Federal Reserve Bank of New York Staff Report No.
557, An Analysis of OTC Interest Rate Derivatives Transactions:
Implications for Public Reporting 2 (2012) (``2012 FRBNY
Analysis''). The analysis further identified ``a meaningful degree
of customization in contract terms, particularly in payment
frequencies and floating rate tenors.'' Id. at 3. The Commission
acknowledges that while some of the swaps that were included in the
FRBNY's analysis would not be subject to the clearing requirement,
e.g., any IRS with a 55-year tenor, the Commission nevertheless
believes that this analysis captures many of the swaps that are
subject to the clearing requirement.
\289\ In a 2011 Senate hearing related to SEFs, one participant
testified that ``[t]rading in [swaps] markets is characterized by
variable or non[-]continuous liquidity. Such liquidity can be
episodic, with liquidity peaks and troughs that can be seasonal . .
. or more volatile and tied to external market and economic
conditions (e.g., many credit, energy and interest rate products).''
Emergence of Swap Execution Facilities: A Progress Report: Hearing
Before the S. Subcomm. on Sec., Ins., and Investment of the S. Comm.
on Banking, Hous., and Urban Affairs, 112th Cong. 15 (2011)
(statement of Stephen Merkel, Executive Vice President and General
Counsel, BGC Partners, Inc.).
\290\ In their review of three months of OTC IRS swaps, FRBNY
staff also ``found over 10,500 combinations of product, currency,
tenor and forward tenor traded during [their] three-month sample,
with roughly 4,300 combinations traded only once.'' 2012 FRBNY
Analysis at 3. Further, their analysis found that within the data
set, even the most commonly traded instruments were not frequently
traded. No single instrument in the data set traded more than 150
times per day, on average, and the most frequently traded
instruments in OIS and FRA only traded an average of 25 and 4 times
per day, respectively. Id. Collin-Dufresne, Junge, and Trolle also
made similar observations with respect to index CDS trading on SEFs,
noting that the market is generally characterized by relatively few
trades in very large sizes. Based on their analysis, the CDX.IG
swaps market consists of 114 dealer-to-client trades and 24 dealer-
to-dealer trades per day, on average, with a median trade size of
USD $50 million in both segments. The average number of trades in
the CDX.HY market are greater--164 dealer-to-client trades and 27
dealer-to-dealer trades per day, on average--but the median trade
size is smaller--USD $10 million in both segments--which they
attributed to the significantly higher volatility of high-yield
contracts. 2017 Collin-Dufresne Research Paper at 16.
\291\ Those means include, for example, voice-based trading
systems or platforms that utilize human trading specialists who
exercise discretion and judgment in managing the degree to which
trading interests are exposed and how orders are filled. Where pre-
trade market information from bids and offers may be limited due to
market participants' caution in displaying trading interests, SEFs
often offer session-based execution methods, such as auctions, to
generate trading interest.
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The existing execution methods for Required Transactions under the
current framework, however, has precluded the full use of such
discretion and forces participants to trade certain swaps in accordance
with an Order Book or an RFQ System. As noted above, the Commission
believes that these limited execution methods would not be suitable for
the broad swath of the swaps market that would become newly subject to
the trade execution requirement. Instead, prescribing those execution
methods for this expanded group of swaps would likely impose greater
trading risks on market participants, including execution and liquidity
risks that negate any benefits associated with the centralized exchange
trading of such swaps.\292\ The Commission also notes that the current
execution methods could exacerbate the current information leakage and
front running risks as described above.\293\
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\292\ See supra note 130 (explaining that requiring all market
participants to use a central limit order book will not necessarily
promote price competition among dealers in markets that lack
continuous trading or have episodic liquidity).
\293\ SEF Core Principles Final Rule at 33562. See generally
2017 Riggs Study (discussing the ``winner's curse,'' which is
similar to information leakage in context, in the dealer-to-client
CDS market).
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The existing framework was designed to promote the SEF statutory
goals, in particular to promote pre-trade price transparency, but based
on its implementation experience, the Commission believes that a SEF
regulatory framework that requires a greater number of swaps to be
traded through flexible execution methods on a SEF will better promote
both SEF statutory goals. The Commission believes that requiring more
swaps to be traded on SEFs would help foster vibrant and liquid SEF
markets as liquidity formation and price discovery is centralized on
these markets. With more swaps trading activity occurring in a
concentrated SEF environment, the Commission anticipates that a greater
number of observable transactions--for example, IRS of varying tenors
along a single price curve--would allow for a richer price curve that
provides participants with more accurate pricing for economically
similar swaps along other points of the curve.
For example, auction platforms and work-up sessions--both of which
SEFs currently offer under the existing framework--help to maximize
participation and trading on the SEF at specific points of time and
serve as effective tools for price discovery for market participants in
periods of episodic liquidity. By allowing SEFs the flexibility to
develop and tailor these types of functionalities to facilitate trading
across a wide range of market liquidity conditions, a SEF can
effectively promote appropriate counterparty and swap-specific levels
of pre-trade price transparency \294\ across a broader range of swaps.
Further, as discussed above, affording SEFs with greater flexibility
with execution methods would avoid forcing them to alter these types of
functionalities in a sub-optimal manner simply to conform to certain
limited execution methods that are not suitable for trading a broad
range of swaps with varying liquidity profiles.
---------------------------------------------------------------------------
\294\ See supra note 270 (discussing appropriate counterparty
and swap-specific levels of pre-trade price transparency).
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By eliminating the existing approach to required methods of
execution, the Commission's proposed regulatory framework is also
expected to foster customer choice in a manner that would benefit the
swaps markets. The Commission believes that its proposed approach
appropriately allows market participants, each of whom is a
sophisticated entity trading in a professional market, to determine the
execution method that best suits the swap being traded and their
trading needs and strategies.\295\ As noted above, the Commission
believes that market participants in a professional market, in part
because of sophistication and self-interest, will seek the most
efficient and cost-effective method of execution to achieve their
business and trading objectives. The Commission believes that providing
for customer choice, while also concentrating liquidity and price
discovery onto SEFs, may help create an environment for swaps trading
that is better able to promote appropriate counterparty and swap-
specific levels of pre-trade price transparency than the existing
framework and will also do so for a significantly broader segment of
the swaps markets than the existing framework. As noted above,
execution methods such as auction platforms and work-up sessions may do
a better job of maximizing participation and concentrating liquidity
than Order Books or RFQ Systems in episodically liquid markets.
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\295\ The Commission notes that other markets--such as bonds,
U.S. treasuries, and FX--do not prescribe methods of execution, but
rather permit their market participants to determine the best method
of execution for the transaction. Swaps markets have historically
followed this model. In this respect, the Commission believes that
its proposal realigns the swaps market trading characteristics with
other fixed income markets.
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The proposed approach would allow SEFs to offer varied and
innovative execution methods that are best suited to the products they
list, as well as the
[[Page 61982]]
trading needs of their market participants. Rather than being confined
to limited execution methods, SEFs would be able to develop more
efficient, transparent, and cost-effective means for participants to
trade swaps. In turn, the Commission believes that this innovation may
serve to promote more competition between SEFs to attract participation
through novel trading systems or platforms. The Commission further
believes greater execution flexibility may also potentially incentivize
new entrant trading venues to enter the SEF marketplace, as they would
be able to utilize new and different execution methods than are
currently employed by incumbent platforms.
Request for Comment
The Commission requests comment on all aspects of its proposed
approach to execution methods as well as any alternative approaches.
V. Part 37--Subpart B: Core Principle 1 (Compliance With Core
Principles)
The Commission is not proposing any amendments to Sec. 37.100,
which codifies the language of Core Principle 1.\296\
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\296\ Core Principle 1 requires a SEF to comply with the core
principles set forth in CEA section 5h(f) and any requirement that
the Commission may impose by rule or regulation pursuant to CEA
section 8a(5) as a condition of obtaining and maintain registration
as a SEF. 7 U.S.C. 7b-3(f)(1). Core Principle 1 also provides a SEF
with reasonable discretion in establishing the manner in which it
complies with the core principles, unless the Commission determines
otherwise by rule or regulation. 7 U.S.C. 7b-3(f)(1)(B).
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VI. Part 37--Regulations Related to SEF Execution Methods--Subpart C:
Core Principle 2 (Compliance With Rules)
Core Principle 2 requires a SEF to establish and enforce rules that
govern its facility, including trading procedures to be followed when
entering and executing orders, among other requirements.\297\
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\297\ Core Principle 2 also requires a SEF to (i) establish and
enforce compliance with rules, including terms and conditions of
swaps traded or processed on or through the SEF and any limitation
on access to the SEF; (ii) establish and enforce trading, trade
processing, and participation rules that will deter abuses and have
the capacity to detect, investigate, and enforce those rules,
including means to provide market participants with impartial access
to the market and to capture information that may be used in
establishing whether rule violations have occurred; and (iii)
provide by its rules that when a SD or MSP enters into or
facilitates a swap that is subject to the clearing requirement, the
SD or MSP will be responsible for compliance with the trade
execution requirement. 7 U.S.C. 7b-3(f)(2). The Commission codified
Core Principle 2 under Sec. 37.200. 17 CFR 37.200.
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To support the proposed approach of allowing more flexible
execution methods on SEFs, which is intended to foster more liquidity
formation through trading activity on SEF trading systems and
platforms, the Commission is proposing to amend certain rules and adopt
new rules under Core Principle 2, as described below. These proposed
rules would, among other things, help foster open and transparent
markets as well as promote market efficiency and integrity. In
particular, the Commission proposes to establish general rules that
would apply to any execution method that a SEF offers on its facility.
The Commission also proposes to limit the ability of market
participants to conduct pre-execution communications and submit
resulting pre-negotiated or pre-arranged trades to a SEF for execution;
and eliminate exceptions to the pre-arranged trading prohibition under
Sec. 37.203(a), including the time delay requirement under Sec.
37.9(b).
Additionally, the Commission proposes to amend certain existing
rules and adopt new rules under Core Principle 2, as described below,
that correspond to the Commission's application of the SEF registration
requirement to swap broking entities, including interdealer brokers.
Among other goals, these proposed rules would enhance professionalism
requirements for certain SEF personnel--``SEF trading specialists''--
that operate as part of a SEF's trading system or platform, e.g.,
voice-based trading functionalities, by facilitating trading and
execution on the facility. Specifically, the Commission proposes rules
under Sec. 37.201(c) that would require SEFs to ensure minimum
proficiency and conduct standards for SEF trading specialists.
A. Sec. 37.201--Requirements for Swap Execution Facility Execution
Methods 298
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\298\ The Commission proposes to retitle Sec. 37.201 to
``Requirements for swap execution facility execution methods'' from
``Operation of swap execution facility and compliance with rules''
based on the proposed changes described below.
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Section 37.201 implements the Core Principle 2 requirement that a
SEF establish and enforce rules that govern its facility. Section
37.201(a) specifies that these requirements include trading procedures
to be followed when entering and executing orders traded or posted on
the SEF.\299\ Section 37.201(b) additionally requires a SEF to
establish and impartially enforce rules related to (i) the terms and
conditions of swaps traded or processed on the SEF; (ii) access to the
SEF; (iii) trade practice requirements; (iv) audit trail requirements;
(v) disciplinary requirements; and (vi) mandatory trading
requirements.\300\ The Commission proposes to eliminate these rules,
which are largely duplicative of the Core Principle 2 requirements, and
adopt the new rules described below.
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\299\ 17 CFR 37.201(a).
\300\ 17 CFR 37.201(b).
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1. Sec. 37.201(a)--Required Swap Execution Facility Rules
Proposed Sec. 37.201(a) would require a SEF to establish rules
that govern the operation of the SEF, including rules that specify (i)
the protocols and procedures for trading and execution; (ii) the
permissible uses of ``discretion'' in facilitating trading and
execution; and (iii) the sources and methodology for generating any
market pricing information.
Pursuant to a SEF regulatory framework that would allow SEFs to
offer flexible execution methods, the Commission believes that such
rules would benefit market participants by providing a baseline level
of transparency in SEF trading. As the Commission previously noted, one
of the central goals of the Dodd-Frank Act is to bring transparency to
the opaque OTC swaps market.\301\ The Commission has further observed
that when markets are open and transparent, prices are more competitive
and markets are more efficient.\302\ In this regard, the Commission
notes that rather than imposing detailed, prescriptive SEF execution
method requirements that do not comport with swaps market
characteristics, this proposed rule represents a more balanced
approach--a SEF would have the flexibility to develop and offer
execution methods designed to foster trading based on the dynamics of
the applicable swaps market (e.g., liquidity and product
characteristics) and on its market participants' needs, but also would
be required to disclose how these execution methods operate. This
disclosure would help to foster open and transparent markets, and
promote market efficiency and integrity by establishing a consistent
level of disclosure and information across all SEFs, which would allow
market participants to make informed decisions regarding whether to
onboard to a particular SEF and whether to use a particular execution
method offered by a SEF.\303\ In making such decisions,
[[Page 61983]]
market participants would be able to understand more fully any
differences among those flexible methods across SEFs.
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\301\ SEF Core Principles Final Rule at 33553.
\302\ Id.
\303\ The Commission notes that this view is analogous to the
principles set forth in the FX Global Code. The FX Global Code was
developed by a partnership between central banks and participants
from 16 jurisdictions. The code does not impose legal or regulatory
obligations on participants nor does it act as a substitute for
regulation, but rather serves as a supplement to local laws by
setting forth guidelines for good practices in the FX markets. The
code specifies, among other recommendations, that ``Market
Participants,'' which include operators of trading systems or
platforms, should provide all relevant disclosures and information
to participants to help them make informed decisions about whether
to transact or not. See FX Global Code at 13-14 (updated Aug. 2018)
(``FX Global Code''), available at https://www.globalfxc.org/docs/fx_global.pdf.
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Based on the definition of ``rule'' under Sec. 40.1(a), which
encompasses any SEF ``trading protocol,'' the proposed rule clarifies
those features of a SEF's execution methods that constitute SEF
``rules'' and must be submitted to the Commission pursuant to part 40
and disclosed to SEF market participants.\304\ Accordingly, SEFs would
be required to disclose such information in their rulebooks. After
reviewing SEF rulebooks, the Commission believes that this proposed
disclosure requirement is consistent with current market practice and
the general level of information already disclosed by many SEFs.
Accordingly, the Commission does not anticipate that this proposed rule
would require material changes to most SEF rulebooks; rather, the
proposed rule would ensure that currently-registered and new SEFs
provide a consistent, minimum level of transparency and disclosure to
the marketplace. The Commission further notes that SEFs are free to
provide additional levels of disclosure beyond that required under
proposed Sec. 37.201(a).
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\304\ See supra note 179 (definition of ``rule'' in the
Commission's regulations).
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a. Sec. 37.201(a)(1)--Trading and Execution Protocols and Procedures
Proposed Sec. 37.201(a)(1) would require a SEF to establish rules
governing the protocols and procedures for trading and execution,
including entering, amending, cancelling, or executing orders for each
execution method offered by the SEF. The Commission believes that
requiring SEFs to provide this level of detail and transparency for
each of their execution methods is particularly important given the
Commission's proposal to permit SEFs to offer flexible execution
methods for all of their listed swaps.
The Commission believes that proposed Sec. 37.201(a)(1) clarifies
a SEF's existing obligations and is consistent with current market
practice, in particular the general level of disclosure and information
that many SEFs already provide in their rulebooks. This proposed rule
is also better aligned with other proposed Core Principle 2 regulations
that relate to SEF trading protocols and procedures, such as proposed
Sec. 37.203(e), which would require SEFs to promulgate rules and
procedures to resolve error trades, including trade amendments or
cancellations, as discussed below.\305\
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\305\ See infra Section VII.B.5.--Sec. 37.203(e)--Error Trade
Policy.
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To comply with this rule, for example, a SEF that offers an RFQ
protocol could specify various operational aspects of that protocol in
its rulebook. Those aspects could include, among other things, how a
requestor could initiate an RFQ; whether the RFQ requestor's identity
is disclosed or anonymous; whether an RFQ request could be made visible
to the entire market; whether a responder could offer either indicative
or firm bids or offers; the length of time that an RFQ response with a
firm bid or firm offer would have to remain executable by the RFQ
requestor; or whether RFQ responses are disclosed to the whole market
or just the requestor. By specifically requiring a SEF to disclose
information regarding how each offered execution method operates, a
market participant would have the ability to (i) make an informed
decision about whether to trade and execute on that SEF; (ii) determine
the type of trading system or platform that best suits its needs; and
(iii) conform its trading and execution practices to the SEF's
protocols and procedures.\306\
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\306\ See FX Global Code at 13-14 (recommending that trading
systems or platforms have rules that are transparent, including how
orders are handled and transacted).
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b. Sec. 37.201(a)(2)--Discretion
Proposed Sec. 37.201(a)(2) would require a SEF, where applicable,
to establish rules specifying the manner or circumstances in which the
SEF may exercise ``discretion'' in facilitating trading and execution
for each of its execution methods. Many SEFs, in particular those that
resemble or are based upon operations of swaps broking entities,
including interdealer brokers, feature execution methods that involve
the use of discretion.\307\ SEF trading specialists,\308\ who have
traditionally served as interdealer brokers in the wholesale swaps
market, exercise discretion on behalf of market participants in a
variety of ways. This discretion includes determining how, when, and
with whom to disseminate, arrange, and execute bids and offers; and
determining whether and when to amend or cancel those bids and offers
in response to market developments. Exercising this type of trading and
execution judgment involves taking different factors into account, such
as the characteristics and needs of the client, size and nature of the
order, likelihood and speed of execution, price and costs of execution,
and current market conditions. The use of discretion in trading
reflects the market characteristics of the wholesale swaps market,
where the wide range of different swaps and transaction sizes results,
in some instances, in low liquidity markets with episodic, non-
continuous trading activity.
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\307\ As noted above, upon the adoption of part 37, some
interdealer brokers have registered their operations or components
of their operations, i.e., trading systems or platforms, as SEFs.
See supra Section IV.C.1.c.(1)--Structure and Operations of Swaps
Broking Entities, Including Interdealer Brokers.
\308\ ``SEF trading specialist'' refers to a natural person
employed by a SEF (or acting in a similar capacity as a SEF
employee) to perform various core functions that facilitate trading
and execution, including discussing market color with market
participants, negotiating trade terms, issuing RFQs, and arranging
bids and offers. For the Commission's proposed definition of ``SEF
trading specialist,'' see infra Section VI.A.3.--Sec. 37.201(c)--
SEF Trading Specialists.
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Given the established role of swaps broking entities, including
interdealer brokers, in fostering market liquidity through identifying
and arranging multiple trading interests--both liquid and illiquid--
amidst changing market conditions, the Commission recognizes that the
use of discretion is an important element in fostering an efficient
market. Therefore, the Commission's proposed regulatory framework would
further accommodate the use of discretion by SEFs. As described above,
SEFs would be allowed to offer flexible execution methods, thereby
allowing methods that involve the exercise of discretion by SEF trading
specialists.\309\ Further, the proposed expansion of the trade
execution requirement would lead to a greater number of swaps being
traded on SEFs.
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\309\ The Commission's clarification of the SEF registration
requirement, as discussed above, would require swaps broking
entities, including interdealer brokers, to register as SEFs. Id.
The Commission notes that as a result, a significant number of
personnel at these entities would likely meet the definition of
``SEF trading specialist.''
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The Commission believes that the proposed broadening of both the
SEF registration requirement and the trade execution requirement would
increase the level of discretion that SEFs (and their trading
specialists) exercise in connection with swaps trading. To address this
situation, proposed Sec. 37.201(a)(2) would require SEFs to disclose
the manner or circumstances in which they may exercise discretion. The
Commission believes that such a disclosure requirement is important to
[[Page 61984]]
inform market participants, facilitate an orderly SEF trading
environment, foster open and transparent markets, and promote market
integrity while remaining consistent with Core Principle 2.\310\ Such
information would help a market participant have important awareness of
how a trading system or platform is designed, thereby allowing them to
make informed decisions with respect to swaps trading on a particular
SEF. For example, such information would help market participants
determine appropriate parameters or instructions in submitting their
bids and offers to a particular SEF, as well as inform their
expectations about possible trading outcomes or objectives on that SEF.
The Commission believes that more informed market participants would
promote fairer and more efficient trading on SEFs and, ultimately, make
SEFs more robust price discovery mechanisms.
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\310\ See FX Global Code at 13-14 (recommending that trading
systems or platforms should make participants aware of where
discretion may exist or may be expected, and how it may be
exercised, as a way to promote fairness and transparency in
trading).
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Pursuant to proposed Sec. 37.201(a)(2), the Commission intends to
require each SEF to generally disclose the possible areas in which it
may use discretion for each execution method, rather than establish
exact, pre-determined trading protocols and procedures. In identifying
those general areas, a SEF's rules should disclose sufficient
information that a reasonable market participant would consider
important in deciding whether to onboard onto the SEF and, once
participating on the SEF, in understanding how discretion may affect
trading. The proposed rule, however, does not necessarily require a SEF
to disclose any proprietary or confidential information in its public
rulebook.\311\ Based on its experience with reviewing SEF rulebooks,
the Commission believes that proposed Sec. 37.201(a)(2) is consistent
with current market practice and the general level of information that
many SEFs already provide in their rulebooks.\312\ Accordingly, the
Commission does not anticipate that existing SEFs will be required to
adopt material changes to their rulebooks; rather, the proposed rule
would ensure that both currently-registered and new SEFs continue to
provide sufficient transparency and disclosure.
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\311\ The Commission notes, however, that if a SEF believes that
any such information should be kept confidential, such that it
should be provided to market participants but not in a public
filing, the SEF may submit a request for confidential treatment with
its respective rule submission. 17 CFR 40.8. The Commission's
treatment of such information would be governed by Sec. 145.9, 17
CFR 145.9, and the Freedom of Information Act. 5 U.S.C. 552.
\312\ The Commission notes, for example, that SEF rules have
generally specified several areas where discretion may be exercised
in facilitating trading, such as determining when to enter orders on
behalf of participants; determining when and with which participants
to gauge possible trading interest; and determining how to calculate
mid-market prices for use in a session-based execution method, i.e.,
determining the number of factors to consider in the calculation of
a mid-market price or the weight of each factor.
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c. Sec. 37.201(a)(3)--Market Pricing Information
Proposed Sec. 37.201(a)(3) would require each SEF to adopt rules
that disclose the general sources and methodology for generating any
market pricing information that the SEF provides to market participants
to facilitate trading and execution. The term ``sources'' would include
any general inputs that the SEF may consider when forming a price, such
as swaps pricing data, e.g., the last traded price; historical,
executable, or indicative bids and offers on the SEF or other trading
platforms; or the views of market participants, who the SEF may contact
to ascertain interest. The term ``methodology'' means that a SEF should
generally identify the extent to which it may formulate a price on its
trading systems or platforms, whether prices generated by SEFs are
based on discretion or some type of pre-set approach, and how the
information or data sources are generally applied or weighted within
the SEF's methodology.
The Commission recognizes that some SEFs provide participants
either an indicative or executable ``market price'' to encourage price
discovery and liquidity or otherwise inform trading interest. The use
of market prices is particularly prevalent in connection with certain
execution methods, such as auctions and similar matching sessions.\313\
SEFs often generate these prices by considering various sources of
data, including prices from executed transactions, prices from
executable or indicative bids and offers, publicly reported swaps data,
active market participant views, or prices from related instruments in
other markets. Based on the availability of this information at a given
time, a SEF may take one or more of these factors into account
differently in formulating a single price. These pricing mechanisms
help to initiate the price discovery process and allow market
participants to formulate views about the current state of the market.
By relying upon an established price, a market participant may make
trading decisions without being exposed to information leakage that
might otherwise cause widened bid-offer spreads and impose higher
transaction costs.\314\ Given this unique feature of the swaps market
due to its episodic liquidity, the Commission recognizes that SEF
pricing practices are an important element in fostering liquidity on
SEFs and, therefore, in promoting the Act's statutory goals of
encouraging SEF trading and pre-trade price transparency.
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\313\ In a typical SEF auction or matching session-based trading
functionality, a SEF establishes a price for a listed swap that is
determined through a variety of different factors. Participants may
submit their trading interest in the swap at the established price,
either within an established time session or on a continuous basis,
and subsequently execute that swap at the established price, often
on a time-priority basis.
\314\ The Commission understands that participants often avoid
acting as a ``first-mover'' for relatively less liquid swaps by
exercising caution in displaying their trading interests, i.e.,
price and size; accordingly, SEFs--similar to historical OTC trading
environments--utilize these types of methods to promote trading for
particular swaps and pre-trade price transparency.
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Where pricing generated by a SEF in lieu of pricing based on market
participant bids and offers help to foster liquidity and price
discovery, the Commission believes that requiring SEFs to inform market
participants as to their price formation sources and methodology would
foster open and transparent markets and promote market integrity and
efficiency. Requiring a SEF to disclose the sources of information used
to generate a price and the methodology for calculating that price, for
example, would allow market participants to be aware of prevailing
liquidity and market conditions, thereby helping them to form views as
to whether that price is an appropriate indicator of a particular
market. Accordingly, market participants would be able to make informed
trading decisions, such as whether to participate in an available
trading session, and if so, the level of participation, e.g., whether
they would contribute their own information to help establish a trading
price in a particular execution method.\315\ The Commission believes
that this information should build confidence among participants in the
integrity, fairness, and effectiveness of the SEF as a regulated
trading venue. In turn, a greater level of confidence in SEFs should
lead to increased swaps trading volume and, ultimately, an increased
potential for higher levels of pre-trade price transparency through
increased participation.
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\315\ See supra note 313 (describing mechanics of a SEF auction
or matching session-based trading functionality).
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Similar to proposed Sec. 37.201(a)(2), the Commission emphasizes
that proposed Sec. 37.201(a)(3) would establish a general
[[Page 61985]]
approach as to the scope of information that a SEF must disclose and
does not require the SEF to specify detailed calculations or algorithms
used to generate pricing information. The Commission also notes that
the proposed rule would not require SEFs to disclose the identities of
market participants who provide data used to formulate prices or to
disclose proprietary aspects of their pricing methodology.\316\ Rather,
a SEF's rules should disclose sufficient information that a reasonable
market participant would consider important to determine whether to
join the SEF and to generally understand the nature of the market
pricing information provided by the SEF. In addition, proposed Sec.
37.201(a)(3) would not require a SEF to provide any proprietary or
confidential information in its public rulebook. Based on its
experience with reviewing SEF rulebooks submitted via the part 40 rule
filing process, the Commission believes that proposed Sec.
37.201(a)(3) is consistent with current market practice and the general
level of information that many SEFs already include in their
rulebooks.\317\
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\316\ The Commission further notes, however, that regardless of
whether market participants participate in the price-formation
process or whether their identities remain anonymous, all market
participants remain subject to section 9(a)(2) of the Act. That
provision prohibits any attempt to provide false, misleading, or
knowingly inaccurate reports concerning market information or
conditions that affect or tend to affect the price of any swap. 7
U.S.C. 13(a)(2).
\317\ In disclosing the general sources and methodologies for
generating market pricing information, the Commission notes that
such SEF rules have generally specified (i) the SEF's ability to
consider either a single or multiple number of established factors
in determining a price; (ii) the various types of factors that it
may take into account to determine a price; or (iii) other
additional analytical methods that may be used to supplement a price
calculated from existing bids and offers on the platform.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.201(a). In particular, the Commission requests comment on the
following question:
(28) Do the requirements under proposed Sec. Sec. 37.201(a)(1)-(3)
set an appropriate level of disclosure by SEFs to market participants?
Are the requirements too broad? Should the Commission require
additional disclosures that would be material for market participants
to make an informed decision to participate on the SEF? If so, what
additional disclosures should be required? Please provide specific
examples in your responses.
2. Sec. 37.203(a)--Pre-Arranged Trading Prohibition; Sec. 37.9(b)
Time Delay Requirement
Part 37 has permitted market participants to communicate with one
another away from a SEF in connection with the eventual execution of
swap transactions via the SEF's trading systems or platforms.\318\ The
Commission has observed that such communications, which commonly occur
on a direct basis between swap dealers and their clients in the dealer-
to-client market, vary in nature and scope. Such communication may, for
example, include communications to discern trading interest prior to
trading on the SEF, e.g., obtaining market color, identifying potential
trades, and locating interested counterparties. Such communications,
however, may also consist of the actual negotiation or arrangement of a
swap transaction's terms and conditions prior to execution on a SEF.
Such communications are permitted through several provisions in the
current regulatory framework, as described below, based in part on
whether the transaction qualifies for an exception to the prohibition
on pre-arranged trading under Sec. 37.203(a); or whether the swap is
otherwise not subject to the trade execution requirement.
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\318\ SEF Core Principles Final Rule at 33503.
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The Commission notes that ``pre-arranged trading'' is prohibited as
an abusive trading practice under Sec. 37.203(a). This prohibition
generally applies to market participants who communicate with one
another to pre-negotiate the terms of a trade away from a SEF's trading
system or platform, but then execute the trade on such system or
platform in a manner that appears competitive and subject to market
risk. The Commission has intended for this prohibition to maintain the
integrity of price competition and market risk that is incident to
trading in the market.\319\ Notwithstanding this prohibition, SEFs have
permitted pre-arranged trading on their facilities in certain
instances.
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\319\ The Commission generally considers pre-arranged trading to
be a form of ``fictitious'' trading that is prohibited pursuant to
CEA section 4c(a)(1), which makes it unlawful for any person to
offer to enter into, or confirm the execution of a fictitious sale.
7 U.S.C. 6c(a)(1), 6c(a)(2)(A)(ii). Specifically, pre-arranged
trading involves ``the use of trading techniques that give the
appearance of submitting trades to the open market while negating
the risk of price competition incident to such a market.'' Harold
Collins, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) 22982,
31902 (CFTC Apr. 4, 1986). Generally, pre-arranged trading creates a
false impression to the market that an executed transaction is
indicative of a competitive trading environment. Id. at 31903 (``By
determining trade information such as price and quantity outside the
pit, then using the market mechanism to shield the private nature of
the bargain from public scrutiny, both price competition and market
risk are eliminated.'').
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For Required Transactions executed via an Order Book, a SEF may
permit market participants to communicate with one another and pre-
arrange or pre-negotiate a swap transaction away from its trading
system or platform, subject to a time delay requirement and facility
rules on pre-execution communications. Section 37.9(b)(1) currently
permits a broker or dealer to engage in pre-execution communications to
pre-arrange or pre-negotiate a swap, as long as one side of the
resulting transaction is entered into the Order Book for a 15-second
delay before the second side is entered for execution against the first
side (the ``time delay requirement''). The Commission defined ``pre-
execution communications'' as communications between market
participants to discern interest in the execution of a transaction
prior to the exposure of the market participants' orders (e.g., price,
size, and other terms) to the market; such communications include
discussion of the size, side of market, or price of an order, or a
potentially forthcoming order.\320\ To the extent that SEFs would allow
their market participants to engage in such pre-execution
communications, the Commission required SEFs to adopt associated
rules.\321\
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\320\ SEF Core Principles Final Rule at 33503. In light of the
Commission's general prohibition on pre-arranged trading under Sec.
37.203(a), the Commission defined this term to clarify the
permissible types of communications in which market participants can
pre-arrange or pre-negotiate a transaction consistent with Sec.
37.9(b)(1). The Commission currently requires that SEFs that choose
to allow their market participants to engage in pre-execution
communications prior to executing such transactions must do so
pursuant to their rules. 17 CFR 37.203(a). Such communications may
constitute an element of pre-arranged trading, which is an abusive
trading practice prohibited under existing Sec. 37.203(a).
\321\ SEF Core Principles Final Rule at 33509.
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The Commission implemented Sec. 37.9(b) to ensure a minimum level
of pre-trade price transparency for orders based on pre-execution
communications that occur away from the SEF, and to incentivize price
competition between market participants for orders entered into an
Order Book.\322\ The Commission
[[Page 61986]]
anticipated that disclosing one side of a pre-arranged transaction in
the Order Book first would provide other market participants with an
opportunity to execute against that side prior to entry of the second
side in the Order Book.\323\ A similar requirement, however, was not
applied to Required Transactions executed through a SEF's RFQ System.
The Commission noted that the requirement to send an RFQ to three other
market participants already provides pre-trade price transparency,
thereby obviating the need for a corresponding time delay.\324\
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\322\ Id. at 33503. The Commission modeled the time delay
requirement after similar DCM rules that have imposed time delays on
cross trades involving futures and options on futures. Pursuant to
these rules, market participants are permitted to conduct pre-
execution communications with respect to orders that are later
exposed to the market for a certain period of time prior to
execution on the DCM's trading system or platform. As DCM Core
Principle 9 requires DCMs to provide a competitive, open, and
efficient market and mechanism for executing transactions that
protects the price discovery process of trading in the centralized
market of the DCM, 7 U.S.C. 7(d)(9)(A), DCMs have implemented
certain time delay procedures that establish a ``safe harbor'' for
orders resulting from pre-execution communications that would
otherwise be considered pre-arranged trading. To protect price
discovery, such orders must be exposed to the market for a minimum
amount of time prior to allowing such orders to match against one
another on a DCM. This time delay generally provides other
participants with an opportunity to execute against the initial
order. See, e.g., CME Group, Rule 539.C (rules on pre-execution
communications regarding Globex trades).
\323\ 17 CFR 37.9(b)(1).
\324\ SEF Core Principles Final Rule at 33504. The SEF Core
Principles Final Rule did not explicitly require a SEF to adopt pre-
execution communication rules for swaps executed using its RFQ
System. Nevertheless, the Commission has observed that some SEFs
have self-certified rules under Sec. 40.6 to allow their market
participants to engage in pre-execution communication prior to
transmitting an RFQ through the facility's RFQ System.
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In addition to the time delay requirement, Sec. 37.203(a) also
specifies that a SEF may choose to permit pre-arranged trading in other
instances. First, a SEF may permit a swap that it lists to be executed
as a block trade away from a SEF pursuant to part 43. This exception
allows such large-sized transactions to be privately negotiated to
avoid potentially significant and adverse price impacts that would
occur if traded on trading systems or platforms with pre-trade price
transparency.\325\ Second, a SEF may permit pre-arranged trading for
``other types of transactions'' through rules that are filed with the
Commission pursuant to part 40. These rules permit pre-arranged trading
with respect to Required Transactions that are intended to resolve
error trades \326\ or are executed as a component of certain categories
of package transactions.\327\
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\325\ As defined under Sec. 43.2, a ``block trade'' involves a
SEF-listed swap transaction with a notional amount that meets the
corresponding appropriate minimum block size and is executed away
from the SEF's trading system or platform, but pursuant to the SEF's
rules and procedures. 17 CFR 43.2. The Commission is proposing to
amend that definition to specify that block trades must be executed
on a SEF. See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
\326\ Based on time-limited no-action relief issued by DMO, a
SEF may submit pre-arranged Required Transactions for execution on
the SEF that resolve error trades, i.e., correct transactions to
offset an initial transaction executed on the SEF containing a
clerical or operational error, and where necessary, a new
transaction that reflects the terms to which the counterparties had
originally assented. See infra note 433 and accompanying discussion.
\327\ Based on time-limited no-action relief issued by DMO, a
SEF may submit pre-arranged Required Transactions for execution on
SEFs that are components of certain categories of package
transactions. See infra note 334.
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In the preamble to the SEF Core Principles Final Rule, the
Commission did not discuss the issue of pre-execution communications
regarding swaps that are not subject to the trade execution
requirement, i.e., Permitted Transactions, but the Commission has
permitted SEFs to adopt a more flexible approach to the use of
communications away from the SEF. This approach corresponds to the
Commission's approach to Permitted Transactions, which are not required
to be executed on a SEF and otherwise may be executed on a SEF through
flexible execution methods.\328\ Under a more flexible approach, the
Commission has observed that SEFs--both those that facilitate trading
in the dealer-to-client market and those that facilitate trading in the
dealer-to-dealer market--have consequently adopted rules to allow their
market participants to engage in a variety of pre-execution
communications away from their respective trading systems or platforms
prior to executing Permitted Transactions on SEFs. The Commission notes
in particular that some methods allow counterparties to submit pre-
negotiated terms and conditions of a transaction to a SEF ``order
entry'' system for execution and related post-trade processing.\329\
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\328\ SEF Core Principles Final Rule at 33504.
\329\ As noted above, several SEFs affiliated with interdealer
brokers offer this type of functionality. As participants affiliated
with a SEF, interdealer brokers have arranged Permitted Transactions
on behalf of dealer clients through ``communications'' on their
trading systems or platforms and submitted those transactions to a
SEF for execution without being subject to any corresponding order
exposure. See supra note 88 and accompanying discussion.
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a. Sec. 37.201(b)--Pre-Execution Communications
The Commission proposes several amendments under the proposed
framework that would broadly apply to pre-execution communications that
occur away from a SEF. For swaps subject to the trade execution
requirement, proposed Sec. 37.201(b) would require a SEF to prohibit
its participants from engaging in pre-execution communications away
from its facility, including negotiating or arranging the terms and
conditions of a swap prior to its execution on the SEF, i.e., via the
SEF's methods of execution. This prohibition would be subject to
certain proposed exceptions discussed further below. Given this general
prohibition, the Commission also proposes to eliminate the existing
exceptions to the pre-arranged trading prohibition, including (i) the
time delay requirement under Sec. 37.9(b); (ii) the exception for
block trades under Sec. 37.203(a) as part of the Commission's proposed
amendments to the ``block trade'' definition under Sec. 43.2; \330\
and (iii) the exception for ``other types of transactions'' under Sec.
37.203(a). Proposed Sec. 37.203(a), as discussed below, would continue
to require a SEF to prohibit abusive trading practices, including pre-
arranged trading, as appropriate to its trading systems or platforms.
Therefore, a SEF would not be allowed to provide rules that allow
market participants to pre-negotiate or pre-arrange a transaction and
submit the sides of the transaction to an order book pursuant to a time
delay.
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\330\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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In eliminating the prescriptive execution methods and allowing more
flexible execution for swaps subject to the trade execution
requirement, the Commission believes that pre-execution communications,
including the negotiation or arrangement of those swaps, would be able
to occur entirely within a SEF's trading system or platform. Such
negotiation or arrangement, regardless of the method through which they
may occur, i.e., among participants themselves or through a swaps
broking entity, constitutes ``trading'' that should occur on a SEF. The
Commission notes that ``trading,'' as discussed above, includes the
negotiation or arrangement of transactions through the interaction of
bids and offers.\331\ Based on its experience with implementing part
37, the Commission believes that the broad scope of pre-execution
communications that have been allowed to occur away from the SEF under
the existing framework has undermined a meaningful role of the SEF in
facilitating trading activity and liquidity formation.
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\331\ With respect interdealer brokers, the Commission believes
that their trading systems or platforms facilitate ``trading''
between multiple participants in conformance with the statutory SEF
definition and, therefore, are subject to the SEF registration
requirement. See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers.
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Accordingly, the Commission believes that these proposed changes
are an important element of the proposed SEF regulatory framework and
are intended
[[Page 61987]]
to enhance this framework, such that a broader range of swaps trading
activity would be occurring on SEFs and creating a vibrant and liquid
marketplace for swaps trading. For example, the Commission notes the
likely increase in the number of swaps that would become subject to the
trade execution requirement under this proposal. Currently, many of
those swaps are Permitted Transactions submitted to a SEF for execution
after negotiation or arrangement away from the facility, or are
negotiated and executed on an OTC basis. With an expanded scope of
swaps subject to the trade execution requirement, the Commission is
concerned that allowing a disproportionate amount of SEF transactions
to be pre-arranged or pre-negotiated away from the facility under the
pretense of trading flexibility would undercut the import of the
expansion of the requirement. Without a limitation on pre-execution
communications that occur away from the SEF, the SEF's role in
facilitating swaps trading is also diminished and would undermine the
statutory goals of promoting greater swaps trading on SEFs and
promoting pre-trade price transparency.
The Commission also notes that its proposed approach to pre-
execution communications, as applied to SEFs in the dealer-to-dealer
market, is consistent with the application of the SEF registration
requirement to swaps broking entities, e.g., interdealer brokers that
facilitate swaps trading activity between market participants. As
discussed above, the Commission believes that brokers, who facilitate
trading communications between market participants away from a SEF and
subsequently submit pre-negotiated or pre-arranged trades to the SEF
for execution, relegate the SEF to a de facto post-trade processing
venue. Requiring these entities to register as SEFs would ensure that
this type of liquidity formation occurs on a SEF.\332\ Similarly, the
submission of trade terms negotiated or arranged via direct
communications between participants, e.g., a swap dealer and a client,
away from a SEF allows liquidity formation to occur outside of the SEF
regulatory framework, which undermines the statutory SEF goals.
Limiting the scope of these communications would also help ensure that
this activity occurs on a registered SEF via flexible means of
execution, which promotes the statutory goals of promoting trading on
SEFs and promoting pre-trade price transparency.
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\332\ As noted above, the Commission recognizes that domestic
swaps broking entities and foreign swaps broking entities would be
subject to a six-month and two-year delayed application of the SEF
registration requirement, respectively. These delays would allow
them to continue to negotiate or arrange swaps transactions between
multiple participants and route them to SEFs or Exempt SEFs for
execution. Accordingly, the compliance date of any final rule with
respect to the prohibition on pre-execution communication under
proposed Sec. 37.201(b) and the pre-arranged trading prohibition
under Sec. 37.203(a) for these entities would also be subject to a
delay of six months or two years, depending on the entity's domicile
and starting from the effective date of the final rule. See supra
Section IV.C.1.c.--Swaps Broking Entities, Including Interdealer
Brokers and Section IV.C.1.d.--Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading Facilities.
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(1) Exception for Swaps Not Subject to the Trade Execution Requirement
The Commission proposes an exception to the proposed prohibition on
pre-execution communications under Sec. 37.201(b) for swaps that are
not subject to the trade execution requirement. The Commission's
proposed exception recognizes that market participants do not have to
execute such swaps on SEFs. The Commission also acknowledges that two
counterparties may initially discuss or negotiate a potential swap
transaction on a bilateral basis away from a SEF with the intent to
execute the transaction away from the SEF, but subsequently determine
to submit the resulting arranged transaction to be executed on a SEF.
The Commission believes that applying the proposed Sec. 37.201(b)
prohibition to swaps not subject to the trade execution requirement
would not be practical, given that counterparties do not have to
execute these swaps on a SEF. The Commission emphasizes, however, that
this proposed exception does not affect the SEF registration
requirement under proposed Sec. 37.3(a), which would specify that a
person operating a facility that meets the statutory SEF definition
must register as a SEF without regard to whether the swaps that it
lists for trading are subject to the trade execution requirement.\333\
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\333\ See supra Section IV.C.1.a.--Footnote 88. For example, the
exception would inherently not apply to a swaps broking entity that
conducts pre-execution communications to facilitate trading activity
on behalf of multiple participants in swaps that are not subject to
the trade execution requirement. As noted above, such an entity
would be subject to the SEF registration requirement and personnel
facilitating those communications would likely be designated as SEF
trading specialists that constitute part of a SEF's trading system
or platform. See supra notes 308-309.
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(2) Sec. 37.201(b)(1)--Exception for Package Transactions
The Commission also proposes an exception under Sec. 37.201(b)(1)
to the proposed prohibition on pre-execution communications for swaps
subject to the trade execution requirement that are components of
``package transactions'' that also include components that are not
subject to the trade execution requirement.\334\ For purposes of this
[[Page 61988]]
exception, a ``package transaction'' involves two or more
counterparties and consist of two or more component transactions whose
executions are (i) contingent upon one another, (ii) priced or quoted
together as one economic transaction, and (iii) executed simultaneous
or near simultaneous to each other.\335\
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\334\ The Commission notes that the swap components of different
categories of package transactions have been subject to time-limited
no-action relief provided by Commission staff from the trade
execution requirement and required methods of execution. These
categories of package transactions include those where (i) each of
the components is a swap subject to the trade execution requirement
(``MAT/MAT''); (ii) at least one of the components is subject to the
trade execution requirement and each of the other components is
subject to the clearing requirement (``MAT/Non-MAT (Cleared)'');
(iii) each of the swap components is subject to the trade execution
requirement and all other components are U.S. Treasury securities
(``U.S. Dollar Swap Spreads''); (iv) each of the swap components is
subject to the trade execution requirement and all other components
are agency mortgage-backed securities (``MAT/Agency MBS''); (v) at
least one individual swap component is subject to the trade
execution requirement and at least one individual component is a
bond issued and sold in the primary market (``MAT/New Issuance
Bond''); (vi) at least one individual swap component is subject to
the trade execution requirement and all other components are futures
contracts (``MAT/Futures''); (vii) at least one of the swap
components is subject to the trade execution requirement and at
least one of the components is a CFTC swap that is not subject to
the clearing requirement (``MAT/Non-MAT (Uncleared)''); (viii) at
least one of the swap components is subject to the trade execution
requirement and at least one of the components is not a swap
(excluding aforementioned categories) (``MAT/Non-Swap
Instruments''); and (ix) at least one of the swap components is
subject to the trade execution requirement and at least one of the
components is a swap over which the CFTC does not have exclusive
jurisdiction, e.g., a mixed swap (``MAT/Non-CFTC Swap''). See CFTC
Letter No. 14-12, No-Action Relief from the Commodity Exchange Act
Sections 2(h)(8) and 5(d)(9) and from Commission Regulation Sec.
37.9 for Swaps Executed as Part of a Package Transaction (Feb. 10,
2014) (``NAL No. 14-12''); CFTC Letter No. 14-62, No-Action Relief
from the Commodity Exchange Act Sections 2(h)(8) and 5(d)(9) and
from Commission Regulation Sec. 37.9 for Swaps Executed as Part of
Certain Package Transactions and No-Action Relief for Swap Execution
Facilities from Compliance with Certain Requirements of Commission
Regulations Sec. 37.9(a)(2), Sec. 37.203(a) and Sec. 38.152 for
Package Transactions (May 1, 2014) (``NAL No. 14-62''); CFTC Letter
No. 14-121, Extension of No-Action Relief for Swap Execution
Facilities and Designated Contract Markets from Compliance with
Certain Requirements of Commission Regulations Sec. 37.9(a)(2),
Sec. 37.203(a) and Sec. 38.152 for Package Transactions (Sept. 30,
2014) (``NAL No. 14-121''); CFTC Letter No. 14-137, Extension of No-
Action Relief from the Commodity Exchange Act Sections 2(h)(8) and
5(d)(9) and from Commission Regulation Sec. 37.9 and Additional No-
Action Relief for Swap Execution Facilities from Commission
Regulation Sec. 37.3(a)(2) for Swaps Executed as Part of Certain
Package Transactions (Nov. 10, 2014) (``NAL No. 14-137''); CFTC
Letter No. 15-55, Extension of No-Action Relief from the Commodity
Exchange Act Sections 2(h)(8) and 5(d)(9) and from Commission
Regulation Sec. 37.9 and No-Action Relief for Swap Execution
Facilities from Commission Regulation Sec. 37.3(a)(2) for Swaps
Executed as Part of Certain Package Transactions (Oct. 15, 2014)
(``NAL No. 15-55''); CFTC Letter No. 16-76, Re: Extension of No-
Action Relief from the Commodity Exchange Act Sections 2(h)(8) and
5(d)(9) and from Commission Regulation Sec. 37.9 and No-Action
Relief for Swap Execution Facilities from Commission Regulation
Sec. 37.3(a)(2) for Swaps Executed as Part of Certain Package
Transactions (Nov. 1, 2016) (``NAL No. 16-76''); CFTC Letter No. 17-
55, Re: Extension of No-Action Relief from Sections 2(h)(8) and
5(d)(9) of the Commodity Exchange Act and from Commission
Regulations 37.3(a)(2) and 37.9 for Swaps Executed as Part of
Certain Package Transactions (Oct. 31, 2017) (``NAL No. 17-55''). To
the extent that counterparties may be facilitating package
transactions that involve a ``security,'' as defined in section
2(a)(1) of the Securities Act of 1933 or section 3(a)(10) of the
Securities Exchange Act of 1934, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
\335\ The Commission notes that it similarly defines ``package
transaction'' under proposed Sec. 36.1(d)(1) for purposes of
providing an exemption to the trade execution requirement for swaps
that are executed as part of package that includes a bond issued in
a primary market. See infra Section XXI.A.4.--Sec. 36.1(d)--
Exemption for Swaps Executed with Bond Issuance.
---------------------------------------------------------------------------
The Commission recognizes that some package transactions contain
both a swap that is subject to the trade execution requirement and
other swap or non-swap components that are not subject to the
requirement. Components not subject to the requirement include, for
example, swaps not subject to the clearing requirement, e.g.,
swaptions, and various types of securities.\336\ The negotiation or
arrangement of each of these components generally occurs concurrently
or on a singular basis; in particular, negotiations for the pricing of
such package transactions may be primarily based on the components that
are not subject to the requirement. Further, the swap components in
those types of transactions that are subject to the requirement often
serve as hedging tools to other components. For those components not
subject to the requirement, market participants may negotiate the terms
away from a SEF.
---------------------------------------------------------------------------
\336\ Based on time-limited no-action relief issued by DMO, the
categories of package transactions that consist of components not
subject to the requirement include (i) U.S. Dollar Swap Spreads;
(ii) MAT/Agency MBS; (iii) MAT/New Issuance Bond; (iv) MAT/Futures;
(v) MAT/Non-MAT (Uncleared); (vi) MAT/Non-Swap Instruments; and
(vii) MAT/Non-CFTC Swaps. See supra note 334.
---------------------------------------------------------------------------
The Commission believes that imposing a prohibition on swaps
subject to the trade execution requirement that are part of a package
transaction that includes components not subject to the requirement
would inhibit the ability of counterparties to negotiate or arrange the
latter components away from the SEF.\337\ Given that components of
package transactions are each priced or quoted together as part of one
economic transaction, the Commission recognizes the impracticality of
requiring communications related to the negotiation or the arrangement
of the swap component that is subject to the trade execution
requirement to occur on the SEF. Accordingly, an exception from the
prohibition on pre-execution communications away from the SEF for swap
components subject to the requirement would be appropriate in such
circumstances.\338\ Consistent with its intent to incorporate existing
staff no-action relief into the Commission's regulations, the
Commission notes that the proposed exception would codify some of the
relief that currently applies to certain types of package
transactions.\339\
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\337\ Package transactions composed entirely of swaps that are
subject to the trade execution requirement would be subject to the
prohibition of pre-execution communications under proposed Sec.
37.201(b) and are not eligible for this proposed exception.
\338\ The Commission notes that a swaps broking entity that
facilitates trading in any swap component on behalf of multiple
participants, regardless of whether the swap is subject to the trade
execution requirement, would be subject to the SEF registration
requirement. See supra note 333.
\339\ Swap components in the following categories of package
transactions are currently subject to relief from the required
methods of execution under existing Sec. 37.9: (i) MAT/Non-MAT
(Uncleared); (ii) MAT/Non-Swap Instruments; and (iii) MAT/Non-CFTC
Swap. NAL No. 17-55 at app. A. Pursuant to this relief, the
Commission notes that SEFs have allowed market participants to
negotiate or arrange the swap components away from the SEF and
submit them for execution.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.201(b). In particular, the Commission seeks insights regarding
market participants' use of pre-execution communications and requests
comment on the following questions:
(29) What are market participants' current pre-execution
communication practices? How often do market participants currently
engage in pre-execution communication? What level of trade detail is
discussed during such pre-execution communications? What role, if any,
should pre-execution communications continue to have in the SEF market
structure?
(30) Is the Commission's proposal to require a SEF to prohibit
market participants from conducting pre-execution communications away
from a SEF with respect to swaps that are subject to the trade
execution requirement appropriate? In light of the Commission's
proposal to allow SEFs to offer flexible execution methods, are there
any impediments for market participants to execute those swaps, in
particular those that would become subject to the Commission's proposed
approach to the trade execution requirement?
(31) With respect to swaps that are not subject to the trade
execution requirement, is the Commission's proposal to allow SEFs to
permit market participants to conduct pre-execution communications away
from a SEF appropriate?
(32) Are there any technical limitations that a SEF would face to
accommodate pre-execution communications that would otherwise impede
the ability of market participants to trade and execute swaps on a SEF?
(33) Should the Commission allow an exception to the proposed
prohibition against pre-execution communications for communications
involving ``market color''? If so, how should the Commission define
``market color''? For example, should such a definition consist of
views shared by market participants on the general state of the market
or trading information provided on an anonymized and aggregated basis?
Should such a definition exclude (i) an express or implied arrangement
to execute a specified trade; (ii) non-public information regarding an
order; and (iii) information about an individual trading position? Are
these elements appropriate and should the Commission consider
additional elements?
(34) Should the Commission allow an exception to the proposed
prohibition against pre-execution communications for communications
intended to discern the type of transaction--which may or may not be a
swap--that a market participant may ultimately execute on a SEF? The
Commission understands that these types of communications are common in
the dealer-to-client market and allow a dealer to assist a client with
determining which financial instruments may be best suited to manage
the client's risks or to establish certain market positions. If so,
please describe the nature and scope of these communications that would
support an exception to the proposed prohibition.
(35) Should the Commission allow an exception to the proposed
prohibition against pre-execution communications for all corrective
trades intended to resolve error trades pursuant to the proposed error
trade policy rules under Sec. 37.203(e), as discussed further below?
Please explain why or why not.
[[Page 61989]]
(36) The Commission is proposing to allow market participants to
engage in pre-execution communications away from a SEF for package
transactions in which at least one component is not subject to the
trade execution requirement. For the swap components of some of these
package transactions that are currently traded and executed on SEFs--
for example, those where all other components are U.S. Treasury
securities--should they not be subject to this exception? Are there
other types of package transactions for which the Commission should
provide an exception to the proposed prohibition on pre-execution
communications?
3. Sec. 37.201(c)--SEF Trading Specialists
The Commission notes that a number of registered SEFs--in
particular, those that operate in the dealer-to-dealer market--offer
voice-based or voice-assisted execution platforms that utilize natural
persons to facilitate trading in varying degrees. These persons,
commonly referred to as ``trading specialists'' or ``execution
specialists,'' perform core functions that facilitate swaps trading and
execution in a multiple-to-multiple participant environment, including
disseminating trading interests to the market, e.g., transmitting RFQs
provided by participants; matching bids and offers; and negotiating or
arranging transaction terms and conditions on behalf of participants.
Many individuals currently carry out the same functions away from a
SEF as part of a swaps broking entity, such as an interdealer broker,
prior to execution of the transaction on the SEF.\340\ These swaps
broking entities are often registered with the Commission as IBs \341\
and these individuals are registered as associated persons of IBs.\342\
As associated persons of IBs, these persons are subject to various
regulatory requirements for intermediaries aimed at protecting
customers.\343\ As noted above, the Commission has proposed that these
swaps broking entities be registered as a SEF, given that they
facilitate trading.\344\
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\340\ See supra Section IV.C.1.c.(1)--Structure and Operations
of Swaps Broking Entities, Including Interdealer Brokers.
\341\ The Commission notes above that IBs are registered with
the Commission pursuant to CEA section 4f. See supra note 93 and
accompanying discussion. IBs and their associated persons are
required to register pursuant to registration procedures set forth
by the NFA. 17 CFR 3.10, 3.12. Section 170.17 requires that each IB
becomes and remains a member of at least one registered futures
association, e.g., the NFA. 17 CFR 170.17. Pursuant to CEA sections
4p and 17(p), such entities are subject to, among other requirements
administered by the registered futures association, training
standards and proficiency testing. 7 U.S.C. 6p, 21(p). Depending on
the category of intermediary, registrants may be subject to various
financial and reporting requirements, e.g., 17 CFR 1.10 (financial
reports of FCMs and IBs), 1.17 (minimum financial requirements for
FCMs and IBs), as well as trading standards, e.g., 17 CFR part 155
(trading standards for floor brokers, FCMs, and IBs). Pursuant to
CEA section 6c and part 180, all registrants are subject to
prohibitions against fraud and manipulation. 7 U.S.C. 9; 17 CFR part
180. Applicants for registration are subject to statutory
disqualifications from registration pursuant to CEA section 8a(2)
based on related past convictions that involve fraud or other acts
of malfeasance. 7 U.S.C. 12a(2).
\342\ Section 1.3 defines an ``associated person'' of an IB as
any natural person who is associated with an introducing broker as a
partner, officer, employee, or agent (or any natural person
occupying a similar status or performing similar functions), in any
capacity which involves the solicitation or acceptance of customers'
orders (other than in a clerical capacity) or the supervision of any
person or persons so engaged. 17 CFR 1.3.
\343\ See supra note 341. See also NFA Registration Rules part
400 (proficiency requirements established by the NFA for various
registered entities and associated person).
\344\ Upon adoption of the SEF Core Principles Final Rule, some
swaps broking entities, in particular interdealer brokers,
registered their operations or components of their operations, i.e.,
trading systems or platforms, as SEFs. See supra Section
IV.C.1.c.(1)--Structure and Operations of Swaps Broking Entities,
Including Interdealer Brokers. As part of this process, the
Commission understands that some specialists have transitioned to
the SEF from affiliated broker entities, in either a permanent
capacity or pursuant to a secondment arrangement.
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The Commission recognizes, however, that the current regulatory
requirements for swaps broking entities do not necessarily fully
address the unique functions of trading specialists on a SEF, which are
broader in scope than the traditional IB functions of solicitation or
acceptance of orders. SEF trading specialists serve an intermediary-
type role for each market participant that accesses their SEF by
facilitating fair, orderly, and efficient trading and overall market
integrity. From a regulatory perspective, the Commission believes that
SEF trading specialists--whether operating as part of a fully voice-
based system or as a voice-assisted system with electronic-based
features--are an integral part of their respective SEF's trading system
or platform.
A voice-based or voice-assisted SEF trading system or platform is
unique among SEF execution methods. Unlike a trading system or platform
that executes orders and facilitates trading through generally
automated means, trading specialists that comprise part of the voice-
based or voice-assisted systems usually exercise a level of discretion
and judgment in facilitating interaction between bids and offers from
multiple market participants. That discretion and judgment is informed
by their knowledge and understanding of market conditions, which are
based upon information obtained from observing historical activity and
gauging potential or actual trading interest from communications with
participants.
By allowing SEFs to offer flexible methods of execution and
broadening the trade execution requirement to swaps with more episodic
liquidity, the Commission believes that the proposed rulemaking would
lead to greater volumes of trading on voice-based trading systems or
platforms that utilize discretion and judgment. The use of these
methods should increase and enhance the utility of SEFs in a manner
consistent with the SEF statutory intent and goals, but the Commission
also believes that the expected increased role of discretion in SEF
trading operations should be accompanied with a regulatory approach
that aims to enhance professionalism among trading specialists and
enhance market integrity. The Commission believes in particular that
such a regulatory approach should address in particular the integral
role that trading specialists play in exercising that discretion in a
SEF's multiple-to-multiple trading environment.
Therefore, the Commission proposes to adopt a definition under
Sec. 37.201(c) that would categorize certain persons employed by a SEF
as a ``SEF trading specialist'' and require a SEF to ensure that any
such person (i) is not subject to a statutory disqualification under
CEA sections 8a(2) or 8a(3); (ii) has met certain proficiency
requirements; and (iii) undergoes ethics training on a periodic basis.
The proposed regulations would further require a SEF to establish and
enforce a code of conduct for its SEF trading specialists, as well as
diligently supervise their activities. These proposed rules are
intended to enhance professionalism in the swaps market and promote
market integrity.
a. Sec. 37.201(c)(1)--Definition of ``SEF Trading Specialist''
The Commission proposes to define a ``SEF trading specialist''
under Sec. 37.201(c)(1) as any natural person who, acting as an
employee (or in a similar capacity) of a SEF, facilitates the trading
or execution of swap transactions (other than in a ministerial or
clerical capacity), or who is responsible for direct supervision of
such persons. This proposed definition would include both persons
directly employed by the SEF and persons who are not directly employed,
such as independent contractors and persons who are serving as SEF
personnel pursuant to an arrangement with an affiliated broker
employer, i.e.,
[[Page 61990]]
``seconded'' persons. Based on the Commission's proposed application of
the SEF registration requirement, as described above, the Commission
notes that this definition would also apply to those persons who
facilitate swaps trading through swaps broking entities, including
interdealer brokers, who would be subject to SEF registration.\345\ As
noted above, facilitating the ``trading'' of swaps means the
negotiating or arranging swaps transactions; \346\ negotiating or
arranging consists of facilitating the interaction of bids and
offers.\347\ The proposed definition, however, would exclude SEF
personnel who facilitate trading solely in a ministerial or clerical
capacity because the activities of such employees do not involve the
level of discretion and judgement as the activities of SEF trading
specialists and, thus, do not implicate the same regulatory
concerns.\348\
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\345\ See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers and Section IV.C.1.d.--Foreign Swaps Broking Entities and
Other Foreign Multilateral Swaps Trading Facilities.
\346\ See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers.
\347\ Id.
\348\ The Commission notes that persons acting in a ministerial
or clerical capacity are subject to exceptions from other Commission
requirements. For example, the definition of ``associated person''
under Sec. 1.3 excludes a person who solicits or accepts customer
orders in a clerical capacity on behalf of an FCM or IB, or who
solicits or accepts swaps in a clerical or ministerial capacity on
behalf of an SD or MSP. 17 CFR 1.3.
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b. Sec. 37.201(c)(2)--Fitness
In light of the activities of SEF trading specialists and the
regulatory considerations discussed above, the Commission proposes
Sec. 37.201(c)(2)(i) to prohibit a SEF from permitting any person who
is subject to a statutory disqualification under CEA sections 8a(2) or
8a(3) to serve as a SEF trading specialist if the SEF knows, or in the
exercise of reasonable care should know, of the person's statutory
disqualification.\349\ CEA sections 8a(2) and 8a(3) set forth numerous
bases upon which the Commission may refuse to register a person,
including, without limitation, felony convictions, commodities or
securities law violations, and bars or other adverse actions taken by
financial regulators.\350\ While SEF trading specialists would not be
required to register with the Commission, the Commission believes that
given the nature of their interaction with market participants in
facilitating swaps trading and execution, as well as the central role
they play in maintaining market integrity and orderly trading, a SEF
should not be permitted to employ those who are subject to such a
statutory disqualification.
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\349\ The Commission notes that CEA section 4s(b)(6) makes it
unlawful for an SD or MSP to permit any person associated with the
SD or MSP who is subject to a statutory disqualification to effect
or be involved in effecting swaps on behalf of the SD or MSP, if the
SD or MSP knew, or in the exercise of reasonable care should have
known, of the statutory disqualification. 7 U.S.C. 6s(b)(6). This
prohibition applies with respect to an AP of an SD or MSP, but does
not include an individual employed in a clerical or ministerial
capacity. 17 CFR 23.22(a) (definition of ``person'' applicable to
the prohibition).
\350\ 7 U.S.C. 12a(2)-(3).
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The Commission, however, also proposes two exceptions to the
proposed prohibition. Under proposed Sec. 37.201(c)(2)(ii)(A), the
prohibition would not apply where a person is listed as a principal
\351\ or is registered with the Commission as an AP of a Commission
registrant or as a floor trader or floor broker, notwithstanding that
the person is subject to a disqualification from registration under
sections 8a(2) or 8a(3) of the Act. Pursuant to authority delegated to
it by the Commission,\352\ the NFA has permitted a person to be listed
as a principal or registered with the Commission where, in its
discretion, the NFA has determined that the incident giving rise to a
statutory disqualification is insufficiently serious, recent, or
otherwise relevant to evaluating the person's fitness. Under proposed
Sec. 37.201(c)(2)(ii)(B), the prohibition also would not apply where a
person subject to a statutory disqualification is not registered with
the Commission, but provides a written notice from a registered futures
association (``RFA'') stating that if the person were to apply for
registration as an AP, then the RFA would not deny the application on
the basis of the statutory disqualification. The Commission believes
that a statutory disqualification that has not or would not prevent a
person from being listed as a principal or from registering with the
Commission because it is insufficiently serious, recent, or otherwise
relevant to evaluating the person's fitness for registration with the
Commission, as determined by an RFA, should not be a basis for
prohibiting a SEF from employing the person as a SEF trading
specialist.
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\351\ Section 3.10(a)(2) requires each natural person who is a
principal of an applicant for registration to execute a Form 8-R to,
among other things, be listed as a principal of a registrant. 17 CFR
3.10(a)(2).
\352\ CEA section 8a(10) enables the Commission to authorize any
person to perform any portion of the registration functions under
the Act. 7 U.S.C. 12(a)(10). The Commission has delegated to the NFA
the authority to perform the full range of registration functions,
including vetting of applicants for statutory disqualifications.
See, e.g., 50 FR 34885 (Aug. 28, 1985); 57 FR 23136 (Jun. 2, 1992).
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c. Sec. 37.201(c)(3)--Proficiency Requirements
The Commission proposes to require a SEF to maintain proficiency
standards for SEF trading specialists. Proposed Sec. 37.201(c)(3)(i)
would require a SEF to establish and enforce standards and procedures
to ensure that its SEF trading specialists have the proficiency and
knowledge necessary to fulfill their responsibilities to the SEF and to
comply with the Act, applicable Commission regulations, and the SEF's
rules. Further, the Commission proposes under proposed Sec.
37.201(c)(3)(ii) to mandate that a SEF require any person employed as a
SEF trading specialist to have taken and passed a swaps proficiency
examination as administered by an RFA.\353\ Accordingly, SEFs would not
have to comply with the examination requirement until an RFA, such as
the NFA, completes development of the exam and establishes an
administration process. Pursuant to proposed Sec. 37.201(c)(3)(iii), a
SEF's compliance with the proficiency examination requirement would
constitute compliance with the general proficiency requirements upon
establishment of an exam and administration process by the RFA.\354\
Additionally, a SEF would satisfy the examination requirement if a SEF
trading specialist took and passed the examination once without any
further testing, unless the person has
[[Page 61991]]
not served in such a capacity for a continuous two-year period. In that
case, the SEF trading specialist would have to retake and pass the
examination.
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\353\ As proposed, the swaps proficiency examination would have
to be developed and administered by an RFA. The NFA currently
requires persons seeking to become members or associate members of
the NFA, or persons seeking to register with the Commission as an AP
to take and pass the National Commodity Futures Examination
(``Series 3 Exam''), which is administered by FINRA, subject to
certain exceptions. The Series 3 Exam does not test for swaps
proficiency. As a result, NFA Registration Rule 401(e) currently
provides an exception to the NFA's qualification testing requirement
for a person applying for registration with the Commission as an AP,
if the applicant's sole activities subject to regulation by the
Commission are swaps-related. NFA Registration Rule 401(e). The
Commission is aware that the NFA recently announced that it would
develop a swaps proficiency requirements program for all APs
engaging in swaps activities, including those of FCMs, IBs,
commodity pool operators (``CPOs''), commodity trading advisors
(``CTAs''), and individuals who act as APs at SDs. NFA, NFA to
Develop Swaps Proficiency Requirements Program,'' https://www.nfa.futures.org/news/newsRel.asp?ArticleID=5014 (Jun. 5, 2018).
\354\ The Commission clarifies, however, that in the absence of
an available examination that meets the Commission's requirements,
SEFs would still be required to ensure that their SEF trading
specialists meet the general proficiency requirements set forth
under proposed Sec. 37.201(c)(3)(i).
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Given the level of discretion and judgement that SEF trading
specialists exercise in facilitating swaps trading and execution, as
well as the size and complexity of the transactions often executed on a
SEF, the Commission believes that it is essential that a SEF ensure
that its SEF trading specialists possess appropriate skills and
knowledge. Accordingly, the Commission believes that demonstrating such
skills and knowledge would be best achieved through a swaps proficiency
examination regime. The Commission notes that persons who intermediate
transactions in the futures markets and securities markets are already
subject to proficiency requirements that include examinations.\355\ The
Commission believes that requiring SEFs to ensure that their SEF
trading specialists have the necessary skills and proficiency to
perform the key functions of a SEF would similarly enhance the level of
professionalism and market integrity in the swaps market.\356\
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\355\ In addition to the Series 3 Exam, which applies to persons
seeking membership with the NFA as an AP of a registered entity with
respect to futures and options on futures, see supra note 353,
persons who seek registration as a securities professional must also
pass various qualification exams to demonstrate competency in
particular securities-related areas. See generally FINRA,
Registrations and Qualifications, www.finra.org/industry/registration-qualification.
\356\ The Commission notes that this proposed requirement is
analogous to the principles set forth in the FX Global Code
regarding ethics. The code specifies, among other recommendations,
that operators of trading systems or platforms and their personnel,
have sufficient knowledge of, and comply with, applicable law and
have sufficient relevant experience, technical knowledge, and
qualifications. FX Global Code at 6-7.
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d. Sec. 37.201(c)(4)--Ethics Training
The Commission proposes Sec. 37.201(c)(4) to require a SEF to
establish and enforce policies and procedures to ensure that its SEF
trading specialists receive ethics training on a periodic basis. Given
each trading specialist's obligation to promote a fair and orderly
market in facilitating trading and execution while also using
discretion in handling orders on behalf of individual market
participants, a SEF must maintain a training program to ensure that its
trading specialists are aware of and understand the relevant
professional and ethical standards established by the SEF.\357\
Proposed Sec. 37.201(c)(4) is consistent with and would further a
SEF's existing obligation under Core Principle 12 to establish and
enforce rules that minimize conflicts of interest.\358\ Additionally,
the proposed rule corresponds to the existing requirement under Sec.
37.1501 that a SEF CCO establish and administer a written code of
ethics for the SEF that is designed to prevent ethical violations and
promote honesty and ethical conduct by the SEF's personnel.\359\ The
Commission also views ethics training as a necessary element of a SEF's
adequate supervision of its trading specialists and, accordingly,
proposes to require such supervision under Sec. 37.201(c)(6), as
described below.\360\ The Commission believes that the proposed
requirement would enhance professionalism in the overall swaps market
and promote swaps market integrity.
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\357\ As discussed above, this proposed requirement is similar
to one of the leading principles set forth in the Global FX Code
regarding ethical standards. The Global FX Code states, in part,
that firms should promote ethical values and behavior, support
efforts to promote such ethical standards in the wider FX market,
and encourage involvement by personnel in such efforts. FX Global
Code at 6-7.
\358\ 7 U.S.C. 7b-3(f)(12).
\359\ See infra Section XX.A.3.--Sec. 37.1501(c)--Duties of
Chief Compliance Officer (requirement under proposed Sec.
37.1501(c)(6)).
\360\ See infra Section VI.A.3.f.--Sec. 37.201(c)(6)--Duty to
Supervise.
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(1) Guidance to Core Principle 2 in Appendix B--Ethics Training
The Commission also proposes new guidance to Core Principle 2 in
Appendix B that would provide the general objectives for an ethics
training program and examples of topics that should be addressed.\361\
The guidance provides SEFs with the latitude to determine the
appropriate frequency, duration, and format of ethics training for its
trading specialists, including the use of qualified third-party
providers and various forms of technology and media. The proposed
guidance, however, specifies that an ethics training program is
essential to enable SEF trading specialists to remain current with
respect to the ethical and regulatory implications of evolving
technology, trading practices, products, and other relevant changes.
For example, if a SEF's trading protocols or operations continue to
develop, e.g., the SEF adopts a new discretionary approach to
prioritizing or managing competing bids on its voice-based or voice-
assisted trading system, then the SEF's ethics training should address
how its trading specialists should appropriately conduct themselves
under such new protocols. This approach is generally consistent with
the Commission's implementation of the training requirements applicable
to Commission registrants under CEA section 4p(b), as set forth in
acceptable practices established by the Commission for ethics training
for registered persons under part 3 of the Commission's
regulations.\362\
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\361\ The Commission proposes to add this guidance as a new
paragraph (a)(1) and eliminate existing paragraph (a)(1), which
states that a SEF's rules may authorize its compliance staff to
issue warning letters or recommend that a disciplinary panel take
such action. See infra note 456 (discussing proposed changes to the
existing SEF warning letter requirements).
\362\ 17 CFR part 3 app. B (Statement of Acceptable Practices
With Respect to Ethics Training).
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e. Sec. 37.201(c)(5)--Standards of Conduct
The Commission proposes to require a SEF to establish and enforce a
code of conduct for its SEF trading specialists. Like the proposed
ethics training requirement under Sec. 37.201(c)(4), the proposed code
of conduct requirement aims to ensure that SEFs foster and maintain a
high level of professionalism, integrity, and ethical conduct among
their trading specialists when dealing with market participants and
facilitating trading and execution. A SEF's code of conduct may provide
that, among other things, a SEF trading specialist should (i) act in an
honest and ethical manner and observe high standards of
professionalism; (ii) handle orders with fairness and transparency; and
(iii) not engage in fraudulent, manipulative, or disruptive conduct.
The Commission includes these items for SEF consideration, but a SEF
may include different or additional standards as well. These proposed
standards of conduct are intended to be general and principles-based,
given the many unique aspects of a SEF trading specialist's role in
facilitating trading and execution as part of the SEF's particular
trading system or platform.
f. Sec. 37.201(c)(6)--Duty To Supervise
To help promote compliance with a SEF's professionalism
requirements, including ethics requirements and standards of conduct,
the Commission also proposes Sec. 37.201(c)(6) to require a SEF to
diligently supervise the activities of its trading specialists in
facilitating trading and execution on the SEF. While a SEF is generally
responsible for the actions of its agents pursuant to CEA section
2(a)(1)(B) and Sec. 1.2,\363\ proposed Sec. 37.201(c)(6) would impose
an affirmative duty of supervision on each SEF. Given the dynamic
manner in
[[Page 61992]]
which SEF trading specialists may use discretion to facilitate swaps
trading and execution on behalf of market participants, a SEF should
have an affirmative obligation to supervise its trading specialists.
The Commission notes that a similar customer protection rule currently
applies to registered entities, including IBs--Sec. 166.3 requires
each Commission registrant to diligently supervise all the activities
of its partners, officers, employees and agents (or persons occupying a
similar status or performing a similar function) relating to its
business as a Commission registrant.\364\ Therefore, to the extent that
some of these SEFs were previously registered with the Commission and
operated as IBs, the Commission believes that proposed Sec.
37.201(c)(6) would impose certain analogous requirements.
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\363\ CEA section 2(a)(1)(B) and Sec. 1.2 establish that the
act, omission, or failure of any official, agent, or other person
acting for a principal within the scope of his employment or office
is imputed to the principal. 7 U.S.C. 2(a)(1)(B); 17 CFR 1.2.
\364\ 17 CFR 166.3.
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g. Sec. 37.201(c)(7)--Additional Sources for Compliance
The Commission is proposing Sec. 37.201(c)(7) to refer SEFs to the
new guidance to Core Principle 2 in Appendix B as discussed above.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.201(c). In particular, the Commission requests comment on the
following questions:
(37) Is the proposed definition of the term ``SEF trading
specialist'' overly broad or too narrow? Are there additional
activities that SEF trading specialists engage in that should be
reflected in the definition? Are there additional natural persons who
should be captured by the proposed definition?
(38) Are the exceptions to the fitness requirement for SEF trading
specialists under proposed Sec. 37.201(c)(2)(ii) appropriate? Should
the Commission prohibit a SEF from employing persons other than those
subject to a statutory disqualification under CEA sections 8a(2) or
8a(3)? If so, what additional disqualification factors should the
Commission use? In this connection, should the Commission not rely on
any of the disqualification factors in CEA sections 8a(2) or 8a(3)?
(39) Should the qualification testing requirement under proposed
Sec. 37.201(c)(3)(ii) be broadened to allow a SEF to employ persons
who have taken and passed a swaps proficiency examination developed and
administered by parties other than an RFA? If so, should the Commission
then adopt standards to ensure that such testing adequately ensures
proficiency? How could the Commission ensure that the examination meets
appropriate standards and consistency, such that it could be recognized
by all SEFs? Should the Commission approve each examination to ensure
appropriate standards are met and consistency is achieved across
different examinations?
(40) Are the ethics training and standards of conduct requirements
under proposed Sec. Sec. 37.201(c)(4)-(5), respectively, overly
prescriptive or too flexible? Should the Commission provide greater
specificity regarding the standards of conduct that a SEF must enforce?
Are there particular subjects that should be specifically required as
part of ethics training?
VII. Additional Part 37 Regulations--Subpart C: Core Principle 2
(Compliance With Rules)
In addition to requiring a SEF to establish and enforce rules that
govern its facility, Core Principle 2 requires a SEF to adopt trading,
trade processing, and participation rules that provide participants
with impartial access to the market and deter abuses; and establish and
enforce compliance with any limitation on access.\365\ Further, Core
Principle 2 requires a SEF to have the capacity to detect, investigate,
and enforce those rules, including the means to capture information
that may be used in identifying rule violations.\366\ The Commission
adopted many detailed regulations in part 37 to further implement these
requirements, including impartial access requirements under Sec.
37.202; rule enforcement program requirements under Sec. 37.203;
third-party service provider requirements under Sec. 37.204; audit
trail requirements under Sec. 37.205; and disciplinary procedures and
sanctions requirements under Sec. 37.206.
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\365\ 7 U.S.C. 7b-3(f)(2)(B)(i).
\366\ 7 U.S.C. 7b-3(f)(2)(B)(ii).
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The Commission is proposing several new rules and rule amendments
under Core Principle 2, including clarifications of existing rules
where appropriate, to implement its proposed swaps regulatory
framework. These proposed amendments would streamline the SEF rules and
allow SEFs to account for technological developments, existing market
practices, and costs in their trading and market operations. Further,
the amendments would codify no-action relief that has been provided
under several existing Commission staff no-action letters. Among these
changes, the Commission is proposing a modification to the impartial
access requirements under Sec. 37.202 and several corresponding
amendments, which would provide a SEF with the ability to devise its
participation criteria based on its own trading operations and market
focus. Further, the Commission is proposing several amendments to
Sec. Sec. 37.203-206 that would allow a SEF to better tailor its own
compliance and regulatory oversight rules to its trading operations and
markets, while still maintaining a robust compliance program.
A. Sec. 37.202 Access Requirements
The Commission implemented the statutory impartial access
requirement by adopting Sec. 37.202. Existing Sec. 37.202(a)(1)
requires a SEF to provide any ECP and any independent software vendor
(``ISV'') with impartial access to its market(s) and market services,
including indicative quote screens or any similar pricing data
displays, provided that the facility has, among other things, criteria
governing such access that are ``impartial, transparent, and applied in
a fair and non-discriminatory manner.'' \367\ In the preamble to the
SEF Core Principles Final Rule, the Commission stated that
``impartial'' means ``fair, unbiased, and unprejudiced.'' \368\ The
Commission further stated that the impartial access requirement allows
ECPs to ``compete on a level playing field'' \369\ and does not allow a
SEF to ``limit access . . . to certain types of ECPs or ISVs.'' \370\
The Commission also noted that each similarly situated group of ECPs
and ISVs must be treated similarly.\371\ The Commission believed that
this approach would increase the number of market participants on SEFs,
which in turn would increase SEF trading, thereby improving liquidity
and price discovery in the swaps market.\372\
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\367\ 17 CFR 37.202(a)(1).
\368\ SEF Core Principles Final Rule at 33508.
\369\ Id.
\370\ Id.
\371\ Id.
\372\ Id.
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Core Principle 2, however, also allows a SEF to establish and
enforce compliance with any rule of the SEF, including any limitation
on access to the SEF.\373\ Accordingly, existing Sec. 37.202(c)
requires a SEF to establish and impartially enforce rules that govern
the SEF's decision to allow, deny, suspend, or permanently bar ECPs'
access to the SEF, including when such decisions are made as part of a
disciplinary or emergency action by the SEF.\374\ The Commission
further stated that a SEF may establish different access criteria for
each of its markets, provided that the criteria are impartial and are
not
[[Page 61993]]
used as a competitive tool against certain ECPs and ISVs.\375\ Subject
to these requirements, the Commission stated that a SEF may ``use its
own reasonable discretion to determine its access criteria, provided
that the criteria are impartial, transparent and applied in a fair and
non-discriminatory manner, and are not anti-competitive.'' \376\
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\373\ 7 U.S.C. 7b-3(f)(2)(A)(ii).
\374\ 17 CFR 37.202(c).
\375\ SEF Core Principles Final Rule at 33508.
\376\ Id.
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Existing Sec. 37.202(a)(3) requires a SEF to have a comparable fee
structure for ECPs and ISVs receiving comparable access to, or services
from, the SEF.\377\ The Commission clarified that this requirement
neither sets nor limits fees that a SEF may charge.\378\ The Commission
further clarified that a SEF may establish different categories of ECPs
and ISVs seeking access to, or services from, the SEF, but may not
discriminate with respect to fees within a particular category.\379\
The Commission stated that existing Sec. 37.202(a)(3) is not intended
to be a ``rigid requirement that fails to take into account legitimate
business justifications for offering different fees to different
categories of entities seeking access to the SEF.'' \380\
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\377\ 17 CFR 37.202(a)(3).
\378\ SEF Core Principles Final Rule at 33509.
\379\ Id.
\380\ Id.
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Finally, existing Sec. 37.202(a)(2) requires SEFs to have
procedures for ECPs to provide written or electronic confirmation of
their ECP status with the SEF prior to obtaining access.\381\ Under
existing Sec. 37.202(b), an ECP must consent to a SEF's jurisdiction
prior to obtaining access to the SEF.\382\
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\381\ 17 CFR 37.202(a)(2).
\382\ 17 CFR 37.202(b).
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1. Sec. 37.202(a)--Impartial Access to Markets, Market Services, and
Execution Methods \383\
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\383\ The Commission proposes to retitle Sec. 37.202(a) to
``Impartial access to markets, market services, and execution
methods'' from ``Impartial access to markets and market services''
based on the proposed changes described below.
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The Commission has applied the impartial access requirements to
various areas of a SEF's operations that concern participant access to
the market. These features include (i) eligibility or onboarding
criteria; (ii) a participant's ability to access the SEF's
functionalities, i.e., trade and execute on a SEF's execution methods;
(iii) the manner in which a SEF's execution methods treat market
participants' bids and offers, in particular the use of discretion; and
(iv) participation fee structures. The Commission's current approach to
impartial access in these areas, however, has raised two issues that
have led to certain inconsistencies in implementation of the
requirement.
First, the existing approach has created uncertainty for SEFs
seeking to establish and apply access criteria in a consistent manner.
The Commission recognizes that SEF Core Principle 2 requires a SEF to
provide impartial access, but also allows a SEF to establish
limitations on access. Accordingly, the Commission has allowed SEFs to
establish different access criteria for different markets, but has also
required each ``similarly situated'' group of ECPs and ISVs to be
treated in the same manner.\384\ The preamble to the SEF Core
Principles Final Rule also states that SEFs can use their own
reasonable discretion to determine their access criteria, provided that
they are impartial. In practice, implementation of the rule has led to
some uncertainty by SEFs as to whether different access criteria for
their markets, market services, and execution methods would be allowed
or not allowed under Sec. 37.202.
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\384\ SEF Core Principles Final Rule at 33508.
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Second, the manner in which the Commission has implemented the
existing approach has often favored the promotion of an ``all-to-all''
trading environment and has, thus, limited the ability of SEFs to adapt
their operations to the characteristics and dynamics of the swaps
market.\385\ All-to-all trading environments, such as futures markets,
are generally marked by smaller-sized products with standardized terms
and conditions that appeal to a broad range of market participants,
including retail customers. These same characteristics are also more
conducive to continuous and liquid trading. By contrast, swaps trading
often occurs between a limited number of ECPs in a broad array of
unique, larger-sized products with more variable terms that are
customized to address specific and unique hedging risks. These
characteristics result in episodic market liquidity in many swaps
markets, in contrast to the continuous liquidity found in all-to-all
trading environments. The Commission believes that the imposition of
features found in an ``all-to-all'' trading environment upon swaps
markets is at odds with general market characteristics and dynamics of
swaps trading.
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\385\ Id.
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a. Sec. 37.202(a)(1)--Impartial Access Criteria
Based on its experience with implementing part 37, the Commission
proposes to modify its approach to applying the impartial access
requirement. In doing so, the Commission proposes to streamline and
consolidate the existing language and relevant preamble discussion from
the SEF Core Principles Final Rule, including the Commission's view of
``impartial'' and the concept of ``similarly situated,'' to establish a
revised impartial access requirement. Under proposed Sec.
37.202(a)(1), a SEF would be required to establish rules that set forth
impartial access criteria for accessing its markets, market services,
and execution methods, including any indicative quote screens or any
similar pricing data displays. Such impartial access criteria must be
transparent, fair and non-discriminatory and applied to all or
similarly situated market participants.
In proposing this approach, the Commission believes that criteria
that are ``fair and non-discriminatory'' would inherently be ``fair,
unbiased, and unprejudiced,'' which the Commission previously defined
as ``impartial.'' The Commission also believes that the proposed rule
clarifies that this criteria must be applied to market participants in
a fair and non-discriminatory manner, as currently required under the
existing requirements of Sec. 37.202(a)(1). Finally, proposed Sec.
37.202(a)(1) would continue to allow each SEF to determine which market
participants are ``similarly situated'' in its market and configure
appropriate access criteria, provided that such criteria are
transparent, fair, and non-discriminatory to participants. Applying
access criteria in a ``fair and non-discriminatory'' manner means that
a SEF should permit or deny access to a market participant on a non-
arbitrary basis, based on objective, pre-established requirements or
limitations. The Commission emphasizes, however, that this streamlined
approach does not mean that a SEF must create an ``all-to-all'' trading
environment.
The Commission acknowledges that it has often applied the impartial
access requirement to promote an ``all-to-all'' trading environment,
which is neither required under Core Principle 2 nor is consistent with
swaps market structure. Under the proposed approach, the Commission
would not seek to apply the requirement to mandate that all
participants have access to all SEFs, which may have circumscribed a
SEF's ability under Core Principle 2 to set access limitations. Rather,
to allow SEFs to serve different types of market participants or have
different access criteria for different execution methods, the
Commission would allow SEFs to apply access limitations, as long as
they
[[Page 61994]]
are applied in a fair and non-discriminatory manner.
This approach would also align with swaps market characteristics--
in particular, the episodic nature of swaps liquidity--that have led to
the overall swaps market being made up of both dealer-to-client and
dealer-to-dealer markets, as described below. The Commission believes
that the structure of the swaps market is a natural outgrowth of
certain fundamental features of swaps trading. The Commission further
believes that all-to-all markets are inimical to these fundamental
swaps trading features; therefore, imposing all-to-all, market-derived
requirements on swaps markets ultimately detracts from achieving the
statutory SEF goals of promoting swaps trading on SEFs and pre-trade
price transparency in the swaps market. Accordingly, the Commission
believes that each SEF should be able to use access criteria to develop
its business in a manner that is both consistent with the
characteristics of swaps markets and accommodating of the types of
participants that comprise the SEF's intended market.
The Commission still believes that any access criteria intended to
prevent or reduce competition among similarly situated market
participants would be unfair and discriminatory and, therefore,
inconsistent with proposed Sec. 37.202(a)(1). If a market participant
is willing or able to meet the objective, pre-established, and
transparent criteria for eligibility to onboard to a SEF or gain
additional access to a SEF's trading mechanisms, then the SEF should
not preclude that market participant from onboarding to the SEF or
using its functionalities. Accordingly, such a market participant
should not be subject to access criteria that are unfair and
discriminatory and are intended to prevent or dis-incentivize that
market participant's participation on the SEF.\386\
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\386\ The Commission also notes that such criteria may be
inconsistent with Core Principle 11. Core Principle 11 prohibits a
SEF from adopting measures that result in any unreasonable restraint
of trade or impose any material anticompetitive burdens on trading
or clearing, unless they are necessary or appropriate to achieve the
purposes of the CEA and are otherwise consistent with the CEA and
the Commission's regulations. 17 CFR 37.1100.
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The Commission emphasizes that under proposed Sec. 37.202(a)(1),
any access criteria--whether it concerns eligibility or onboarding
criteria, prerequisites for using certain trading functionalities, or
fee schedules--constitutes a ``rule,'' as that term is defined under
Sec. 40.1(i), that would be subject to rule approval or self-
certification procedures under part 40.\387\ Through the part 40 rule
review process, the Commission would continue to evaluate a SEF's
compliance with the impartial access requirements as proposed.
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\387\ 17 CFR 40.5-6.
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The Commission also proposes to eliminate the reference to
``ISVs,'' which the Commission notes is not required under Core
Principle 2. Given that a SEF should be able to set its access criteria
to develop its business based on its desired market and participant
needs, the Commission also believes that a SEF should be able to
determine an ISV's level of access to the SEF. The Commission
previously applied the impartial access requirement to ISVs on the
basis that such types of vendors would provide various benefits to the
swaps market and market participants, such as enhanced transparency and
trading efficiency through the consolidation of trading data from
multiple venues, analytics, and best displayed prices.\388\ Based on
the Commission's experience and notwithstanding the existing impartial
access requirement, ISVs have not established a significant level of
participation on SEFs, nor have they achieved a broad level of adoption
among market participants. Rather, the Commission has observed that
most participants access SEFs through means other than ISV
services.\389\ Therefore, the Commission believes that the impartial
access requirement should apply to market participants who are
accessing SEF trading systems or platforms to trade swaps, rather than
establish requirements for a separate set of entities that are merely
providing ancillary market services.
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\388\ The Commission previously cited examples of ISVs that
included smart order routers, trading software companies that
develop front-end trading applications, and aggregator platforms.
SEF Core Principles Final Rule at 33508 n.423.
\389\ See supra notes 52-54 (describing the various modes of
participation on SEFs by market participants).
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(1) Application of Impartial Access Requirement
Based on the areas in which the Commission has applied the existing
impartial access requirement to various aspects of a SEF's operation
during the part 37 implementation, the Commission discusses below how
the proposed impartial access approach would apply to these areas to
provide further clarity, including (i) eligibility and onboarding; (ii)
execution methods; and (iii) SEF use of discretion.
(i) Eligibility and Onboarding Criteria
The Commission has applied the impartial access requirement to
assess a SEF's eligibility and onboarding criteria. In the preamble to
the SEF Core Principles Final Rule, the Commission prospectively
identified whether or not certain hypothetical arrangements would
comply with the rulemaking's approach to impartial access. Certain
criteria were deemed non-compliant, such as platforms whose
participants were limited to wholesale liquidity providers; \390\
platforms that imposed participation limits based on maintaining
financial integrity and operational safety; \391\ platforms that
established objective minimum capital or credit requirements; \392\ and
platforms that limited participation to sophisticated market
participants.\393\ The Commission generally characterized these types
of criteria as inconsistent with Core Principle 2 because they would
inherently limit access to certain types of ECPs and ISVs.\394\
Subsequent Commission staff guidance further identified other
eligibility criteria that Commission staff viewed as inconsistent with
impartial access, based on the view that limiting access to a SEF's
trading systems or platforms to certain types of ECPs or ISVs is
inconsistent with Core Principle 2.\395\
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\390\ SEF Core Principles Final Rule at 33507-08.
\391\ Id.
\392\ Id. at 33507.
\393\ Id.
\394\ Id. at 33508.
\395\ These criteria included (i) not providing access to an ECP
that is both a liquidity provider and taker; (ii) prohibiting
individuals from obtaining access despite their meeting the
requirements to be an ECP; (iii) limiting access to ECPs that
satisfy minimum transaction volume level requirements; and (iv)
requiring an ECP to be a clearing member or to have an agreement
with a clearing member to access the SEF, even if only for the
purpose of trading swaps that are not intended to be cleared.
Commission staff also expressed concern that SEFs allowing only
either intermediated access or direct access may impede impartial
access in certain instances. Division of Clearing and Risk, Division
of Market Oversight and Division of Swap Dealer and Intermediary
Oversight Guidance on Application of Certain Commission Regulations
to Swap Execution Facilities (Nov. 14, 2013) (``2013 Staff Impartial
Access Guidance'').
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The Commission has realized from experience that certain criteria
developed by SEFs reflect fundamental swap market segments. In
particular, the swaps market consists of both a dealer-to-client market
segment and a dealer-to-dealer market segment that are related, but
also differ in important respects. In the dealer-to-client segment,
corporate end-users and other buy-side participants access and utilize
the swaps market to manage risk positions
[[Page 61995]]
that are unique to their particular circumstances. Swap dealers provide
liquidity to the participants within this market segment for a fee,
which participants are willing to pay, that reflects the risks incurred
by dealers from the episodic or relative lack of liquidity in the swaps
market for many specific swaps. The swap dealers subsequently offset
positions established through the dealer-to-client market segment by
hedging their swaps inventories on a portfolio basis in the dealer-to-
dealer market, which is wholesale in nature. Those dealer-to-dealer
markets consist of other primary dealers and sophisticated market-
making participants seeking to fulfill similar objectives through
competitive execution of large-sized transactions. In pricing a
customer trade, dealers base their prices on the cost of hedging those
trades in the dealer-to-dealer markets.
The dealer-to-dealer market may provide benefits to the swaps
markets, in particular to non-dealer clients, by allowing dealers who
provide liquidity to offload risk from clients. Without this market,
liquidity in the dealer-to-client market may suffer because the
inherent risks of holding swaps inventory could arguably dis-
incentivize participation by dealers in the dealer-to-client market or
otherwise require dealers to charge their customers higher prices for
taking on this risk. Absent the supply of liquidity providers, non-
dealers who are liquidity takers would have difficulty executing swaps
at competitive pricing. SEFs that serve the wholesale, dealer-to-dealer
market have stated that using eligibility or participation criteria to
maintain a dealer-to-dealer market is beneficial, given that it allows
participants who share similar profiles and trading interests to
interact with each another, thereby helping to promote liquid markets
with tight pricing.
For the reasons stated above, the Commission believes that SEF
eligibility and onboarding criteria that would serve to maintain this
market structure would be appropriate and consistent with existing
market dynamics and may provide the benefits discussed above.
Accordingly, a SEF could premise these criteria in different ways, such
as limiting access upon the type of the market participant or the swap
product itself. For example, a SEF would be able to calibrate access to
serve market participants within a particular market segment, such as
dealers trading in a wholesale swaps market, who may be categorized as
``similarly situated.''
(ii) Access to Execution Methods
In addition to assessing SEF onboarding and eligibility, the
Commission has also applied the current impartial access standard to
evaluate various SEF-established prerequisites for trading on certain
platforms or interacting with certain participants. Some of those
prerequisites reflect the nature of the swap involved, e.g., whether
the swap is submitted for clearing or is uncleared, which determines
whether certain market participants are eligible to trade with one
another.\396\ When a SEF lists a swap that is traded as a component of
a transaction with other non-swap legs, the SEF might also establish
trading eligibility criteria that take account of a participant's
ability to trade the non-swap leg components of such swaps.\397\ Other
prerequisites may be based upon the prior or ongoing level of trading
activity generated by a particular participant, e.g., whether the
participant has been actively submitting bids and offers. During the
implementation of part 37, the Commission has deemed appropriate
certain criteria based on business or operational justifications, but
also deemed other criteria as inconsistent with impartial access. For
example, platform access criteria that require a market participant to
contribute a certain amount of liquidity, e.g., provide a minimum
number of bids and offers, have been prohibited, despite the business
or operational justifications offered by SEFs.
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\396\ Such a situation might result in a SEF limiting trading
access to uncleared swaps to only those market participants who have
existing underlying documentation to execute such swaps with other
potential counterparties.
\397\ For example, a SEF could require market participants (or
their clearing members) to have membership in a particular clearing
organization, e.g., membership with the Fixed Income Clearing
Corporation (``FICC''), in order to access a method of execution in
which counterparties execute a package transaction with a non-swap
leg that FICC must clear.
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SEFs have also argued that requiring market participants to meet
trading prerequisites or participation criteria to access certain
platforms or trade certain products can be beneficial to promoting
effective trading markets on SEFs. In implementing part 37, the
Commission has acknowledged that such criteria may be beneficial toward
maintaining and promoting orderly trading for uncleared swaps on SEFs--
for example, where participants must have certain trading enablements
in place prior to trading uncleared swaps with other participants on
the platform.\398\ Specifically, the Commission has allowed such types
of enablements, e.g., trading relationship documentation with a minimum
percentage of trading participants prior to posting bids and offers or
trading in certain established minimum sizes, to promote a more dynamic
and liquid trading environment for uncleared swaps with active
participation.\399\
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\398\ The Commission notes that Commission staff previously used
the term ``enablement mechanism'' in guidance to refer to ``any
mechanism, scheme, functionality, counterparty filter, or other
arrangement that prevents a market participant from interacting or
trading with, or viewing the bids and offers (firm or indicative)
displayed by any other market participant on that SEF, whether by
means of any condition or restriction on its ability or authority to
display a quote to any other market participant or to respond to any
quote issued by any other market participant on that SEF, or
otherwise.'' 2013 Staff Impartial Access Guidance at 1.
\399\ The Commission notes that Commission staff previously
viewed a SEF's application or support otherwise for enablement
mechanisms with respect to swaps that were intended to be cleared as
``prohibited discriminatory treatment,'' that is inconsistent with
the existing impartial access requirement under Sec. 37.202. Id. at
1-2.
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The Commission's current approach to impartial access, however, has
led to confusion as to whether these types of criteria are
inappropriate because they do not ensure equal participation by all
market participants; or as to whether they are appropriate because they
reflect a SEF's ability to impose limitations on access and are
consistent with the view that SEFs should have the discretion to
determine the most suitable way to promote trading on their platforms.
Specifically, the Commission recognizes that requiring impartial access
for ``similarly situated'' groups of market participants has currently
been interpreted to require that a SEF allow all participants in that
group to be able to interact with one another in the same manner and
degree.
The Commission clarifies that a SEF must have impartial access
criteria, i.e., transparent, fair, and non-discriminatory, for trading
prerequisites or participation criteria prior to accessing certain
platforms or trading certain products. As long as these access criteria
are impartial, such that any market participant who meets the criteria
is able to utilize a certain execution method or trade a certain
product, then they would be allowed to do so under the proposed
approach. For example, if a SEF established a minimum trade size for
its order book that applied to a market participant's orders, then such
criteria would be allowed if any of its market participants who met
these criteria could trade on the order book. As noted above, Core
Principle 2 does not require a SEF to create an ``all-to-all''
marketplace, and the Commission believes that SEFs should be allowed to
establish criteria that would facilitate trading based on its products
and the intended trading environment. As long as a SEF also
[[Page 61996]]
applies its impartial access criteria in a fair and non-discriminatory
manner, as described above, the Commission believes that such criteria
would comply with Sec. 37.202(a)(1).
(iii) Use of Discretion
The Commission has also previously determined whether a SEF
complies with the impartial access requirement based on how the SEF's
trading systems or platforms handle participant orders. For example, a
SEF's voice-based or voice-assisted execution methods involve the
exercise of ``discretion'' by a SEF trading specialist in managing the
interaction of multiple bids and offers from multiple participants. As
described above, SEF trading specialists solicit orders on behalf of
the SEF and seek to arrange transactions by matching those orders with
reciprocal trading interests.\400\ Given the variability in how
participant orders may be handled through the use of discretion, the
Commission has sought to ensure that market participants are receiving
``impartial access'' in the manner in which their orders are handled
while also acknowledging that discretion is inherent to these types of
systems or platforms.
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\400\ For the Commission's previous description of the role of
SEF trading specialists, who function as part of a SEF's voice-based
or voice-assisted trading system or platform, and their use of
discretion, see supra Section VI.A.1.b.--Sec. 37.201(a)(2)--
Discretion and Section VI.A.3.--Sec. 37.201(c)--SEF Trading
Specialists.
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The Commission also recognizes that its current approach to
impartial access may be in tension with its proposal to allow more
flexible execution methods on SEFs, particularly those that involve
discretion and are prevalent in the dealer-to-dealer market. While some
SEF execution methods facilitate trading and execution on a non-
discretionary basis, e.g., electronic trading systems, including Order
Books and RFQ Systems, some execution methods rely upon the ability of
a SEF trading specialist to ascertain liquidity for particular products
and manage multiple competing bids and offers, e.g., voice-based
platforms. To facilitate trading and execution in such a trading
environment, SEF trading specialists must account for a host of
changing market conditions, such as available pricing, product
complexity, prevailing trade sizes, and market participant needs. The
Commission recognizes that SEF trading specialists may apply these
factors differently among different participants during different
periods of trading. In contrast to prevailing practices among swaps
broking entities, such as interdealer brokers that have operated
outside of the SEF regulatory framework,\401\ the Commission has
scrutinized similar practices on SEF voice-based platforms against the
impartial access requirements. The Commission acknowledges that its
application of impartial access at times has constrained the ability of
SEFs to establish trading systems or platforms that serve particular
segments of the swaps marketplace.
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\401\ As discussed above, the Commission is clarifying the
application of the SEF registration requirement in this notice to
specify that these types of entities are subject to SEF registration
based on their activity in facilitating trading and execution in
swaps on a multiple-to-multiple basis between market participants.
See supra Section IV.C.1.c.(2)--SEF Registration Requirement for
Swaps Broking Entities, Including Interdealer Brokers.
---------------------------------------------------------------------------
The Commission also believes that the trading discretion exercised
by SEF trading specialists may affect the manner in which market
participants are treated on a facility, but would not necessarily be
inconsistent with the Commission's proposed approach to impartial
access. The Commission believes that to the extent that the exercise of
discretion furthers a SEF's ability to facilitate trading and execution
on its system or platform--including identifying trading interest in a
discrete manner or managing bids and offers to maintain accurate market
pricing--it should be viewed as being consistent with impartial access.
The Commission also notes that proposed Sec. 37.201(a)(2) would
support the use of discretion in a manner consistent with impartial
access; as discussed above, the proposed rule would provide
transparency into the use of discretion by requiring each SEF to
disclose the general manner and circumstances behind its use within
each execution method.\402\ Notwithstanding proposed Sec.
37.201(a)(2), however, the Commission emphasizes that a SEF would still
be required to ensure that any use of trading discretion occurs in a
fair and non-discriminatory manner.
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\402\ See supra Section VI.A.1.b.--Sec. 37.201(a)(2)--
Discretion and Section VI.A.3.--Sec. 37.201(c)--SEF Trading
Specialists.
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b. Sec. 37.202(a)(2)--Fees
Based on its experience in reviewing fee structures for SEFs, the
Commission proposes to eliminate the requirement under Sec.
37.202(a)(3) that a SEF must establish ``comparable fee structures''
for ECPs and ISVs receiving ``comparable access'' to the SEF or
services from the SEF. In practice, this requirement has not fully
accounted for the market practices described above. Instead, the
Commission proposes Sec. 37.202(a)(2) to require a SEF to establish
and apply fee structures and fee practices in a fair and non-
discriminatory manner to its market participants.\403\
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\403\ To further streamline the other existing impartial access
requirements, the Commission proposes to renumber existing paragraph
(a)(2), which requires confirmation of a participant's ECP status,
to subsection (c); and to renumber existing paragraph (a)(3), which
addresses SEF fee requirements, to paragraph (a)(2). The Commission
also proposes to renumber subsection (c)--``Limitations on
access''--to subsection (b) and to amend that existing language, as
described below. Accordingly, the Commission also proposes to
renumber existing subsection (b)--``Jurisdiction''--to subsection
(d).
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Currently, SEFs have established different fee levels for different
categories of market participants or different types of trading
activity, whether imposed directly through a trading fee schedule or
indirectly through the use of trading incentive or discount
programs.\404\ The Commission has observed that SEFs have generally
based their fees or discounts on a host of different considerations,
such as technological costs attributable to facilitating a particular
method of accessing the platform or a listed product's complexity. In
particular, fee-setting arrangements for swaps trading in the dealer-
to-dealer segment, which includes interdealer broker operations that
would become subject to the proposed SEF registration requirement,\405\
may differ, even in instances where market participants are receiving
comparable access or services from the SEF. Rather, fee arrangements in
the dealer-to-dealer market are often subject to individualized
negotiations between a particular market participant and its broker,
often involving a combination of different factors and business
considerations that can lead to different fees for market participants
who could otherwise be characterized as similarly situated.\406\ The
Commission has observed that these factors or considerations may
include discounts based on past or current trading volume attributable
to the market participant, market maker participation, or pricing
arrangements related to services
[[Page 61997]]
provided by a SEF-affiliated entity involving other non-swap products.
The confluence of such factors, and the varying degrees to which they
help inform swap trading fee determinations, have been difficult to
distill into fee structures applicable to categories of market
participants.
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\404\ With respect to trading incentive or discount programs,
the Commission has observed various types of arrangements, such as
discounts from trading fees that vary in size and scope based on the
method of execution utilized and the relative rank of a SEF
participant vis a vis other participants in terms of quoting
frequency and number of products quoted.
\405\ See supra Section IV.C.1.c.(2)--SEF Registration
Requirement for Swaps Broking Entities, Including Interdealer
Brokers.
\406\ In some instances, swap trading fees comprise part of a
larger overall negotiated fee that is agreed upon between a market
participant and a broker for broking services in a broad range of
other products, including other fixed income instruments and
equities.
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Based on this practical difficulty, the Commission is proposing to
allow SEFs and market participants the flexibility to determine fees
based on legitimate business negotiations. In this proposal, the
Commission does not intend to limit the scope of business-related
factors that a SEF may continue to consider in establishing
participation fee arrangements. Proposed Sec. 37.202(a)(2) is intended
to provide market participants and SEFs with the flexibility to
negotiate fee arrangements on an individualized basis based on
legitimate business justifications. The Commission emphasizes, however,
that consistent with the impartial access requirement under proposed
Sec. 37.202(a)(1), a SEF should not use fees to discriminate against
certain market participants.
2. Sec. 37.202(b)--Limitations on Access
The Commission proposes to require a SEF to maintain documentation
of any decision to deny, suspend, permanently bar, or otherwise limit a
market participant's access to the SEF.\407\ The Commission believes
that such documentation is important to assisting a SEF's CCO in
reviewing the SEF's adherence to its access criteria rules and
determining whether the SEF is applying its access criteria in a manner
that meets Sec. 37.202. This documentation can further assist the
Commission in reviewing any limitation on access determinations for a
market participant during rule enforcement reviews or in the event that
a market participant or the Commission challenges a SEF's access
decision.
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\407\ The Commission proposes to renumber existing subsection
(c)--``Limitations on access''--to subsection (b) and amend the
requirement as described above.
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The Commission also proposes non-substantive amendments to the
existing provision, including amending the existing reference to
``eligible contract participant'' to ``market participant'' to provide
greater clarity.
3. Sec. 37.202(c)--Eligibility
The Commission proposes under Sec. 37.202(c) to maintain the
existing requirement that a SEF must require its market participants to
provide a written confirmation (electronic or otherwise) of their ECP
status prior to obtaining access to the SEF. The Commission also
proposes to make minor non-substantive revisions to the current
language.\408\
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\408\ The Commission proposes to renumber existing paragraph
(a)(2) to subsection (c) and adopt a new title--``Eligibility.''
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4. Sec. 37.202(d)--Jurisdiction
The Commission proposes under Sec. 37.202(d) to maintain the
existing requirement that a SEF must require that a market participant
consent to its jurisdiction prior to granting any market participant
access to its facilities. The Commission also proposes to make minor
non-substantive revisions to the current language.\409\ In addition,
the Commission confirms that consistent with prior Commission staff
guidance, a SEF does not need to obtain consent to its jurisdiction
through an affirmative writing, and a SEF may obtain consent through a
notification in its rulebook.\410\
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\409\ The Commission proposes to renumber existing subsection
(b)--``Jurisdiction'' to subsection (d).
\410\ 2014 Staff Jurisdiction Guidance at 2.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.202. In particular, the Commission requests comment on the following
questions:
(41) Should the Commission specify a basis for how it would
determine that a SEF's access criteria are unfair and discriminatory?
Should a SEF be limited in the type of justifications that it may
provide for its access criteria to demonstrate that they are impartial,
e.g., such criteria are intended to promote participation and/or
liquidity? If so, what would those justifications be?
(42) What should be the bases or factors for determining whether
market participants are ``similarly situated''?
(43) Should enablements be allowed as a type of access criteria for
cleared swaps, in addition to their usage for uncleared swaps? Is this
consistent with the Commission's proposed approach to impartial access?
Why or why not? If so, please provide examples of enablements for
cleared swaps that are consistent with the Commission's proposed
approach to impartial access.
B. Sec. 37.203--Rule Enforcement Program
Section 37.203 implements certain aspects of Core Principle 2,
which requires a SEF to (i) establish and enforce trading, trade
processing, and participation rules to deter abuses; and (ii) have the
capacity to detect, investigate, and enforce those rules, including the
ability to capture information to identify rule violations.\411\ The
regulation sets forth the requirements of an acceptable SEF rule
enforcement program, including requirements related to prohibiting
abusive trading practices; detecting and investigating rule violations;
maintaining sufficient staffing and resources; maintaining an automated
trade surveillance system; conducting real-time market monitoring; and
conducting investigations.
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\411\ 7 U.S.C. 7b-3(f)(2).
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During the part 37 implementation process, the Commission has
acquired greater experience with the swaps markets, in particular
related to SEF compliance and regulatory oversight requirements. The
Commission acknowledges that the existing swaps regulatory framework
was developed based in part on the futures regulatory framework. As a
result, the current part 37 regulations do not sufficiently account for
differences between futures and swaps markets, in particular the
differences in the complexity and size of transactions, the number and
sophistication of market participants,\412\ and the variations in the
methods of execution offered. Within the swaps market, the Commission
also recognizes that product offerings, execution methods, types of
market participants, and liquidity may even vary among SEFs.
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\412\ The Commission notes that CEA section 2(e) limits swaps
trading to ECPs, as defined by section 1a(18) of the Act. 7 U.S.C.
2(e).
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Accordingly, the Commission believes that instead of prescribing a
limited approach to compliance and regulatory oversight requirements, a
SEF should be enabled to tailor its compliance and oversight program to
fit its respective operations and market.\413\ Further, the Commission
seeks to ensure that SEF rule enforcement requirements are consistent
with the ability of a SEF to offer flexible execution methods for any
of its listed swaps. Therefore, as described below, the Commission
proposes to amend Sec. 37.203 to enable a SEF to establish a rule
enforcement program that is best suited to its trading systems and
platforms, as well as its market participants, while still ensuring the
ability to fulfill its self-regulatory obligations. The Commission
believes that these proposed amendments would also reduce certain
complexities, costs, and burdens, while still continuing to implement
the Core Principle 2 requirements and require a robust compliance
program.
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\413\ The Commission proposes to eliminate the introductory
sentence under Sec. 37.203, which states that a SEF shall establish
and enforce trading, trade processing, and participation rules that
will deter abuses and it shall have the capacity to detect,
investigate, and enforce those rules. This language is duplicative
of the existing requirements under Core Principle 2.
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[[Page 61998]]
1. Sec. 37.203(a)--Abusive Trading Practices Prohibited
Section 37.203(a) requires a SEF to generally prohibit abusive
trading practices on its markets by members and market participants,
but also enumerates specific practices that a SEF must specifically
prohibit, including front-running, wash trading, pre-arranged trading
(except for block trades or other types of transactions certified or
approved by the Commission under part 40), fraudulent trading, money
passes, and any other trading practice that the SEF deems to be
abusive.\414\ Section 37.203(a) further requires a SEF to prohibit any
other manipulative or disruptive trading practices prohibited by the
Act or Commission regulations. SEFs permitting intermediation must also
prohibit customer-related abuses, such as trading ahead of customer
orders, trading against customer orders, accommodation trading, and
improper cross trading.
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\414\ 17 CFR 37.203(a).
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The Commission proposes a non-substantive amendment to Sec.
37.203(a) to eliminate the term ``members.'' The Commission notes that
its proposed definition of ``market participant'' under Sec. 37.2(b)
would capture the universe of persons and entities that could engage in
abusive trading practices, including a SEF's members.\415\
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\415\ See supra Section IV.B.2.--Sec. 37.2(b)--Definition of
``Market Participant.''
---------------------------------------------------------------------------
As discussed above in conjunction with the proposed prohibition on
pre-execution communications under Sec. 37.201(b), the Commission is
also proposing to eliminate exceptions to the pre-arranged trading
prohibition under Sec. 37.203(a).\416\
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\416\ See supra Section VI.A.2.a.--Sec. 37.201(b)--Pre-
Execution Communications.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(a). In particular, the Commission requests comment on the
following questions:
(44) Are there any abusive trading practices enumerated under
proposed Sec. 37.203(a) that are not applicable to swaps trading on a
SEF, on certain SEF markets, or through certain methods of execution?
(45) Are there other abusive trading practices that could
potentially occur in the swaps markets that the Commission should
enumerate as a required prohibition under Sec. 37.203(a), e.g.,
intradesk and intracompany trading; order flashing; a failure to honor
firm prices; attempting to change the general conditions of a swap
transaction after price has been agreed upon; or potential abuses at
those points in the day when options are settled against swaps levels?
2. Sec. 37.203(b)--Authority To Collect Information \417\
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\417\ The Commission proposes to retitle Sec. 37.203(b) to
``Authority to collect information'' from ``Capacity to detect and
investigate rule violations'' based on the proposed changes
described below.
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Section 37.203(b) currently requires a SEF to have arrangements and
resources for effective enforcement of its rules, which includes the
authority to collect information and examine books and records of SEF
members and persons under investigation. A SEF must also facilitate
direct supervision of the market and analysis of data collected to
determine whether a rule violation has occurred.\418\
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\418\ 17 CFR 37.203(b).
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The Commission proposes several amendments to the existing
requirements. First, the Commission proposes to eliminate the
requirement that a SEF's arrangements and resources must facilitate the
direct supervision of the market and the analysis of data collected to
determine whether a rule violation has occurred. The Commission views
the language of this requirement as superfluous because other
regulations already set forth these requirements in greater
specificity, such as Sec. 37.203(d), which requires a SEF to maintain
an automated trade surveillance system that is capable of detecting and
reconstructing potential trade practice violations.\419\
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\419\ 17 CFR 37.203(d). The Commission also notes that other
part 37 regulations require a SEF to supervise the market and
analyze data, including regulations that implement Core Principle 4.
As amended, Sec. 37.401(a) would require a SEF to conduct real-time
market monitoring of all trading activity on the SEF to identify
disorderly trading, any market or system anomalies, and instances or
threats of manipulation, price distortion, and disruption. See infra
Section IX.A.--Sec. 37.401--General Requirements.
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Second, the Commission proposes to eliminate the requirements that
SEFs have the authority to collect documents on a routine and non-
routine basis and examine books and records kept by members and persons
under investigation. Instead, the Commission proposes to require that
each SEF have the authority to collect information required to be kept
by persons subject to the SEF's recordkeeping rules.\420\ The
Commission recognizes that the existing requirement does not provide
clarity as to the meaning of collecting of documents on a ``routine and
non-routine'' basis and how a SEF can collect information from
``persons under investigation.'' \421\ Based on the Commission's
experience in implementing part 37, the Commission believes that SEFs
are better suited to determine what recordkeeping rules are appropriate
based on the products that it offers for trading and the types of
participants on its market, among other considerations.
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\420\ A SEF's recordkeeping rules are established by, among
other provisions, Sec. 37.404(b), which requires a SEF to have
rules that require its market participants to keep records of their
trading. 17 CFR 37.404(b).
\421\ The Commission notes that this lack of clarity existed
during the adoption of part 37. For example, one commenter
previously requested clarity regarding the scope of the rule. SEF
Core Principles Final Rule at 33511.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(b).
3. Sec. 37.203(c)--Compliance Staff and Resources
Section 37.203(c) currently requires a SEF to establish and
maintain sufficient compliance staff and resources to conduct a number
of enumerated tasks, such as audit trail reviews, trade practice
surveillance, market surveillance, and real-time monitoring. The rule
further requires that such staff must be sufficient to address unusual
market or trading events and to conduct investigations in a timely
manner.\422\
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\422\ 17 CFR 37.203(c).
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The Commission proposes to eliminate the enumerated tasks and
replace them with the phrase ``self-regulatory obligations under the
Act and Commission regulations.'' The proposed amendment is intended to
apply the requirement to all of the SEF's applicable self-regulatory
functions and clarify that the existing requirement is not limited to
the enumerated tasks. Similarly, the Commission also proposes to
eliminate the language that requires staffing to be sufficient to
address unusual market or trading events and to complete investigations
in a timely manner, given that these enumerated requirements are an
inherent part of a SEF's existing self-regulation obligations. As the
Commission noted in the SEF Core Principles Final Rule, a SEF may also
take into account the staff and resources of any third-party entities
it uses under Sec. 37.204 to provide regulatory services when
evaluating the sufficiency of its compliance staff.\423\ Further, the
Commission reiterates that as stated in the preamble to the SEF Core
Principles
[[Page 61999]]
Final Rule, some SEF compliance staff can be shared among affiliated
entities as appropriate.\424\
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\423\ The Commission notes that a SEF must, at all times,
maintain sufficient internal compliance staff to oversee the quality
and effectiveness of the regulatory services provided, as required
by Sec. 37.204. As discussed below, the Commission proposes to
expand Sec. 37.204(a) to allow a SEF to use a non-registered entity
approved by the Commission for the provision of regulatory services.
\424\ SEF Core Principles Final Rule at 33511.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(c).
4. Sec. 37.203(d)--Automated Trade Surveillance System
Section 37.203(d) requires a SEF to maintain an automated trade
surveillance system capable of detecting potential trade practice
violations.\425\ The rule also requires that the system load and
process daily orders and trades no later than twenty-four hours after
the completion of the trading day. Given that this requirement applies
to all orders and trades regardless of the type of execution method,
Sec. 37.203(d) requires orders that are not submitted to an electronic
trading system, e.g., orders submitted by voice or certain other
electronic communications, such as instant messaging and email, also be
loaded and processed into an automated trade surveillance system. Such
a system, among other requirements, must have the capability to detect
and flag specific trade execution patterns and trade anomalies;
compute, retain, and compare trading statistics; compute trading gains
and losses and swap-equivalent positions; and reconstruct the sequence
of trading activity.
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\425\ 17 CFR 37.203(d).
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The Commission proposes to eliminate the specific automated trade
surveillance system capabilities enumerated under Sec. 37.203(d),
except for the ability of a SEF to reconstruct the sequence of market
activity. Specifically, the Commission proposes to retain this concept
by amending the remaining rule language to require that a SEF's
automated trade surveillance system be capable of detecting potential
trade practice violations and reconstructing the sequence of market
activity and trading. The Commission believes that an automated trade
surveillance system must be able to reconstruct both the sequence of
market activity and trading in order to detect such violations.
The Commission recognizes based on its experience with implementing
the existing requirement that a SEF's automated trade surveillance
system cannot perform all of the enumerated capabilities under the
existing rule, such as computing trade gains, losses, and swap
equivalent positions. The Commission also acknowledges that it has not
clarified the enumerated capabilities, which has led to some
confusion.\426\ As amended, the rule would provide each SEF with the
ability to tailor its automated trade surveillance system requirements
as needed to fulfill its compliance responsibilities, thereby allowing
the SEF to account for the nature of its trading systems or platforms.
The Commission believes that this proposed approach is consistent with
the reasonable discretion given to a SEF under Core Principle 1 to
establish the manner in which it complies with the SEF core principles.
---------------------------------------------------------------------------
\426\ The Commission notes that some commenters previously
expressed concern about the clarity of the enumerated capabilities.
SEF Core Principles Final Rule at 33512.
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The Commission also proposes to amend Sec. 37.203(d) to clarify
that all trades executed by voice or by entry into a SEF's electronic
trading system or platform, as well as orders that are ``entered into
an electronic trading system or platform,'' must be loaded and
processed into the automated trade surveillance system. This proposed
amendment reflects the Commission's recognition that no cost-effective
and efficient means currently exists that would provide a SEF with the
capability to load and process orders that are not initially entered
into an electronic trading system or platform, e.g., orders entered by
voice or certain other electronic communications, such as instant
messaging and email, given that those orders are in different formats.
The Commission notes that this proposed change is consistent with the
proposed amendments to Sec. Sec. 37.205(b)(2)-(3), as discussed below,
that would similarly limit a SEF's electronic transaction history
database and electronic analysis capability requirements.\427\ The
Commission, however, emphasizes that a SEF must continue to have the
capability to load and process all executed trades, including those
resulting from orders entered by voice or certain other electronic
communications, such as instant messaging and email. The Commission
also emphasizes that under proposed Sec. 37.205(a), a SEF must
continue to capture all orders entered by voice (i.e., oral
communications) or certain other electronic communications, such as
instant messaging and email.
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\427\ See infra Section VII.D.2.a.--Sec. 37.205(b)(1)--Original
Source Documents; Sec. 37.205(b)(2)--Transaction History Database;
Sec. 37.205(b)(3)--Electronic Analysis Capability.
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Finally, the Commission proposes to clarify that the term ``trading
day''--on which such data must be loaded into the automated trade
surveillance system--means the day ``on which such trade was executed
or such order was entered.''
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(d).
5. Sec. 37.203(e)--Error Trade Policy \428\
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\428\ The Commission also proposes to retitle Sec. 37.203(e) to
``Error trade policy'' from ``Real-time market monitoring'' based on
the proposed changes described below.
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Section 37.203(e) currently requires a SEF to conduct real-time
market monitoring of all trading activity on its system(s) or
platform(s) to identify disorderly trading and any market or system
anomalies.\429\ The regulation further requires a SEF to have the
authority to adjust prices and cancel trades when needed to mitigate
``market disrupting events'' caused by SEF trading system or platform
malfunctions or errors in orders submitted by market participants.
Further, any trade price adjustments or trade cancellations must be
transparent to the market and subject to standards that are clear,
fair, and publicly available.
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\429\ 17 CFR 37.203(e).
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a. Error Trades--Swaps Submitted for Clearing
In 2013, the Division of Clearing and Risk (``DCR'') and DMO
(together, the ``Divisions'') issued guidance (the ``2013 Staff STP
Guidance'') to address ``straight-through processing'' requirements
that, among other things, expressed the view that SEFs should have
rules stating that trades that are rejected from clearing are ``void ab
initio.'' \430\ According to the Divisions, swap transactions that are
executed and subsequently rejected by the DCO from clearing would be
considered void, even where the rejection is attributable to an
operational or clerical error from the SEF or market participants.\431\
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\430\ Staff Guidance on Swaps Straight-Through Processing at 5
(Sept. 26, 2013) (``2013 Staff STP Guidance''). In addition to
discussing the void ab initio concept, as discussed below, the 2013
Staff STP Guidance also discussed ``straight-through processing''
for swap transactions. See infra Section XII.B.2.--Sec. 37.702(b)
and Sec. 39.12(b)(7)--Time Frame for Clearing. The Commission notes
that to the extent that error trades leading to a rejection from
clearing could be corrected without the execution of a new trade,
such methods would depart from the void ab initio concept
articulated by the Divisions.
\431\ As previously stated by Commission staff for purposes of
granting time-limited no-action relief, an operational or clerical
error is any type of error other than a rejection from clearing due
to credit reasons. CFTC Letter No. 17-27, Re: No-Action Relief for
Swap Execution Facilities and Designated Contract Markets in
Connection with Swaps with Operational or Clerical Errors Executed
on a Swap Execution Facility or Designated Contract Market (May 30,
2017) at 1 n.2 (``NAL No. 17-27'').
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[[Page 62000]]
SEFs and market participants raised concerns that considering such
transactions to be void ab initio under the guidance would impede their
ability to correct trades that were rejected from clearing at the DCO
on the basis of such errors. For example, some transactions submitted
for clearing may fail to match a specified term due to a clerical
error, e.g., counterparty names; as a result, the trades would be
rejected from clearing and deemed void ab initio, even though the error
would be readily correctable.\432\ The Divisions' view on void ab
initio would compel counterparties to execute a new trade with the
corrected terms, rather than allow a SEF to identify and correct the
error through other established protocols and procedures.
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\432\ The Commission understands that when a swap trade that is
intended to be cleared has an operational or clerical error, a DCO
will reject that trade, even if it otherwise complies with the risk-
based limits established for the respective counterparties. As DCOs
do not distinguish clearing rejections for credit reasons from
clearing rejections due to clerical or operational errors, error
trades are treated as void ab initio.
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For those SEFs that apply the concept of void ab initio, however,
the Commission's current execution method requirements have inhibited
the ability to correct errors through subsequent trades, where a swap
has been rejected from clearing due to the error or where a swap
containing an error has been accepted for clearing by a DCO. For swaps
that are Required Transactions, market participants have been otherwise
prohibited from determining how to resolve the error between themselves
by entering into an offsetting trade or a new trade with the correct
terms due to (i) the execution method requirements under Sec.
37.9(a)(2), which requires that all Required Transactions be traded via
either an Order Book or RFQ System; and (ii) the corresponding
prohibition on pre-arranged trading under Sec. 37.203(a). In response
to these concerns related to void ab initio, Commission staff has
provided time-limited no-action relief.\433\
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\433\ CFTC Letter No. 13-66, Time-Limited No-Action Relief for
Swap Execution Facilities from Compliance With Certain Requirements
of Commission Regulation 37.9(a)(2) and 37.203(a) (Oct. 25, 2013)
(``NAL No. 13-66''). In April 2015, staff issued additional no-
action relief, which reinstated the previous time-limited no-action
relief from NAL No. 13-66 for SEFs from Sec. 37.9(a)(2) and Sec.
37.203(a) for swaps rejected from clearing due to an operational or
clerical error. Under the expanded no-action relief, SEF market
participants have resolved error trades accepted for clearing at the
DCO, among other types of transaction. CFTC Letter No. 15-24, Re:
No-Action Relief for Swap Execution Facilities and Designated
Contract Markets in Connection with Swaps with Operational or
Clerical Errors Executed on a Swap Execution Facility or Designated
Contract Market (Apr. 22, 2015) (``NAL No. 15-24''). Commission
staff subsequently extended the relief provided in NAL No. 15-24 in
June 2016. CFTC Letter No. 16-58, Re: No-Action Relief for Swap
Execution Facilities and Designated Contract Markets in Connection
with Swaps with Operational or Clerical Errors Executed on a Swap
Execution Facility or Designated Contract Market (June 12, 2016).
This relief has been most recently extended by NAL No. 17-27 in May
2017.
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Based on this no-action relief, SEFs have allowed market
participants to pre-arrange corrective trades for execution and
submission to a DCO for clearing through means not prescribed under
Sec. 37.9 for Required Transactions. Such trades include a new trade
with the corrected terms, where an error trade has been rejected from
clearing. Such trades also include a new trade to offset an error trade
accepted for clearing and a second subsequent trade with the corrected
terms, as originally intended between the counterparties. This relief
has enabled counterparties to address error trades, but has required
SEFs to adopt mechanisms to identify these corrective trades and
additional related rules and procedures for their respective market
participants.
In light of the challenges described above, the Commission proposes
clarifications and amendments to address the role of void ab initio
with respect to error trades for SEFs as described below.\434\ The
Commission notes that void ab initio is a determination made by a SEF,
and not by a DCO, which merely accepts or rejects a trade from
clearing. Additionally, consistent with the 2013 Staff STP
Guidance,\435\ the Commission notes that void ab initio does not apply
to back-loaded trades, i.e., trades originally executed without an
intent to clear, which the parties subsequently decided to clear.
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\434\ The Commission notes that it is also proposing certain
clarifications and amendments related to the 2013 Staff STP Guidance
with respect to straight-through processing of swaps. See infra
Section XII.B.2.b.--Proposed Approach to Straight-Through
Processing.
\435\ 2013 Staff STP Guidance at 5.
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b. Current SEF Error Trade Policies
SEFs have adopted rules and protocols to address other general
aspects of correcting an error trade. These factors, among the many
specified across all SEFs, include a definition of ``error trade''; the
circumstances to which the SEF's error trade rules would apply; the
process for a market participant to report an alleged error trade; the
process through which a SEF may review and determine that an error
trade has occurred; notification procedures; and the possible courses
of action that a SEF may take (or allow its market participants to
take) to correct the error trade. The Commission believes that the
adoption of such error trade policies by SEFs reflects their
understanding that such policies are a beneficial practice that
promotes a fair and orderly trading market for their market
participants.\436\
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\436\ The Commission notes that the guidance to Core Principle 4
in Appendix B cites ``clear error-trade and order-cancellation''
policies as a type of trading risk control that could be part of an
acceptable program for preventing market disruptions. 17 CFR part 37
app. B (guidance to Core Principle 4--paragraph (a)(5)--``Risk
controls for trading'').
---------------------------------------------------------------------------
Notwithstanding the existence of error trade rules and protocols
across different SEFs, market participants have stated that those rules
and protocols, and the manner in which they are applied, have been
inconsistent in some respects. Participants have cited a number of such
examples, including inconsistent approaches to notifying SEFs of
alleged error trades; the varying factors that SEFs consider in
evaluating alleged error trades; and the level of notification provided
to other market participants regarding alleged errors. Therefore, some
market participants--particularly those that are participants of
multiple SEFs--have recommended that the Commission adopt some general
error trade policy requirements to promote a more consistent approach.
Based on the feedback received and its own observations during the part
37 implementation, the Commission proposes to refine its approach to
SEF error trade policies in a manner that would benefit market
participants.
c. Sec. 37.203(e)--Error Trade Policy \437\
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\437\ The Commission proposes to retitle Sec. 37.203(e) to
``Error trade policy'' from ``Real-time market monitoring.''
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The Commission proposes to eliminate the real-time market
monitoring requirement, which is duplicative of Core Principle 4, and
adopt a refined approach to SEF error trade policies under proposed
Sec. 37.203(e) that would allow a SEF to implement its own protocols
and processes to correct error trades with respect to swaps (i)
rejected by a DCO due to an operational or clerical error or (ii)
accepted for clearing by a DCO that contains an operational or clerical
error.\438\ Therefore, the Commission's
[[Page 62001]]
proposal would explicitly permit a SEF to establish its own rules
regarding error trades rejected from clearing, which the Commission
believes would facilitate a SEF's ability to establish its own error
trade procedures that it believes is best suited to its particular
market, including whether to maintain an approach based on the void ab
initio concept for trades rejected from clearing due to non-credit
related errors.
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\438\ The Commission notes that the real-time market monitoring
requirement is duplicative of Core Principle 4, which requires a SEF
to conduct real-time monitoring of trading and comprehensive and
accurate trade reconstructions. To account for the minor difference
between the real-time monitoring requirements under Sec. 37.203(e),
which requires a SEF's monitoring to ``identify disorderly
trading,'' and Sec. 37.401, which currently does not specify that
requirement, the Commission is proposing to amend Sec. 37.401 to
incorporate this requirement. See infra Section IX.A.--Sec.
37.401--General Requirements.
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Consistent with proposed Sec. 37.702(b)(1),\439\ however, the
Commission notes that SEFs would now be required to deem any swap
submitted for clearing as void ab initio if a DCO rejects the trade
from clearing due to credit reasons. Under this scenario, clearing
members for the executing counterparties to the rejected trade must
resolve the outstanding credit issue that prevented a DCO from
accepting the trade for clearing. The ability for a clearing member to
resolve credit issues, a process which is outside of a SEF's purview,
is inconsistent with the SEF's ability to provide for the financial
integrity of swaps entered into on the SEF in contravention of Core
Principle 7 and proposed Sec. 37.702(b)(1), which would require a SEF
to coordinate with a DCO to facilitate prompt, efficient, and accurate
processing and routing of transactions to the DCO.\440\ In contrast, a
SEF's role in this context is limited to controlling the process of
correcting an operational or clerical error within the terms of a swap
using the SEF's error trade-related rules and procedures. Therefore, a
SEF should not rely upon a clearing member to resolve such credit
issues, but instead must declare a swap that is rejected from clearing
for credit reasons as void ab initio.
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\439\ The Commission proposes to renumber Sec. 37.702(b)(2) to
Sec. 37.702(b)(1). See infra Section XII.B.2.b.(1)--Sec.
37.702(b)(1) and Sec. 39.12(b)(7)(i)(A)--``Prompt, Efficient, and
Accurate'' Standard.
\440\ In some cases, clearing members and the DCO may not be
able to resolve an outstanding credit issue, but the swap
nevertheless remains void ab initio.
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In addition to allowing a SEF to configure an approach to
correcting non-credit related error trade swaps submitted to a DCO for
clearing, however, the Commission emphasizes that proposed Sec.
37.203(e) would generally require a SEF to establish baseline
procedural requirements for an error trade policy for all swaps
executed on its facility. The proposed approach would permit a SEF to
develop and adopt a more efficient approach based on the nature of the
transaction and error, as well as the SEF's own operational and
technological capabilities.\441\ Given that market participants often
execute subsequent swaps to hedge the risk of an initial transaction,
this approach would help mitigate the potential exposure to market and
execution risk that arises if such hedge positions are established
against a swap that has been deemed void ab initio. Accordingly, a SEF
may reduce that risk by facilitating a more targeted and timely
correction of errors in the initial transaction that would not
necessitate the resubmission of an entire transaction that has been
voided.\442\
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\441\ See 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(5)--``Risk controls for trading'') (noting that risk
controls such as error trade policies should be adapted to the
unique characteristics of the trading platform and of the markets to
which they apply). The Commission notes that based on its proposal
to adopt separate error trade policy rules under Sec. 37.205(e), it
also proposes to eliminate the guidance to Core Principle 4 in
Appendix B that specifies error trade policies as a type of risk
control that a SEF may adopt. See infra Section IX.E.--Sec.
37.405--Risk Controls for Trading.
\442\ The Commission notes, however, that to the extent that a
DCO has its own protocols and policies for resolving error trades--
both for error trades that are rejected for clearing due to non-
credit related errors and for error trades that have been accepted
for clearing--a SEF should coordinate its own approach with the DCO,
pursuant to the requirements of proposed Sec. 37.702(b)(1)
(existing Sec. 37.702(b)(2)), which requires a SEF to coordinate
with a DCO, to which it submits transactions for clearing, to
develop rules and procedures to facilitate prompt and efficient
transaction processing in accordance with Sec. 39.12(b)(7).
---------------------------------------------------------------------------
The proposed approach, in conjunction with the proposed adoption of
more flexible methods of execution, would also render the current no-
action relief unnecessary for those SEFs that choose to deem error
trades as void ab initio.\443\ For example, if a SEF maintains an
approach similar to the current no-action relief, then the elimination
of the prescriptive execution methods under Sec. 37.9 would allow
counterparties to execute a corrective trade via flexible methods of
execution offered by the SEF.\444\ Under the proposed approach,
however, a SEF also may not choose to follow the void ab initio
approach for non-credit related errors and instead adopt operational
protocols or procedures to resolve an error trade that do not require
the execution or resubmission of a corrective trade. Relief from the
pre-arranged trading prohibition under Sec. 37.203(a) would also be
unnecessary; under the proposed approach, a SEF could allow
counterparties to use flexible means of execution to execute a
corrective trade.\445\
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\443\ NAL No. 17-27.
\444\ To the extent that a SEF currently maintains a similar
approach as set forth in the no-action relief, however, the
Commission clarifies that a SEF could maintain those protocols and
procedures, notwithstanding the adoption of the proposed version of
Sec. 37.203(e).
\445\ See infra note 319 and accompanying discussion (noting
that the pre-arranged trading prohibition is intended to maintain
the integrity of price competition and market risk that is incident
to trading in the market).
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In conjunction with the proposed flexibility to correcting error
trades, Sec. 37.203 would also set forth general requirements that are
intended to create a baseline consistency among SEF error trade
policies. Proposed Sec. 37.203(e)(1) defines an ``error trade'' as any
swap transaction executed on a SEF that contains an error in any term,
including price, size, or direction.\446\ Proposed Sec. 37.203(e)(2)
would require a SEF to establish and maintain rules and procedures to
help resolve error trades in a ``fair, transparent, consistent, and
timely manner.'' At a minimum, such rules would be required to provide
the SEF with the authority to adjust trade terms and cancel trades; and
specify the rules and procedures for market participants to notify the
SEF of an error trade, including any time limits for notification.
While the Commission is providing SEFs with flexibility in designing
their error trade policies, the Commission believes that fairness,
transparency, consistency, and timeliness should be key principles in a
SEF's error trade policy.
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\446\ This definition, however, would not include a swap trade
that is rejected from clearing for credit reasons, as discussed
above. Therefore, the Commission notes that proposed Sec. 37.203(e)
would not apply to such trades.
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Further, proposed Sec. 37.203(e)(3) would establish a minimum set
of notification requirements for a SEF. A SEF would be required to
notify all of its market participants, as soon as practicable, of (i)
any swap transaction that is under review pursuant to the SEF's error
trade rules and procedures; (ii) a determination that the trade under
review is or is not an error trade; and (iii) the resolution of any
error trade, including any trade term adjustment or cancellation. The
Commission proposes an ``as soon as practicable'' standard based on
competing considerations, such as the need to maintain orderly trading
versus the need for timely transparency. Under this proposed approach,
a SEF may determine that making error trade information available at a
particular point in time is not practicable, given the countervailing
concerns of potential market disruptions caused by the announcement of
a potentially erroneous trade that has been disseminated to the SEF's
participants.
Proposed Sec. 37.203(e)(4) would allow a SEF to establish non-
reviewable ranges.
[[Page 62002]]
The Commission has observed that in the interests of minimizing market
disruption and maintaining orderly trading, many SEFs have established
non-reviewable ranges during the course of trading. Therefore, the
Commission believes that to allow SEFs to maintain existing beneficial
market practices, a SEF should continue to be able to establish such
ranges, which may be adjusted based on market conditions. Pursuant to
proposed Sec. 37.203(e)(2), however, the Commission emphasizes that
such ranges must be established and administered in a fair,
transparent, consistent, and timely manner.
The Commission recognizes that identifying and resolving error
trades in a timely manner is important to promote market integrity and
efficiency and ensure that trade data, which market participants rely
upon to inform their swaps trading decisions, accurately reflects
prevailing market pricing at any given time. The Commission believes
that proposed Sec. 37.203(e) would accomplish these goals for market
participants and the market as a whole.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.203(e). The Commission may consider alternatives to its proposed
error trade policy requirements and requests comment on the following
questions:
(46) Does the lack of a void ab initio requirement for non-credit
related errors create concerns about market risk with respect to error
trades that have been executed, but have not been voided despite the
rejection from clearing? If so, should a SEF be limited in the types of
errors that may be corrected without void ab initio, e.g., errors that
do not create market risk? Should the Commission adopt a mandatory void
ab initio requirement that certain types of errors, e.g., those that do
cause market risk, must be resolved via a corrective trade approach? Or
should counterparties otherwise have the ability to maintain breakage
agreements to address such risks?
(47) Is the Commission's proposed definition of ``error trade''
overly broad or narrow? Should the definition or requirement
specifically address certain types of errors, such as the wrong
affiliate counterparty or the wrong product identified?
(48) Is the Commission's proposed definition of ``error trade''
sufficient to include those trades where an incorrect term (e.g.,
incorrect notional amount) results in a rejection by a DCO ostensibly
due to credit reasons, but where the DCO otherwise would have accepted
the trade had the trade included the correct terms? If not, then how
should the term ``error trade'' be defined to better discern this
situation from a situation where a true rejection for credit reasons
has occurred? Similarly, is the Commission's proposed definition of
``error trade'' sufficiently clear so that the SEF knows which errors
are required to be treated as error trades and which errors are
required to be treated as void ab initio? If not, please explain.
Should the Commission's definition of ``error trade'' specifically
state that it does not include rejections from clearing for credit
reasons?
(49) Should trades that are rejected by a DCO for insufficient
credit be required to be deemed to be void ab initio by SEFs? If so,
should the Commission codify such a requirement under proposed Sec.
37.203(e) or elsewhere in the Commission's regulations?
(50) Are SEFs and DCOs able to distinguish between trades that are
rejected from clearing due to insufficient credit from those trades
that are rejected because they are error trades? Why or why not?
(51) The proposed regulations require that error trades be resolved
in a timely manner, recognizing that a SEF may not be in a position to
resolve every error trade within a specific time frame. Would requiring
resolution of an error trade ``as soon as practicable'' or within a
specific time frame lead to quicker resolutions and reduce risk for
market participants? If so, what time frame would be appropriate and
should it vary based on other factors, such as the nature of the
product or transaction type, whether the error was a participant error
or system error, or whether the error was discovered before or after
the trade was cleared?
(52) Should a SEF be permitted to adjust or cancel an error trade
without consulting with the parties to the trade in some or all
circumstances, or should the Commission require a SEF to consult with
or obtain the consent of the parties to an error trade in some or all
circumstances?
(53) Should market participants be required to report all errors to
a SEF or are there certain errors that are immaterial and do not
otherwise require correction?
(54) What type of error trade policy should a SEF be required to
adopt for swap transactions that are subject to an exception to the
prohibition on pre-execution communications under proposed Sec.
37.201(b), given that such swaps may be negotiated or arranged away
from the SEF's trading system or platform?
(55) Should a SEF be required to specify who may request a review
of a trade as a potential error trade? Should the ability to request a
review be limited to the parties to a trade or should market
participants affected by the trade also have the ability to request a
review?
(56) Are there alternative requirements that would enhance
efficiency and transparency in the error trade resolution process?
(57) Should the Commission require SEFs to notify all market
participants of an error trade and the resolution of such trade or only
a smaller subset of participants? Should the Commission provide any
time frame for such notice?
(58) Should a DCO be required to notify a SEF of the reason why a
trade was rejected from clearing? If so, what type of information
should the Commission require the DCO to provide to the SEF in such a
circumstance?
6. Sec. 37.203(f)--Investigations \447\
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\447\ The Commission proposes to retitle Sec. 37.203(f) to
``Investigations'' from ``Investigations and investigation reports''
based on the proposed changes described below.
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Existing Sec. 37.203(f) currently sets forth requirements for SEFs
with respect to conducting investigations of their market participants
for potential rule violations.\448\ Existing Sec. 37.203(f)(1)
requires a SEF to have procedures that require its compliance staff to
conduct investigations of possible rule violations.\449\ The rule
further requires that an investigation be commenced upon Commission
staff's request or upon discovery of information by a SEF that
indicates a reasonable basis for finding that a violation has occurred
or will occur. Existing Sec. 37.203(f)(2) requires that investigations
be completed in a timely manner, defined as twelve months after an
investigation is opened, absent enumerated mitigating
circumstances.\450\ Existing Sec. 37.203(f)(3) requires a SEF's
compliance staff to submit an investigation report for disciplinary
action any time staff determines that a reasonable basis exists for
finding a rule violation,\451\ while existing Sec. 37.203(f)(4)
requires compliance staff to prepare an investigation report upon
concluding an investigation and determining that no reasonable basis
exists for finding a rule violation.\452\ Existing Sec. Sec.
37.203(f)(3)-(4) enumerate the items that must be included in the
investigation report. Finally, existing Sec. 37.203(f)(5) prohibits a
SEF from issuing more than one
[[Page 62003]]
warning letter to the same person or entity for the same rule violation
during a rolling twelve-month period.\453\
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\448\ 17 CFR 37.203(f).
\449\ 17 CFR 37.203(f)(1).
\450\ 17 CFR 37.203(f)(2).
\451\ 17 CFR 37.203(f)(2).
\452\ 17 CFR 37.203(f)(4).
\453\ 17 CFR 37.203(f)(5).
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The Commission proposes to amend existing Sec. 37.203(f) to
simplify and streamline the procedures for SEFs to conduct
investigations and prepare investigation reports. First, the Commission
proposes to amend Sec. 37.203(f)(1) to state that each SEF must
establish and maintain procedures requiring compliance staff to conduct
investigations, including the commencement of an investigation upon the
receipt of a request from Commission staff or upon the discovery or
receipt of information by the SEF that indicates the existence of a
reasonable basis for finding that a violation may have occurred or will
occur (emphasis added). This proposed amendment reflects the
Commission's view that SEFs may, and should have the right to, choose
to initiate investigations under broader circumstances than the two
instances identified in the existing provision.
Second, the Commission proposes to amend Sec. 37.203(f)(2) to
eliminate the twelve-month requirement for completing investigations
and instead provide SEFs with the ability to complete investigations in
a timely manner taking into account the facts and circumstances of the
investigation. Based on its experience, the Commission recognizes that
each investigation raises unique issues, facts, and circumstances that
affect the time that it takes to complete the investigation. A SEF may
complete some investigations in less than twelve months and complete
some investigations in more than twelve months. The Commission also
recognizes that the list of mitigating factors in the existing rule is
not comprehensive, and other factors may affect the time of an
investigation. Rather than prescribe a singular requirement, the
Commission believes that it is more appropriate to establish general
parameters for completing investigations. In conjunction with this
amendment, the Commission also proposes guidance to Core Principle 2 in
Appendix B to provide SEFs with reasonable discretion to determine that
time frame.\454\
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\454\ The Commission proposes to add this guidance as paragraph
(a)(2) to Core Principle 2 in Appendix B and eliminate the existing
guidance, which currently states that a SEF should adopt and enforce
any additional rules it believes are necessary to comply with Sec.
37.203. The Commission views this guidance as unnecessary based on
the proposed changes to Sec. 37.203(f).
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Third, the Commission proposes to streamline the requirements that
apply to all SEF investigation reports, regardless of whether a
reasonable basis exists for finding a violation, by consolidating the
provisions under existing Sec. 37.203(f)(4) into a new proposed Sec.
37.203(f)(3). Accordingly, proposed Sec. 37.203(f)(3) would require a
SEF's compliance staff to prepare a written investigation report to
document the conclusion of each investigation. The proposed rule would
maintain the existing requirement that each investigation report
contain the following information: (i) The reason the investigation was
initiated; (ii) a summary of the complaint, if any; (iii) the relevant
facts; (iv) the compliance staff's analysis and conclusions; and (v) a
recommendation as to whether disciplinary action should be pursued. To
provide further clarity regarding the actions that a SEF may take once
the investigation report is completed, the Commission proposes adding
guidance to Core Principle 2 in Appendix B to provide that compliance
staff should submit all investigation reports to the CCO or other
compliance department staff responsible for reviewing such reports and
determining next steps in the process; and the CCO or other responsible
staff should have reasonable discretion to decide whether to take any
action, such as presenting the investigation report to a disciplinary
panel for disciplinary action.\455\
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\455\ The Commission proposes to add this guidance as paragraph
(a)(3) to Core Principle 2 in Appendix B. The Commission notes that
it provided similar clarification in the preamble to the SEF Core
Principles Final Rule. SEF Core Principles Final Rule at 33515. As
discussed below, the Commission proposes to renumber the existing
language in paragraph (a)(3) to paragraph (a)(6), see infra Section
VII.E.1.--Sec. 37.206(a)--Enforcement Staff; and eliminate the
existing language in paragraph (a)(6), see infra Section VII.E.2.--
Sec. 37.206(b)--Disciplinary Program.
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As part of the Commission's proposal to consolidate multiple
existing warning letter requirements into a single provision under
proposed Sec. 37.206(c)(2), the Commission also proposes to eliminate
the warning letter requirement under existing Sec. 37.203(f)(5).\456\
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\456\ The Commission proposes to streamline and consolidate
multiple existing provisions that address the SEF's use of warning
letters--under existing Sec. 37.203(f)(5), existing Sec.
37.205(c)(2) with respect to audit trail violations, and existing
Sec. 36.206(f) with respect to rule violations--into a single
provision under proposed Sec. 37.206(c)(2), as discussed below. See
infra Section VII.E.3.--Sec. 37.206(c)--Hearings. Further, the
Commission proposes to eliminate the existing language under
paragraph (a)(1) of the guidance to Core Principle 2 in Appendix B,
which states that a SEF's rules may authorize its compliance staff
to issues warning letters or recommend that a disciplinary panel
take such action. The Commission views this guidance as unnecessary
based on the proposed changes to Sec. 37.203(f).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.203(f) and the associated guidance to Core Principle 2 in Appendix
B.
7. Sec. 37.203(g)--Additional Sources for Compliance
The Commission is not proposing any amendments to Sec. 37.203(g).
C. Sec. 37.204--Regulatory Services Provided by a Third Party
Section 37.204, among other things, permits a SEF to contract with
an RFA, another registered entity, or the Financial Industry Regulatory
Authority (``FINRA'') for the provision of regulatory services, subject
to the requirement that the SEF supervises its regulatory service
provider and retains exclusive authority over substantive decisions. As
described below, the Commission proposes a series of amendments that
would provide a SEF with further options in choosing and utilizing a
regulatory service provider to assist with fulfilling its regulatory
obligations, while still maintaining regulatory protections that relate
to the use of an external services provider.
1. Sec. 37.204(a)--Use of Regulatory Service Provider Permitted
Section 37.204(a) permits a SEF to contract with an RFA, another
registered entity, or FINRA to assist the SEF in complying with the Act
and Commission regulations, as approved by the Commission.\457\ A SEF
that elects to use the services of a regulatory service provider must
ensure that the provider has the capacity and resources to provide
timely and effective regulatory services.\458\ A SEF remains
responsible at all times for the performance of any regulatory services
received, compliance with its obligations under the Act and Commission
regulations, and the regulatory service provider's performance on its
behalf.\459\
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\457\ 17 CFR 37.204(a).
\458\ Id.
\459\ Id.
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Based upon its experience with implementing part 37, the Commission
is proposing to expand the scope of entities that may provide
regulatory services under Sec. 37.204(a) to include any non-registered
entity approved by the Commission.\460\ The Commission believes that
this proposed expansion would be appropriate and notes that the Act
does not address or proscribe the
[[Page 62004]]
types of entities that SEFs may use for the provision of regulatory
services; for example, the Commission used this basis originally to
include FINRA among the list of entities that could provide regulatory
services. Therefore, consistent with the statute, SEFs would be allowed
to choose from a greater number of potential third-party providers. The
Commission believes that this change would potentially increase
competition among existing and potential regulatory service providers
and, thus, reduce operating costs for SEFs, encourage innovation and
technological developments, and mitigate barriers to entry for new
SEFs.
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\460\ The Commission proposes to amend ``Financial Industry
Regulatory Authority'' in the text of Sec. 37.204(a) to ``any non-
registered entity.''
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Section 37.204(a), however, would also continue to be subject to
important protections to ensure that a regulatory service provider
provides effective regulatory services. To ensure each SEF's compliance
with Sec. Sec. 37.203(c)-(d), among other provisions, the Commission
would continue to evaluate the sufficiency of a provider's compliance
staff and resources and the capabilities of its automated trade
surveillance system, and other capabilities.\461\ Section 37.204(a)
would still require each SEF to be responsible at all times for the
performance of the regulatory services received, for compliance with
the SEF's obligations under the Act and Commission regulations, and for
the provider's performance on its behalf. Further, as discussed below,
Sec. 37.204(b) would still impose a duty to supervise the provider.
Accordingly, the Commission believes that these protections, combined
with the Commission's prior evaluation of any provider, support the
ability of a SEF to consider an entity outside of an RFA, a registered
entity, or FINRA.
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\461\ The Commission would evaluate a provider with respect to
these requirements prior to approving any arrangement between a SEF
and the provider, or during the course of conducting routine
oversight of a SEFs self-regulatory program.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.204(a).
2. Sec. 37.204(b)--Duty To Supervise Regulatory Service Provider
Existing Sec. Sec. 37.204(b)-(c) generally set forth a SEF's
oversight responsibilities with respect to a regulatory service
provider. Existing Sec. 37.204(b) requires a SEF to retain sufficient
compliance staff to supervise the quality and effectiveness of the
services performed by a regulatory service provider; hold regular
meetings with the regulatory service provider to discuss ongoing
investigations, trading patterns, market participants, and any other
matters of regulatory concern; and conduct and document periodic
reviews of the adequacy and effectiveness of services provided on its
behalf.\462\ Existing Sec. 37.204(c), however, requires a SEF to
retain exclusive authority over all substantive decisions made by its
regulatory service provider, such as decisions involving trade
cancellations, issuance of disciplinary charges, and access
denials.\463\ A SEF is also required to document any instance where its
actions differ from those recommended by its regulatory service
provider, including the reasons for the course of action recommended by
the regulatory service provider and the reasons why the SEF chose a
different course of action.\464\
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\462\ 17 CFR 37.204(b).
\463\ 17 CFR 37.204(c).
\464\ Id.
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The Commission proposes to combine and streamline the requirements
of existing Sec. Sec. 37.204(b)-(c) into a new proposed Sec.
37.204(b). The Commission further proposes to maintain a SEF's duty to
supervise its regulatory service provider, but to eliminate the
requirement that the SEF hold regular meetings and conduct periodic
reviews of the provider. Instead, the Commission proposes that a SEF be
able to determine the necessary processes for supervising their
regulatory service providers. Consistent with this proposed change, the
Commission also proposes to provide each SEF with the option to allow
its regulatory service provider to make substantive decisions, provided
that, at a minimum, the SEF is involved in such decisions. Therefore, a
SEF would have the discretion to determine how they are involved in
such decisions. The proposed rule would keep the existing examples of
substantive decisions, including the adjustment or cancellation of
trades, the issuance of disciplinary charges, and denials of access to
the SEF for disciplinary reasons. Finally, the Commission proposes to
eliminate the requirement that a SEF document where its actions differ
from the regulatory service provider's recommendations, deferring
instead to the SEF and its regulatory service provider to mutually
agree on the method that they will use to document substantive
decisions.
Based on its experience implementing the SEF regulatory framework,
the Commission believes that some of the specific requirements
currently prescribed under existing Sec. Sec. 37.204(b)-(c) are
unnecessary and overly prescriptive because SEFs, consistent with their
position as self-regulatory organizations, remain ultimately
responsible for the performance of any regulatory services received,
for compliance with their obligations under the Act and Commission
regulations, and for the regulatory service providers' performance on
their behalf. Given a SEF's ultimate responsibility, the Commission
believes that the SEF should be allowed to determine how best to
supervise its regulatory service provider based on the services it
receives and the nature of the SEF's operations and markets. The
Commission also notes that this proposed approach is consistent with a
SEF's discretion under Core Principle 1.\465\ The Commission further
believes that the discretion that SEFs and their regulatory service
providers would have under Sec. 37.204(b) to determine a mutually
acceptable process may enable more timely decision making regarding
substantive matters.\466\
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\465\ 7 U.S.C. 7b-3(f)(1)(B).
\466\ The Commission notes that a commenter to the SEF Core
Principles Final Rule stated that entrusting greater discretion to a
regulatory service provider would provide for prompt decision-
making. SEF Core Principles Final Rule at 33517.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.204(b).
3. Sec. 37.204(c)--Delegation of Authority
The Commission proposes a new Sec. 37.204(c) to delegate to DMO
the authority to approve any regulatory service provider chosen by a
SEF. This does not, however, prohibit the Commission from exercising
authority to approve any third party regulatory service provider. The
Commission anticipates that expanding the scope of entities that may
provide regulatory services under proposed Sec. 37.204(a) may lead to
a greater number of approval requests for such entities. Therefore, the
Commission proposes to delegate this authority to ensure that such a
review is conducted in an efficient manner. Such approval would
require, at a minimum, that each regulatory service provider
demonstrate that it has the capabilities and resources necessary to
provide timely and effective regulatory services on behalf of the SEF,
including adequate staff and automated surveillance systems, as
required under proposed Sec. 37.204(a).
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.204(c).
D. Sec. 37.205--Audit Trail
Section 37.205 sets forth a SEF's audit trail requirements and
generally requires a SEF to establish procedures to
[[Page 62005]]
capture and retain information that may be used in establishing whether
rule violations have occurred. Specifically, Sec. 37.205(a) requires a
SEF to have an audit trail; Sec. 37.205(b) prescribes the elements of
an acceptable audit trail program; and Sec. 37.205(c) requires a SEF
to enforce its audit trail requirements.\467\
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\467\ 17 CFR 37.205(a)-(c).
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Based on the Commission's experience with implementing part 37,
including the SEF registration process, the Commission has observed
that technology limitations have impacted SEFs' ability to comply with
all of the audit trail requirements, particularly for orders submitted
by voice and certain electronic communications that include instant
messages and emails. Based on these observations, as well as the
proposed ability for a SEF to offer flexible execution methods, the
Commission proposes amendments to the audit trail requirements that
seek to strike the appropriate balance between offering SEFs the
ability to adopt such requirements that are best suited to their
respective trading systems or platforms, while also ensuring that such
programs enable SEFs to fulfill their self-regulatory obligations. The
Commission believes that the proposed changes are consistent with Core
Principle 2, which generally requires a SEF to capture information that
may be used in establishing whether rule violations have occurred.\468\
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\468\ 7 U.S.C. 7b-3(f)(2).
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1. Sec. 37.205(a)--Audit Trail Required
Section 37.205(a) requires a SEF to capture and retain all audit
trail data necessary to detect, investigate, and prevent customer and
market abuses.\469\ Such audit trail data must be sufficient to
reconstruct all indications of interest, requests for quotes, orders,
and trades.\470\ The audit trail must also permit a SEF to track a
customer order from the time of receipt through fill, allocation, or
other disposition.\471\
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\469\ 17 CFR 37.205(a).
\470\ Id.
\471\ Id.
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The Commission proposes several amendments to streamline the
existing requirements, account for different execution methods and
swaps market practices, and eliminate redundancies with other part 37
requirements. Notwithstanding the proposed changes described above, the
Commission emphasizes that the type of execution method offered by a
SEF does not alter the obligation to capture all audit trail data
necessary to detect, investigate, and enforce its rules pursuant to
Core Principle 2.
First, the Commission proposes to clarify the existing language to
specify that a SEF must capture and retain all audit trail data
necessary to reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take appropriate
disciplinary action (emphasis added).\472\ By replacing the requirement
to ``prevent'' customer and market abuses with the requirement to
``take appropriate disciplinary action'' and specifying that the data
must enable the SEF to reconstruct all trading on its facility, the
Commission believes that Sec. 37.205(a) would more accurately reflect
the capabilities for which a SEF may use its audit trail data. The
Commission notes that an audit trail cannot ``prevent'' customer and
market abuses and the ability to ``reconstruct'' trading is already
required under existing Sec. 37.205(a), as described below.
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\472\ The Commission proposes to eliminate the introductory
sentence under Sec. 37.205, which states that a SEF shall establish
procedures to capture and retain information that may be used in
establishing whether rule violations have occurred, given that this
language is duplicative of the audit trail requirements under Sec.
37.205(a).
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Second, the Commission proposes to move the requirement that audit
trail data shall be sufficient to reconstruct all indications of
interest, requests for quotes, orders, and trades to the guidance to
Core Principle 2 in Appendix B.\473\ Given the proposal to allow each
SEF to offer flexible methods of execution, as well as continuing
advances in technology, the Commission believes that enumerating
specific audit trail data in the regulatory language may unnecessarily
limit the universe of data relevant to a SEF's audit trail. The
Commission emphasizes that a SEF must capture all audit trail data
related to each offered execution method that is necessary to
reconstruct all trading on its facility, detect and investigate
customer and market abuses, and take disciplinary action as noted
above. The Commission also believes that SEFs must capture such a data
set to be able to detect, investigate and enforce its rules under Core
Principle 2, to reconstruct all trading under Core Principle 4, and to
comply with the audit trail reconstruction program under proposed
37.205(c), as described below.
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\473\ The Commission proposes to add this guidance to paragraph
(a)(4) to Core Principle 2 in Appendix B. As discussed below, the
Commission proposes to eliminate the existing language in paragraph
(a)(4), see infra Section VII.E.2.--Sec. 37.206(b)--Disciplinary
Program.
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Third, the Commission proposes to eliminate the requirement that a
SEF capture post-execution allocation information in its audit trail
data. During the SEF registration process, numerous SEFs indicated that
post-execution allocations normally occur between the clearing firm or
the customer and the DCO, or at the middleware provider.\474\
Therefore, these SEFs represented that they typically do not have
access to post-execution allocation information, and are unable to
obtain such data from third parties, such as DCOs and SDRs, due to
confidentiality concerns. Based on these representations, Commission
staff has issued continuing no-action relief to SEFs from this
requirement.\475\ Based on its experience, the Commission understands
that SEFs are still routinely unable to obtain this information
pursuant to the requirements of Sec. Sec. 37.205(a) and (b)(2).\476\
Accordingly, in lieu of requiring that the audit trail track a customer
order through ``fill, allocation, or other disposition,'' the
Commission proposes to require SEFs to capture the audit trail data
only through execution on the SEF. The Commission understands that this
proposed change is consistent with current swap market practices.
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\474\ CFTC Letter No. 17-54, Re: No-Action Relief for Swap
Execution Facilities from Certain Audit Trail Requirements in
Commission Regulation 37.205 Related to Post-Execution Allocation
Information at 2 (Oct. 31, 2017).
\475\ Id.
\476\ The Commission notes that Sec. 37.205(b)(2) also requires
a SEF's audit trail to include an electronic transaction history
database that captures, among other elements, the identity of each
account to which fills are allocated. 17 CFR 37.205(b)(2). As
discussed below, the Commission proposes to eliminate this
requirement. See infra note 484 and accompanying discussion.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.205(a). In particular, the Commission requests comment on the
following questions:
(59) Is the scope of the proposed audit trail requirements
sufficiently clear? If not, then please explain. Is the scope overly
broad or narrow to enable a SEF to comply with its obligations under
the Act? If so, please explain. Would a SEF's audit trail obligations
be impacted by the Commission's proposed approach to pre-execution
communications? If so, then how?
(60) What challenges, if any, do SEFs encounter in capturing or
retaining audit trail data?
(61) Are there any specific audit trail data points that are too
costly or burdensome for a SEF to capture or maintain?
(62) Is the proposed guidance to this section appropriate? Are SEFs
currently capturing all indications of interest, requests for quotes,
orders, and trades? Is the meaning of ``indications of
[[Page 62006]]
interest'' sufficiently clear? If not, please provide suggestions on
how to clarify this term. Should a SEF be required to capture all
indications of interest and requests for quotes to enable it to comply
with its obligations under the Act? Are there other data points that
should be added to the guidance?
2. Sec. 37.205(b)--Elements of an Acceptable Audit Trail Program
Section 37.205(b) requires, among other things, that SEFs retain
all original source documents; maintain a transaction history database;
conduct electronic analysis; and safely store all audit trail
data.\477\ Section 37.205(b)(1) requires that a SEF's audit trail
include original source documents and specifies the nature and content
of such documents.\478\ Section 37.205(b)(2) requires a SEF's audit
trail program to include an electronic transaction history database and
specifies the required elements of an adequate database.\479\ Section
37.205(b)(3) requires a SEF's audit trail program to include electronic
analysis capability with respect to all audit trail data in the
transaction history database.\480\ Section 37.205(b)(4) requires a
SEF's audit trail program to safely store all audit trail data retained
in the transaction history database.\481\
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\477\ 17 CFR 37.205(b).
\478\ 17 CFR 37.205(b)(1).
\479\ 17 CFR 37.205(b)(2).
\480\ 17 CFR 37.205(b)(3).
\481\ 17 CFR 37.205(b)(4).
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a. Sec. 37.205(b)(1)--Original Source Documents; Sec. 37.205(b)(2)--
Transaction History Database; Sec. 37.205(b)(3)--Electronic Analysis
Capability
The Commission proposes to eliminate certain elements of the
original source documents requirement under Sec. 37.205(b)(1) that
specify the nature and content of the original source documents,\482\
as such requirements may not capture the appropriate universe of
content. The Commission also believes that the detailed requirements
are not necessary; as discussed above, the general requirement that a
SEF must capture all audit trail data necessary to reconstruct all
trading on its facility, detect and investigate customer and market
abuses, and take disciplinary action is sufficient to guide a SEF as to
the content of its original source documents, which would be based on
the SEF's execution methods, trading operations, and markets. Section
37.205(b)(1), however, would maintain that the SEF's audit trail must
include original source documents, including unalterable, sequentially-
identified records on which trade execution information is originally
recorded, whether recorded manually or electronically.
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\482\ Section 37.205(b)(1) requires, among other things, that
records for customer orders (whether filled, unfilled, or cancelled,
each of which shall be retained or electronically captured) shall
reflect the terms of the order, an account identifier that relates
back to the account(s) owner(s), the time of order entry, and the
time of trade execution. A SEF must also require that all orders,
indications of interest, and requests for quotes be immediately
captured in the audit trail. 17 CFR 37.205(b)(1).
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The Commission further proposes to amend Sec. 37.205(b)(2) to
revise the scope of audit trail data that must be captured in a SEF's
electronic transaction history database. Specifically, the Commission
proposes to eliminate the requirement that the database include all
indications of interest, requests for quotes, orders, and trades
entered into a SEF's trading system or platform. Instead, the SEFs
would be required to include (i) trades executed by voice or by entry
into a SEF's electronic trading system or platform; and (ii) orders
that are entered into its electronic trading system or platform.
Similar to proposed Sec. 37.203(d), this proposed amendment recognizes
that a SEF may not have a cost-effective and efficient method for
inputting orders submitted by voice or certain other electronic
communications, such as instant messaging and email, into an electronic
transaction history database, given that they are not in the same
format as orders and trades that are entered into a SEF's electronic
trading system or platform.\483\ As noted above, the Commission
emphasizes that a SEF must continue to keep a record of all orders
entered by voice (i.e., oral communications) or certain other
electronic communications, such as instant messaging and email. Such a
record, however, would not need to be included in the SEF's electronic
transaction history database given the formatting challenges.
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\483\ See supra Section VII.B.4.--Sec. 37.203(d)--Automated
Trade Surveillance System.
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The Commission additionally proposes to eliminate the remaining
requirements of Sec. 37.205(b)(2) that detail the information that
must be included in transaction history database, given that these
requirements are already captured in other audit trail requirements or
do not comport with existing swaps market practices.\484\ Consistent
with the proposed amendments to Sec. 37.205(b)(2), the Commission
further proposes to amend Sec. 37.205(b)(3) to clarify that a SEF's
electronic analysis capability must enable the SEF to reconstruct ``any
trade executed by voice or by entry into a swap execution facility's
electronic trading system or platform and any order entered into its
electronic trading system or platform'' rather than ``indications of
interest, requests for quotes, orders, and trades.''
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\484\ For example, customer type indicator code (``CTI'') is
used in futures trading to designate the capacity in which the
person was executing a trade--for the person's own account; for a
proprietary account; on behalf of another member; or for a customer.
Many DCM-based automated trade surveillance systems are programmed
to detect aberrations in CTI code usage that may indicate potential
rule violations. The Commission understands, however, that a SEF's
automated trade surveillance system does not use CTI codes to detect
potential rule violations. Therefore, the Commission proposes to
eliminate this requirement. Further, as discussed above, since SEFs
cannot routinely obtain post-execution allocation information, it is
not possible to identify ``each account to which fills are
allocated.'' See supra note 476 and accompanying discussion.
Therefore, the proposed amendment to Sec. 37.205(b)(2) would also
eliminate the requirement to include post-execution allocation
information in a SEF's transaction history database.
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These proposed amendments are consistent with feedback received
regarding the audit trail requirements during the SEF registration
process. Some SEFs that offer voice-based trading systems or platforms
stated that they do not have the requisite technology to conduct an
electronic analysis of audit trail data that is not entered into a
SEF's electronic trading system or platform, such as oral
communications, electronic instant messages, and emails. The Commission
understands that during that time, such technology, if available, would
have been costly for SEFs to adopt and would not have been fully
capable of digitizing oral communications in a sufficiently accurate
manner to conduct effective surveillance.
While the Commission is aware that promising technologies are
developing in this area, it does not believe that a viable, cost-
effective automated technology solution currently exists. Currently,
SEFs that offer any form of voice-based trading system or platform are
required, as a condition to their registration, to establish voice
audit trail surveillance programs to ensure that they can reconstruct a
sample of voice trades and review such trades for possible trading
violations. The proposed amendments to Sec. Sec. 37.205(b)(2)-(3)
would relieve a SEF from establishing or maintaining such a program,
but the proposed audit trail reconstruction requirement under Sec.
37.205(c), as discussed below, would apply instead. Nonetheless, a SEF
must continue to conduct electronic analysis, using an automated trade
surveillance system that meets the requirements of proposed Sec.
37.203(d).
[[Page 62007]]
The Commission further proposes to eliminate the safe storage
requirement under Sec. 37.205(b)(4), given that it is generally
duplicative of the requirements under Core Principle 14 and related
regulations.\485\ As discussed below, however, the Commission proposes
a non-substantive amendment to move the requirement that a SEF must
protect audit trail data from unauthorized alteration, accidental
erasure, or other loss to Sec. 37.1401(c), which addresses system
safeguard requirements.\486\
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\485\ 7 U.S.C. 7b-3(f)(14); 17 CFR 37.1401.
\486\ See infra Section XIX.A.--Sec. 37.1401(c).
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Request for Comment
The Commission requests comment on all aspects of proposed
Sec. Sec. 37.205(b)(1)-(3).
3. Sec. 37.205(c)--Audit Trail Reconstruction \487\
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\487\ The Commission proposes to retitle Sec. 37.205(c) to
``Audit trail reconstruction'' from ``Enforcement of audit trail
requirements'' based on the proposed changes described below.
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Section 37.205(c) generally requires a SEF to enforce its audit
trail and recordkeeping requirements.\488\ Section 37.205(c)(1)
requires enforcement through annual reviews and prescribes the minimum
components that must be included in such reviews.\489\ Section
37.205(c)(2) requires that a SEF establish an enforcement program and
to impose meaningful sanctions against persons and firms where
deficiencies are found.\490\
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\488\ 17 CFR 37.205(c).
\489\ 17 CFR 37.205(c)(1).
\490\ 17 CFR 37.205(c)(2). The Commission notes that Sec.
37.205(c)(2) also imposes a warning letter requirement for audit
trail violations. As discussed below, the Commission proposes to
streamline and consolidate this provision into proposed Sec.
37.206(c)(2). See infra Section VII.E.6.--Sec. 37.206(f)--Warning
Letters.
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The Commission proposes to eliminate the existing audit trail
enforcement requirements under Sec. 37.205(c) and adopt an audit trail
reconstruction requirement instead.\491\ The Commission believes that
the primary goal of audit trail enforcement is to ensure that a SEF's
audit trail enables it to reconstruct trading and conduct effective
surveillance to fulfill its Core Principle 2 obligations. To that end,
audit trail enforcement focuses on reviewing certain components of the
audit trail data to ensure that a SEF's audit trail data is complete
and accurate. Existing audit trail reviews include a (1) review of
randomly selected samples of front-end audit trail data; (2) review of
the process by which user identifications are assigned and records
relating to user identifications are maintained; (3) review of the
usage patterns of user identifications to identify violations of user
identification rules; and (4) review of account numbers and CTI codes
for accuracy and proper use. The Commission understands that these
reviews focus on components of the audit trail that are generally not
relevant to SEFs. For example, SEFs have represented that there is
little, if any, ``front-end audit trail data'' that is not already
captured by the SEF, and that many of the data points for review, such
as user identifications, account numbers, and CTI codes, are not used
in the same manner as they are for DCMs. Therefore, the Commission
believes that requiring SEFs to conduct an audit trail enforcement
program based on the requirements of existing Sec. 37.205(c) serves a
limited purpose.
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\491\ Notwithstanding these proposed changes, the Commission
notes that to comply with the general audit trail requirement under
proposed Sec. 37.205(a), which requires a SEF to capture all audit
trail data related to each offered execution method that is
necessary to reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take disciplinary
action, the SEF must ensure that market participants are submitting
accurate and complete audit trail data.
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The Commission believes that ensuring a SEF's audit trail is
accurate and sufficient to conduct effective surveillance--the primary
goals of audit trail enforcement--would be better served through an
audit trail reconstruction program that focuses on verifying the
accuracy of audit trail data and a SEF's ability to comprehensively and
accurately reconstruct all trading on its facility in a timely manner.
As discussed above, the Commission is aware that SEFs that offer any
form of a voice-based trading system or platform do not currently have
cost-effective solutions for consolidating certain types of data, such
as oral communications, electronic instant messages, and emails,
inputting them into an electronic transaction history database, and
loading and processing them into an automated system to reconstruct
trading. Given that the ability to reconstruct all trading is an
essential component to conducting effective surveillance and is
currently not being conducted in a routine, automated manner for
certain key data, the Commission proposes to require that a SEF
establish a program to verify its ability to comprehensively and
accurately reconstruct all trading on its facility in a timely manner.
The Commission also proposes to adopt guidance to Core Principle 2 in
Appendix B specifying that an effective audit trail reconstruction
program should annually review an adequate sample of executed and
unexecuted orders and trades from each execution method offered to
verify compliance with Sec. 37.205(c).\492\
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\492\ The Commission proposes to add this guidance to paragraph
(a)(5) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B. As
discussed below, the Commission proposes to eliminate the existing
language in paragraph (a)(5). See infra Section VII.E.2.---Sec.
37.206(b)--Disciplinary Program.
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Since SEFs that offer only electronic trading systems or platforms
can use their automated trade surveillance systems to reconstruct
trading, the reconstructions under proposed Sec. 37.205(c) would serve
to verify the accuracy of their audit trail data. A SEF that offers any
form of voice-based trading could comply with proposed Sec. 37.205(c)
by conducting manual reconstructions, including orders entered by oral
communications, instant messages, and email, and trades executed by
voice that are captured by the SEF's electronic transaction history
database. In addition to verifying the accuracy of the audit trail data
for SEFs that offer electronic trading systems or platforms, these
reconstructions would help ensure that in the absence of such an
automated solution, a SEF that offers voice-based trading is able to
reconstruct trading as necessary, including when they are investigating
problematic trading activity.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.205(c) and the associated guidance to Core Principle 2 in Appendix
B. In particular, the Commission requests comment on the following
questions:
(63) What factors should a SEF consider in selecting an adequate
sample of orders and trades for reconstruction?
(64) Should SEFs be required to annually reconstruct a minimum
number or orders and trades? If so, what is the minimum number?
(65) Should SEFs be required to conduct annual audit trail reviews
of their members and firms that are subject to recordkeeping
requirements? If so, what should these reviews include?
E. Sec. 37.206--Disciplinary Procedures and Sanctions
Section 37.206 generally requires a SEF to establish rules that
deter abuses and have the capacity to enforce those rules though prompt
and effective disciplinary action. The disciplinary rules that
implement this requirement require a SEF to maintain sufficient
enforcement staff, establish disciplinary panels, follow certain
disciplinary
[[Page 62008]]
procedures that afford respondents procedural safeguards, and impose
sanctions that are commensurate to the violations committed.\493\ The
rules prescribe the use of various sanctions, including suspension or
expulsion of members or market participants; customer restitution; and
issuance of warning letters.\494\
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\493\ 17 CFR 37.206(a)-(f).
\494\ 17 CFR 37.206(e)-(f).
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Since the adoption of Sec. 37.206, the Commission has considered
whether alternative cost-effective methods exist for complying with
Core Principle 2's requirement to establish and enforce trading, trade
processing, and participation rules that deter abuses, and have the
capacity to investigate and enforce such abuses.\495\ Based on its
experience with the part 37 implementation, the Commission believes
that alternative disciplinary methods exist that would ensure that SEFs
maintain robust disciplinary structures necessary to enforce compliance
with their rules and deter abusive trading to promote market integrity.
The Commission acknowledges that Sec. 37.206 is a limited approach
that is based in many respects on its experience with oversight of DCM
disciplinary programs.\496\ While the Commission believes that all SEFs
should be subject to certain threshold requirements, it also believes
that SEFs should be able to use their experience and knowledge to
establish disciplinary procedures that are appropriate for their own
markets and market participants. The Commission notes that this
approach is consistent with the reasonable discretion afforded to SEFs
under Core Principle 1.\497\ Therefore, the Commission proposes to
streamline the SEF disciplinary program rules, discussed further
below.\498\
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\495\ 7 U.S.C. 7b-3(f)(2)(B).
\496\ See SEF Core Principles Final Rule at 33520-21 (noting
that the disciplinary procedures in the part 37 proposed rules
paralleled the procedures for DCMs).
\497\ 7 U.S.C. 7b-3(f)(1)(B).
\498\ The Commission proposes to eliminate the introductory
sentence under Sec. 37.206, which states that a SEF shall establish
trading, trade processing, and participation rules that will deter
abuses and have the capacity to enforce such rules through prompt
and effective disciplinary action, including suspension or expulsion
of members or market participants who violate the rules of the swap
execution facility, given that this language is duplicative of
requirements elsewhere in this part, including Core Principle 2 and
various provisions under Sec. 37.206.
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1. Sec. 37.206(a)--Enforcement Staff
Section 37.206(a) requires a SEF to establish and maintain
sufficient enforcement staff and resources to effectively and promptly
prosecute possible rule violations within the disciplinary jurisdiction
of the SEF.\499\
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\499\ 17 CFR 37.206(a).
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The Commission proposes to change the word ``prosecute'' to
``enforce'' to more accurately describe the requirements under Sec.
37.206(a), given that every rule violation may not lead to a
prosecution.
The Commission also proposes to amend the guidance to Core
Principle 2 in Appendix B that addresses a SEF's enforcement
staff.\500\ The Commission proposes eliminating the language stating
that a SEF's enforcement staff may operate as part of the SEF's
compliance staff. The Commission no longer believes this language is
necessary, given that SEFs should have the option to determine the
appropriate structure for their disciplinary programs, including their
enforcement staff, discussed further below with respect to Sec.
37.206(b).
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\500\ The Commission proposes to renumber paragraph (a)(3) to
paragraph (a)(6) of the guidance to Core Principle 2 in Appendix B
and adopt the amendments described above. 17 CFR part 37 app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(a) and the associated guidance to Core Principle 2 in Appendix
B.
2. Sec. 37.206(b)--Disciplinary Program \501\
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\501\ The Commission proposes to retitle Sec. 37.206(b) to
``Disciplinary program'' from ``Disciplinary panels'' based on the
proposed changes described below.
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Section 37.206(b) currently requires SEFs to establish one or more
disciplinary panels that meet the composition requirements of part 40
and do not include a SEF's compliance staff or any person involved in
adjudicating any other stage of the same proceeding.\502\
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\502\ 17 CFR 37.206(b). The Commission proposed composition
requirements for disciplinary panels, but has not adopted those
requirements in a final rule. Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities Regarding the Mitigation of Conflicts of Interest, 75 FR
63732, 63752 (Oct. 18, 2010).
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The Commission proposes to amend Sec. 37.206(b) to permit a SEF to
administer its disciplinary program through not only one or more
disciplinary panels, as currently allowed, but also through its
compliance staff. As discussed above, this amendment provides SEFs with
the ability to adopt a cost-effective disciplinary structure that best
suits their markets and market participants, while still effectuating
the requirements and protections of Core Principle 2 through compliance
staff, disciplinary panels, or some combination of both.\503\
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\503\ While the participation of SEF compliance staff could
present a possible conflict of interest, the Commission believes
that this concern is adequately addressed through the SEF's CCO.
Under proposed Sec. 37.1501(c)(2), a CCO would be required to take
reasonable steps to resolve any material conflicts of interest. See
infra Section XX.A.3.--Sec. 37.1501(c)--Duties of Chief Compliance
Officer. Further, a CCO would be required to conduct an annual
assessment of the SEF's policies on the handling of conflicts of
interest. See infra Section XX.A.4.--Sec. 37.1501(d)--Preparation
of Annual Compliance Report. The Commission also notes that the
SEF's disciplinary practices are within the scope of the
Commission's examinations.
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The Commission also proposes other amendments to Sec. 37.206(b),
including non-substantive revisions, to streamline certain existing
composition requirements for disciplinary panels.\504\ For SEFs that
elect to administer their disciplinary program though compliance staff,
the Commission proposes to amend Sec. 37.206(b) to exclude compliance
staff from the requirements under Sec. 1.64(c)(4). Section 1.64, among
other things, prescribes rules that govern the composition of an SRO's
major disciplinary committee.\505\ The Commission recognizes that a
SEF's compliance staff could qualify as a ``[m]ajor disciplinary
committee'' \506\ under Sec. 1.64(a)(2) when imposing sanctions under
the proposed rule; therefore, the staff would otherwise be subject to
the composition requirement of Sec. 1.64(c)(4), which requires
``sufficient different membership
[[Page 62009]]
interests.'' \507\ Accordingly, the Commission believes these
amendments are necessary to effectuate the proposed rule of allowing
compliance staff to administer a SEF's disciplinary program.
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\504\ The Commission proposes to amend the panel composition
language by replacing the reference to part 40 with ``applicable
Commission regulations.'' Additionally, paragraph (a)(11)(ii) of the
guidance to Core Principle 2 in Appendix B currently specifies that
the composition of the appellate panels should be consistent with
part 40 and should not include any members of the SEF's compliance
staff or any person involved in adjudicating any other stage of the
same proceeding. 17 CFR part 37 app. B. To avoid duplicative
language, the Commission proposes to consolidate these provisions
under Sec. 37.206(b) to require that any disciplinary panel or
appellate panel established by a SEF must meet the composition
requirements of applicable Commission regulations, and shall not
include any member of the SEF's compliance staff or any person
involved in adjudicating any other stage of the same proceeding
(emphasis added). The Commission also proposes to eliminate
paragraph (a)(11) of the guidance to Core Principle 2 in Appendix B
as noted below. 17 CFR part 37 app. B.
\505\ 17 CFR 1.64.
\506\ Section 1.64(a)(2) defines ``major disciplinary
committee'' as a committee of persons authorized by a self-
regulatory organization to conduct disciplinary hearings, settle
disciplinary charges, or impose disciplinary sanctions. Such a
committee may also hear appeals of cases involving any violation of
a SRO's rules, except for rules related to decorum or attire;
financial requirements; reporting or recordkeeping; and violations
that do not involve fraud, deceit or conversion. 17 CFR 1.64(a)(2).
Under Sec. 37.2, SEFs are subject to all applicable Commission
regulations, including Sec. 1.64.
\507\ Section 1.64(c)(4) requires that each major disciplinary
committee, or hearing panel thereof, include sufficient different
membership interests so as to ensure fairness and prevent special
treatment or preference for any person in the conduct of a
committee's or panel's responsibilities. 17 CFR 1.64(c)(4).
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Consistent with the Commission's intention to streamline
requirements while still effectuating the Core Principle 2
requirements, the Commission proposes to eliminate the guidance to Core
Principle 2 in Appendix B that specifies protocols for the SEF to
handle charges and settlement offers.\508\ Given that proposed Sec.
37.206(b) would permit SEFs to administer their disciplinary program
through compliance staff, the Commission does not believe that this
detailed guidance is necessary. Instead, the Commission proposes new
guidance to specify that a SEF's rules governing the adjudication of a
matter by the SEF's disciplinary panel should be fair, equitable, and
publicly available.\509\
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\508\ The Commission proposes to eliminate paragraphs (a)(4)-(9)
of the guidance to Core Principle 2 in Appendix B. 17 CFR part 37
app. B.
\509\ The Commission proposes to add this guidance as paragraph
(a)(7) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(b) and the associated guidance to Core Principle 2 in Appendix
B.
3. Sec. 37.206(c)--Hearings
Section 37.206(c) requires a SEF to adopt rules that provide
certain minimum procedural safeguards for any hearing. In general, the
rule requires a fair hearing, promptly convened after reasonable notice
to the respondent; and a copy of the hearing to be made and be a part
of the record of the proceeding if the respondent requested the
hearing.\510\
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\510\ 17 CFR 37.206(c).
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The Commission proposes to eliminate Sec. 37.206(c). First, the
detailed hearing procedures under existing Sec. 37.206(c) are not
necessary, as SEFs that choose to establish a disciplinary panel have
reasonable discretion to do so pursuant to Core Principle 1.\511\
Second, the Commission notes that requirements for hearings under Sec.
37.206(c) would not apply to SEFs that choose to administer their
disciplinary program through compliance staff. Third, as noted above,
the Commission proposes to add guidance to Core Principle 2 in Appendix
B that a SEF's rules relating to disciplinary panel procedures should
be fair, equitable, and publicly available.\512\ The Commission
believes this guidance adequately captures the principal procedural
objectives when SEFs are conducting disciplinary hearings and obviates
the need for the otherwise prescriptive regulatory requirements.
Consistent with the Commission's elimination of Sec. 37.206(c), the
Commission also proposes to eliminate the guidance to Core Principle 2
in Appendix B that specifies detailed guidelines for disciplinary
hearing protocols.\513\
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\511\ 7 U.S.C. 7b-3(f)(1)(B).
\512\ See supra note 509.
\513\ The Commission proposes to eliminate paragraph (a)(10) of
the guidance to Core Principle 2 in Appendix B. 17 CFR part 37 app.
B.
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Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.206(c) and the associated guidance to Core
Principle 2 in Appendix B.
4. Sec. 37.206(d)--Decisions
Section 37.206(d) requires a disciplinary panel to render a written
decision promptly following a hearing.\514\ The rule also provides
detailed items to be included in the decision, such as a notice or
summary of charges, the answer, and a statement of finding and
conclusions with respect to each charge.\515\
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\514\ 17 CFR 37.206(d).
\515\ Id.
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The Commission proposes to eliminate the prescriptive requirements
under Sec. 37.206(d). This proposed elimination is consistent with
other proposed amendments to Sec. 37.206 that would allow a SEF to
exercise discretion in establishing its disciplinary procedures
pursuant to Core Principle 2. The Commission, however, also proposes to
add guidance to Core Principle 2 in Appendix B to specify that a SEF's
rules should require the disciplinary panel to promptly issue a written
decision following a hearing or the acceptance of a settlement
offer.\516\ Consistent with the Commission's elimination of the
requirements under Sec. 37.206(d), the Commission also proposes to
eliminate the guidance to Core Principle 2 in Appendix B that specifies
guidelines for a SEF's ability to provide rights of appeal to
respondents and issue a final decision.\517\
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\516\ The Commission proposes to add this guidance as part of
paragraph (a)(7) to Core Principle 2 in Appendix B. 17 CFR part 37
app. B.
\517\ The Commission proposes to eliminate paragraphs (a)(11)-
(12) of the guidance to Core Principle 2 in Appendix B. 17 CFR part
37 app. B.
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Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.206(d) and the associated guidance to Core
Principle 2 in Appendix B.
5. Sec. 37.206(e)--Disciplinary Sanctions
Existing Sec. 37.206(e) requires that all disciplinary sanctions
imposed by a SEF must be commensurate with the violations committed and
must be clearly sufficient to deter recidivism or similar violations by
other market participants.\518\ A SEF is also required to consider a
respondent's disciplinary history when evaluating appropriate
sanctions.\519\ In the event of demonstrated customer harm, any
disciplinary sanction must include full customer restitution, except
where the amount of restitution, or to whom it should be provided,
cannot be reasonably determined.\520\
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\518\ 17 CFR 37.206(e).
\519\ Id.
\520\ Id.
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The Commission proposes to consolidate the requirements that apply
to disciplinary sanctions and warning letters, under existing Sec.
37.206(e) and existing Sec. 37.206(f),\521\ respectively, into a new
proposed Sec. 37.206(c).\522\ Consistent with the Commission's goal to
provide SEFs with a greater ability to develop cost-effective
approaches to administer their disciplinary programs based on their
markets and market participants, the Commission believes that a SEF
should have greater discretion to choose between taking disciplinary
action or issuing a warning letter. Accordingly, as discussed below,
the Commission proposes under Sec. 37.206(c)(2) to expand the current
use of warning letters by allowing a SEF to issue more than one warning
letter over a rolling twelve-month period for violations that involve
minor recordkeeping or reporting infractions. To balance the expanded
authority to issue warning letters and ensure their proper use by SEFs,
the Commission also proposes under Sec. 37.206(c)(1) to extend the
existing criteria for issuing disciplinary sanctions to warning
letters. Specifically, proposed
[[Page 62010]]
Sec. 37.206(c)(1) would require that all warning letters and sanctions
imposed by a SEF must be commensurate with the violations committed and
shall be clearly sufficient to deter recidivism or similar violations
by other market participants. Further, all warning letters and
sanctions, including summary fines and sanctions imposed pursuant to an
accepted settlement offer, must take into account the respondent's
disciplinary history.\523\
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\521\ Existing Sec. 37.206(f) states that where a rule
violation is found to have occurred, no more than one warning letter
may be issued per rolling twelve-month period for the same
violation.
\522\ The Commission proposes to retitle Sec. 37.206(c) to
``Warning letters and sanctions'' from ``Hearings'' based on the
proposed changes described below.
\523\ The Commission proposes to add the term ``summary fine''
to clarify that summary fines are among the types of disciplinary
sanctions that may be issued and would be subject to the
requirements of the proposed rule.
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The Commission also proposes several amendments to related guidance
to Core Principle 2 in Appendix B that are consistent with the proposed
changes and are intended to allow a SEF to determine how to issue
warning letters and sanctions. First, the Commission proposes to adopt
guidance to Core Principle 2 in Appendix B to state that SEFs should
have reasonable discretion in determining when to issue warning letters
and apply sanctions.\524\ Second, the Commission also proposes to
eliminate detailed guidance regarding the procedures for taking
emergency disciplinary action. The guidance, however, would maintain
that a SEF may impose a sanction or take summary action as necessary to
protect the best interest of the marketplace.\525\
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\524\ The Commission proposes to add this guidance as paragraph
(a)(9) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B.
\525\ The Commission proposes to renumber paragraph (a)(14) to
paragraph (a)(8) to Core Principle 2 in Appendix B. 17 CFR part 37
app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(c)(1) and the associated guidance to Core Principle 2 in
Appendix B. In particular, the Commission requests comment on the
following question:
(66) Should the Commission provide further explanation regarding
the meaning of ``minor'' recordkeeping or reporting infractions?
6. Sec. 37.206(f)--Warning Letters
Existing Sec. 37.206(f) states that where a rule violation is
found to have occurred, no more than one warning letter may be issued
per rolling twelve-month period for the same violation.\526\
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\526\ 17 CFR 37.206(f).
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As part of a new proposed Sec. 37.206(c)(2) noted above, the
Commission proposes to amend this provision to establish a more
practical approach to the use of warning letters. Under the proposed
approach, a SEF would be allowed to issue more than one warning letter
over a rolling twelve-month period for violations that involve minor
recordkeeping or reporting infractions. Given the de minimis nature of
such infractions, the Commission believes that a SEF should have the
ability to determine whether they merit the issuance of a warning
letter or sanction. The Commission also proposes to clarify that the
twelve-month limitation on warning letters applies to the same
individual who is found to have committed the same rule violation,
rather than an entity. The Commission acknowledges that applying the
limitation to subject entities is not practical because many of them
have hundreds of employees trading on behalf of the entity.\527\
Further, the Commission notes that the rolling twelve-month period
begins tolling once the SEF finds that a violation occurred, rather
than the date that the subject activity occurred.
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\527\ The Commission notes, however, that this provision would
be evaluated in conjunction proposed Sec. 37.206(c)(1).
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The Commission also proposes to eliminate guidance to Core
Principle 2 in Appendix B that currently specifies that a SEF may adopt
summary fines for violations of rules related to the failure to timely
submit accurate records required for clearing or verifying each day's
transactions.\528\ The Commission notes that Sec. 37.206(c)(1) as
proposed would already specify that a SEF may issue summary fines as a
sanction.
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\528\ The Commission proposes to eliminate paragraph (a)(13) of
the guidance to Core Principle 2 in Appendix B. 17 CFR part 37 app.
B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.206(c)(2) and the associated guidance to Core Principle 2 in
Appendix B. In particular, the Commission requests comment on the
following question:
(67) Is the Commission's approach to warning letters appropriate?
Should the Commission allow SEFs to issue more than one warning letter
to the same individual within a rolling twelve-month period for other
rule violations in addition to minor recordkeeping or reporting
infractions? If so, should the Commission specify which rule
violations? If so, identify those rule violations and explain why.
7. Sec. 37.206(g)--Additional Sources for Compliance
The Commission is not proposing any amendments to Sec.
37.206(g).\529\
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\529\ The Commission proposes to renumber Sec. 37.206(g) to
Sec. 37.206(d) based on the proposed changes described above.
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F. Part 9--Rules Relating to Review of Exchange Disciplinary, Access
Denial or Other Adverse Actions
Part 9 of the Commission's regulations details the process and
procedures for the Commission's review of exchange disciplinary, access
denial, or other adverse actions.\530\ The rules also address the
procedures and standards governing filing and service, motions, and
settlement; the process that exchanges must follow in providing notice
of a final disciplinary action to the subject of the action and to the
Commission; and the publication of such notice.\531\
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\530\ 17 CFR part 9. For these purposes, the Commission
interprets references to ``exchange'' to part 9 to mean DCMs and
SEFs.
\531\ Id.
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The Commission is proposing several non-substantive amendments to
part 9 that correspond to certain proposed amendments to the Core
Principle 2 regulations under part 37.\532\ As discussed above, the
Commission proposes to eliminate various disciplinary procedures under
proposed Sec. 37.206 and the applicable guidance to Core Principle 2
in Appendix B to part 37 to streamline existing Core Principle 2
requirements and provide SEFs with discretion in administering their
disciplinary programs.\533\ These proposed changes include eliminating
requirements concerning disciplinary decisions under Sec. 37.206(d)
and eliminating various procedures detailed in guidance to Core
Principle 2 concerning settlement offers; \534\ sanctions upon persons
who impede the progress of disciplinary hearings; \535\ the right to
appeal adverse actions; \536\ and summary fines for violations of rules
regarding the timely submission of records.\537\ To the extent that the
part 9 regulations contain cross-references to these part 37
provisions, the Commission proposes to eliminate those references.\538\
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\532\ The Commission also proposes to renumber Sec. 9.1(b)(4)
to Sec. 9.1(c) and Sec. 9.1(c) to Sec. 9.1(d).
\533\ See supra Section VII.E.--Sec. 37.206--Disciplinary
Procedures and Sanctions.
\534\ See supra note 508 (elimination of paragraph (a)(9)).
\535\ See supra note 513 (elimination of paragraph (a)(10)(vi)).
\536\ See supra note 517 (elimination of in paragraph
(a)(11)(iv)).
\537\ See supra note 528 (elimination of paragraph (a)(13)).
\538\ The Commission also proposes to renumber the cross-
references under Sec. 9.2(k), Sec. 9.12(a)(1), and Sec.
9.24(a)(2) from paragraph (a)(14) to paragraph (a)(8) of the
guidance to Core Principle 2 in Appendix B. See supra note 525.
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Specifically, the Commission proposes to eliminate those references
under Sec. 9.11(b)(2), which govern the content requirements for SEF
[[Page 62011]]
disciplinary and access denial notices that must be filed with the
person subject to the action. Currently, the notice of such actions
must be provided as a copy of a written decision, which accords with
Sec. 37.206(d) and guidance to Core Principle 2 in Appendix B relating
to the use of written decisions where a disciplinary panel accepts a
settlement offer; \539\ and paragraph (a)(11)(iv), where an appellate
panel responds to appeals of adverse decisions by a disciplinary
panel.\540\ Alternatively, Sec. 9.11(b)(2) provides that SEFs may file
a written notice that includes the items listed under Sec. Sec.
9.11(b)(3)(i)-(vi).\541\ Given the proposed elimination of Sec.
37.206(d) and associated guidance to Core Principle 2, the Commission
proposes that the contents of the SEF disciplinary or access denial
notice be limited to the information specified under Sec. Sec.
9.11(b)(3)(i)-(vi).
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\539\ 17 CFR part 37 app. B (guidance to Core Principle 2--
paragraph (a)(9)(iii)--``Settlement offers'').
\540\ 17 CFR part 37 app. B (guidance to Core Principle 2--
paragraph (a)(11)(iv)--``Right to appeal'').
\541\ Section 9.11(b)(3) requires that the notice of a
disciplinary action or access denial action include the following:
(i) The name of the person against whom the disciplinary action or
access denial action was taken; (ii) a statement of the reasons for
the disciplinary action or access denial action, detailing the
exchange product which was involved, as applicable, and whether the
violation that resulted in the action also resulted in financial
harm to any customers together with a listing of any rules which the
person who was the subject of the disciplinary action or access
denial action was charged with having violated or which otherwise
serve as the basis of the exchange action; (iii) a statement of the
conclusions and findings made by the exchange with regard to each
rule violation charged or, in the event of settlement, a statement
specifying those rule violations which the exchange has reason to
believe were committed; (iv) the terms of the disciplinary action or
access denial action; (v) the date on which the action was taken and
the date the exchange intends to make the disciplinary or access
denial action effective; and (vi) except as otherwise provided under
Sec. 9.1(b), a statement informing the party subject to the
disciplinary action or access denial action of the availability of
Commission review of the exchange action pursuant to section 8c of
the Act and this part. 17 CFR 9.11(b)(3).
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Under Sec. 9.1(b)(2), Sec. 9.2(k), and Sec. 9.12(a)(3), the
Commission also proposes to eliminate references to paragraph (a)(13)
of the guidance to Core Principle 2 in Appendix B, which addresses the
issuance of summary fines for failing to submit certain records in a
timely manner. To replace those references, the Commission proposes to
add new regulatory language that accounts for summary fines being
permitted under the rules of the SEF for recordkeeping or reporting
violations.
Under Sec. 9.2(k) and Sec. 9.12(a)(2), the Commission further
proposes to eliminate references to paragraph (a)(10)(vi) of the
guidance to Core Principle 2 in Appendix B, which addresses the use of
sanctions for persons who impede the progress of disciplinary hearings.
To replace those references, the Commission proposes new regulatory
language that accounts for SEFs imposing disciplinary action on a
person for impeding the progress of a hearing under the rules of the
SEF.
VIII. Part 37--Subpart D: Core Principle 3 (Swaps Not Readily
Susceptible to Manipulation)
Core Principle 3 specifies that a SEF shall permit trading only in
swaps that are not readily susceptible to manipulation.\542\
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\542\ The Commission codified Core Principle 3 under Sec.
37.300. 17 CFR 37.300.
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A. Sec. 37.301--General Requirements
Section 37.301 further implements Core Principle 3 by requiring a
SEF, at the time that it submits a new swap contract to the Commission,
to demonstrate that the swap is not readily susceptible to manipulation
by providing the information required in Appendix C to part 38.\543\
Section 37.301 also states that in addition to referring to Appendix C
to part 38, a SEF may refer to the guidance to Core Principle 3 in
Appendix B.\544\ With respect to swaps, this guidance is similar in
scope to the guidance to Appendix C to part 38.
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\543\ Appendix C to part 38--``Demonstration of Compliance That
a Contract Is Not Readily Susceptible to Manipulation''--provides
guidance regarding (i) the information that a new futures contract
submission should include; (ii) estimations of deliverable supplies;
(iii) contract terms and conditions that should be specified for
physically-delivered contracts; (iv) demonstration that a cash-
settled contract is reflective of the underlying cash market and is
not readily subject to manipulation or distortion; (v) contract
terms and conditions that should be specified for cash-settled
contracts; (vi) requirements for options on futures contracts; (vii)
the terms and conditions for non-price based futures contracts; and
(vii) the terms and conditions for swap contracts. 17 CFR part 38
app. C (``Appendix C to part 38''). The Commission amended and
updated this guidance to address swap transactions in 2012 as part
of a part 38 rulemaking for designated contract markets. Core
Principles and Other Requirements for Designated Contract Markets,
77 FR 36612 (Jun. 19, 2012).
\544\ 17 CFR 37.301.
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Appendix C to part 38 for DCMs, as applied by Sec. 37.301 to SEFs,
provides guidance regarding the relevant considerations for evaluating
if a new or existing swap contract is readily susceptible to
manipulation.\545\ The objective of this guidance, which applies the
guidance for futures contracts to swaps as applicable, is intended to
ensure that a given contract is not readily susceptible to manipulation
and will provide a reliable pricing basis, as well as promote cash and
swaps price convergence. Among other things, the guidance states that a
swap contract submitted under part 40 should conform to prevailing
commercial practices, such that the settlement or delivery procedures
adopted for a swap contract should reflect the underlying cash
market.\546\ For cash-settled swap contracts, the guidance explains
that the cash settlement index should be based on a reliable price
reference series that accurately reflects the underlying market value,
is not readily susceptible to manipulation, and is highly regarded by
industry/market participants.\547\ For physically-settled swap
contracts, the guidance explains that the terms and conditions should
provide for adequate deliverable supply and be designed to avoid
impediments to the delivery of the commodity.\548\
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\545\ See generally Appendix C to part 38.
\546\ See paragraph (g)(4) of Appendix C to part 38, which
references various provisions related to contract terms and
conditions requirements for futures contracts.
\547\ See paragraph (g)(1) of Appendix C to part 38.
\548\ Paragraph (g)(4) of Appendix C to part 38, which applies
to swaps, refers to paragraph (b)(2), which specifies contract term
and condition requirements for futures contracts settled by physical
delivery. Paragraph (b)(2) specifies various criteria related to
quality standards of the underlying commodity, delivery point/area
specifications, and specification of the delivery period. The
Commission notes that paragraph (b)(1) generally specifies that the
terms and conditions should be designed to avoid any impediments to
delivery so as to promote convergence between the price of the
futures contract and the cash market value of the commodity at the
expiration of the contract. Paragraph (b)(1)(i)(A) specifies that
the terms and conditions should result in a deliverable supply that
is sufficient to ensure that the contract is not susceptible to
price manipulation or distortion.
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1. Appendix C to Part 37--Demonstration of Compliance That a Swap
Contract Is Not Readily Susceptible to Manipulation
The Commission proposes to eliminate the existing cross-reference
to Appendix C to part 38 under Sec. 37.301 and establish a separate
Appendix C to part 37 to provide specific guidance to SEFs for
complying with the requirements of Core Principle 3.\549\ In
conjunction with the Commission's proposal to create a separate
Appendix C to part 37, the Commission also proposes to adopt conforming
changes to the guidance to Core Principle 3 in Appendix B.\550\
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\549\ The Commission also proposes a conforming non-substantive
amendment to Sec. 37.301 to update the reference to Appendix C to
part 37.
\550\ The proposed amendments to Appendix B would eliminate the
existing explanatory guidance to Core Principle 3, which the
Commission is proposing to address in the proposed Appendix C to
part 37; and replace the existing cross-reference to sections of
Appendix C to part 38 with a general reference to Appendix C to part
37.
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[[Page 62012]]
Specifically, proposed Appendix C to part 37 specifies (1) measures
that a SEF should take to determine that a cash-settled swap contract
is reflective of the underlying cash market, is not readily subject to
manipulation or distortion, and is based on a cash price series that is
reliable, acceptable, publicly available, and timely; (2) terms and
conditions that should be specified for cash-settled swap contracts;
(3) terms and conditions that should be specified for physically-
settled swap contracts; (4) methodologies that should be utilized in
estimating deliverable supplies; (5) terms and conditions that should
be specified for options on swap contracts; and (6) guidance for
options on physicals contracts.\551\
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\551\ ``Options on physicals'' refers to option contracts that
do not provide for exercise into an underlying futures contract.
Upon exercise, options on physicals can be settled via physical
delivery of the underlying commodity or by a cash payment. See
proposed Appendix C to part 37--paragraph (d)--``Guidance for
options on physicals contracts.''
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The Commission believes that the proposed amendments would
streamline the guidance to Core Principle 3 in a single appendix that
is dedicated to part 37. A separate appendix for SEFs and swaps trading
from the guidance provided in Appendix C to part 38, which primarily
applies to DCMs and futures trading, reflects good regulatory practice
that provides greater clarity and certainty. The proposed Appendix C to
part 37 would serve as a streamlined source of guidance for new and
existing SEFs when developing new swap products to list for trading and
when monitoring their existing swap products.\552\ Based on the number
of swap contracts that SEFs currently list for trading and will likely
submit in the future, the Commission believes that a separate guidance
in part 37 is appropriate for SEFs.
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\552\ The guidance in Appendix C to this part is based on best
practices that were developed over the past three decades by the
Commission and other market regulators in their review of product
submissions. See Core Principles and Other Requirements for
Designated Contract Markets, 75 FR 80572, 80582 (proposed Dec. 22,
2010).
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The Commission believes that the proposed Appendix C to part 37
also clarifies a SEF's obligations pursuant to Core Principle 3 because
the guidance specifically addresses swap contracts and reflects the
diverse and non-standardized nature of the swaps market, including
swaps traded on SEFs. In particular, the guidance provides SEFs with
additional flexibility for certain terms and conditions for non-
standardized swap contracts.\553\ This flexibility reflects the
negotiated nature of non-standardized swap contracts. Similarly, the
proposed Appendix C includes specific guidance for options on swap
contracts. This guidance is not currently included in Appendix C to
part 38, which focuses primarily on futures products. This proposed
guidance, however, is consistent with previous Commission expectations
with respect to contract design and transparency of option contract
terms.
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\553\ The Commission notes that for purposes of establishing the
terms and conditions of a swap that it lists for trading, a SEF has
discretion to determine whether the swap is standardized or non-
standardized in nature. For example, the Commission understands that
the swaps subject to the current trade execution requirement are
generally standardized swaps. See supra notes 33-34 (describing the
characteristics of the swaps that have been submitted as ``available
to trade'').
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Request for Comment
The Commission requests comments on all aspects of the proposed
guidance to Core Principle 3 in Appendix C to part 37. In particular,
the Commission requests comment on the following questions:
(68) Is the scope and content of the proposed guidance
appropriately tailored for swap contracts? If not, then please explain
any changes.
(69) Is the additional flexibility for certain terms and conditions
for non-standardized swap contracts appropriate? If not, please explain
why.
IX. Part 37--Subpart E: Core Principle 4 (Monitoring of Trading and
Trade Processing)
Core Principle 4 requires a SEF to establish and enforce rules or
terms and conditions that define, or specifications that detail, the
trading procedures to be used in entering and executing orders traded
on or through the facilities of the SEF and procedures for trade
processing of swaps on or through the facilities of the SEF.\554\ Core
Principle 4 also requires a SEF to monitor trading in swaps to prevent
manipulation, price distortion, and disruptions of the delivery or cash
settlement process through surveillance, compliance, and disciplinary
practices and procedures.\555\ As part of its monitoring
responsibilities, a SEF must establish methods for conducting real-time
monitoring of trading and comprehensive and accurate trade
reconstructions.\556\ As described below, Sec. Sec. 37.401-408 further
implement Core Principle 4 by establishing requirements that a SEF
monitor trading activity on its facility and beyond its own market in
certain circumstances.
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\554\ 7 U.S.C. 7b-3(f)(4). The Commission codified Core
Principle 4 under Sec. 37.400. 17 CFR 37.400.
\555\ Id.
\556\ Id.
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The Commission received feedback from SEFs during the part 37
implementation that certain Core Principle 4 requirements are
unnecessarily broad and create impracticable monitoring burdens upon
SEFs, especially those requiring a SEF to monitor activity beyond its
own markets. Based on its experience, the Commission has assessed this
feedback and proposes amendments that would establish more practical
monitoring requirements. These amendments, which in many cases would
narrow a SEF's monitoring obligations to trading activity on its own
facility, allow a SEF greater discretion to devise its own monitoring
systems and protocols to suit the products that it offers for trading
in a manner compliant with Core Principle 4. The Commission also
proposes several amendments to the regulations under Core Principle 4
to conform to the proposed Appendix C to part 37, which sets forth
guidance for SEFs to mitigate a swap contract's susceptibility to
manipulation when developing new products and monitoring existing
products.\557\
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\557\ See supra Section VIII.A.1.--Appendix C--Demonstration of
Compliance that a Swap Contract is Not Readily Susceptible to
Manipulation.
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A. Sec. 37.401--General Requirements
Section 37.401 currently implements Core Principle 4 by setting
forth requirements for SEFs to monitor market activity for the purpose
of detecting manipulation, price distortions, and disruptions.\558\
Existing Sec. 37.401(a) creates an ongoing obligation for a SEF to
collect and evaluate data on its market participants' market activity
to detect and prevent, among other things, disruptions to the physical-
delivery or cash-settlement process where possible.\559\ Existing Sec.
37.401(b) requires a SEF to examine general market data in order to
detect and prevent manipulative activity that would result in the
failure of market prices to reflect the normal forces of supply and
demand.\560\ Existing Sec. 37.401(c) requires a SEF to demonstrate an
effective program for conducting real-time monitoring of trading for
the purpose of detecting and resolving abnormalities.\561\ Existing
[[Page 62013]]
Sec. 37.401(d) requires a SEF to demonstrate the ability to
comprehensively and accurately reconstruct daily trading activity.\562\
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\558\ 17 CFR 37.401.
\559\ 17 CFR 37.401(a).
\560\ 17 CFR 37.401(b).
\561\ 17 CFR 37.401(c). The guidance to Core Principle 4 in
Appendix B provides that an acceptable program may include some
monitoring on a T+1 basis. 17 CFR part 37 app. B (guidance to Core
Principle 4--paragraph (a)(1)--``General requirements'').
\562\ 17 CFR 37.401(d).
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In the preamble to the SEF Core Principles Final Rule, the
Commission clarified that Sec. 37.401(a) requires a SEF to monitor its
market participants' trading activity and reference data beyond its own
market on an ongoing basis in certain instances.\563\ The Commission
also clarified that Sec. 37.401(b) requires a SEF to monitor and
evaluate ``general market data,'' such as the pricing of the underlying
commodity or a third-party index or instrument used as a reference
price of its swaps.\564\ The Commission further clarified that the
requirements with respect to ``general market data'' means that a SEF
shall monitor and evaluate general market conditions related to its
swaps.\565\ Despite commenters' concerns about the lack of available
information to meet the scope of these requirements, the Commission
stated that such monitoring would be necessary to comply with Core
Principle 4.\566\
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\563\ SEF Core Principles Final Rule at 33528, 33530.
\564\ Id. at 33528.
\565\ Id.
\566\ Id. at 33527-28. See also ISDA, Path Forward for
Centralized Execution of Swaps 6 (2015) (explaining that a SEF
should not be required to monitor other markets for manipulation
because SEFs do not have, and cannot be expected to obtain,
sufficient information about other marketplaces).
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The Commission proposes to amend Sec. 37.401 to establish more
practical trade monitoring requirements that are based on information
about trading activity that is actually accessible to SEFs and,
therefore, are more consistent with current practice in swaps and other
derivatives markets. First, the Commission proposes to clarify under
proposed Sec. 37.401(a) that a SEF must conduct real-time market
monitoring of ``trading activity'' on its own facility to identify (i)
disorderly trading; (ii) any market or system anomalies; and (iii)
instances or threats of manipulation, price distortion, and
disruption.\567\ This proposed amendment, among other things,
incorporates the existing requirement under Sec. 37.203(e) that
requires a SEF to conduct real-time market monitoring.\568\ Second, the
Commission proposes to specify under proposed Sec. 37.401(b) that a
SEF has discretion to determine when to collect and evaluate data on
its market participants' trading activity beyond its own market, i.e.,
as necessary to detect and prevent manipulation, price distortion, and,
where possible, disruptions of the physical-delivery or cash-settlement
process, rather than on an ``ongoing basis.'' \569\ This data would
include market participants' trading in (i) the index or instrument
used as a reference price; (ii) the underlying commodity for the listed
swap; and (iii) any related derivatives markets.
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\567\ The Commission also proposes to renumber subsection (c) to
subsection (a) and amend the requirement as described.
\568\ The Commission notes that existing Sec. 37.203(e)
specifies that a SEF must conduct real-time market monitoring of all
trading activity on its system(s) or platform(s) to identify
``disorderly trading and any market or system anomalies.'' As
discussed above, the Commission is proposing to eliminate this
provision and establish those requirements under proposed Sec.
37.401(a) to streamline the existing regulations. See supra note
438.
\569\ The Commission proposes to renumber existing subsection
(a) to subsection (b) and amend the requirement as described. In the
adopting part 37, the Commission also clarified that ``market
activity'' in existing Sec. 37.401(a) means the ``trading
activity'' of a SEF's market participants. SEF Core Principles Final
Rule at 33528. The Commission proposes a non-substantive revision to
replace ``market activity'' with ``trading activity.''
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In proposing these changes, the Commission recognizes that Core
Principle 4 does not explicitly mandate the existing requirements under
Sec. Sec. 37.401(a)-(b) and has also learned that requiring a SEF to
monitor trading activity beyond its own market on an ``ongoing basis''
has imposed impractical burdens, particularly given that many swaps
trade both on multiple SEFs and on an OTC basis. For a swap subject to
the trade execution requirement, a SEF is currently required to
continually monitor trading for the same or similar swap listed on
multiple SEFs. For a listed swap not subject to the requirement, the
SEF must additionally monitor trading for the same swap or similar swap
traded bilaterally away from a SEF.\570\ Given that many SEFs list the
same or similar swaps that are traded bilaterally--with a large amount
of related trading activity occurring away from a SEF's own market--
expecting each SEF to maintain an ongoing collection and monitoring
program for these elements is impractical and not consistent with
current practice in other derivatives markets.\571\ SEFs have also
demonstrated that this scope and frequency of monitoring is difficult
because they currently lack the capability to obtain sufficient trading
information. Accordingly, the Commission's proposed changes are
intended to align a SEF's obligation to monitor beyond its own market
more closely with current practice and obligations in other derivatives
markets, where there is not an ongoing monitoring requirement.
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\570\ For example, the Commission notes that multiple SEFs offer
the same fixed-to-floating USD-denominated IRS in standard benchmark
tenors that are currently subject to the trade execution
requirement.
\571\ For example, a SEF offering an FX non-deliverable forward
cannot reasonably monitor over a dozen SEFs that offer equivalent
non-deliverable forward products and the market participants
engaging in hundreds of equivalent bilateral transactions away from
a SEF.
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Given the practical challenges discussed above in complying with
the existing Core Principle 4 monitoring requirements, the Commission
believes that a SEF should monitor beyond its own market as necessary
to detect and prevent manipulation, price distortion, and, where
possible, disruptions of the physical-delivery or cash-settlement
processes. Further, such monitoring should be conducted when necessary
to detect manipulative activity that would result in the failure of the
market price to reflect the normal forces of supply and demand. In such
cases, the SEF should be able to determine the instances in which it
needs to collect and evaluate data related to that activity. As
proposed, the scope of this data corresponds to the existing
requirements of Sec. 37.404, which require a SEF to have the ability
to obtain this trading information.\572\ These amendments would ensure
that SEFs can still collect additional information based on a
legitimate need, but would also reduce the significant and otherwise
duplicative effort among SEFs to collect and evaluate trading and other
information on an ongoing basis. The Commission believes that these
revised monitoring requirements not only reflect current practice in
other markets, but also would continue to protect the integrity of the
swaps markets.
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\572\ The Commission notes that a SEF may collect this data on
market participants' trading activity directly from its market
participants pursuant to Core Principle 5, which requires a SEF to
establish and enforce rules that provide the authority to obtain
information from its participants. 17 CFR 37.501. Further, Sec.
37.503 requires a SEF to share information, as required by the
Commission or as necessary and appropriate, to fulfill its
regulatory responsibilities. 17 CFR 37.503. The Commission notes
that it is proposing various amendments to the Core Principle 5
regulations, as discussed below, but is maintaining these
requirements. See infra Section X.--Part 37--Subpart F: Core
Principle 5 (Ability to Obtain Information).
---------------------------------------------------------------------------
The Commission also proposes to amend Sec. 37.401(c) to establish
more practical monitoring requirements with respect to a SEF's
obligation to monitor general market data. The Commission proposes to
clarify that a SEF has the discretion to determine when to monitor and
evaluate such data beyond its own market, i.e., as necessary to detect
and prevent manipulative activity that would result in the failure of
the market
[[Page 62014]]
price to reflect the normal forces of supply and demand.\573\ The
Commission notes that the existing provision does not specify the
required scope or frequency of monitoring such data, which is used to
evaluate market conditions and includes, among other things, pricing in
a third-party index or instrument used as a reference price. As noted
further below with respect to monitoring requirements for cash-settled
swaps, the Commission has observed that SEFs do not have full access to
certain types of data, such as the pricing of proprietary third-party
indexes.\574\ Therefore, providing a SEF with the discretion to monitor
and evaluate general market data on an as-needed basis would align the
requirement to SEF capabilities and current market practices.
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\573\ The Commission proposes to renumber existing subsection
(b) to subsection (c) and amend the requirement as described.
\574\ See infra Section IX.C.--Sec. 37.403--Additional
Requirements for Cash-Settled Swaps (discussing the proposed
elimination of the requirement to monitor the pricing of the
reference price where a third-party index or instrument is used).
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Finally, the Commission proposes to consolidate the trade
reconstruction requirements under existing Sec. 37.401(d) and existing
Sec. 37.406 into a new proposed Sec. 37.401(d), which would require a
SEF to have the ability to comprehensively and accurately reconstruct
all trading activity on its facility for the purpose of detecting
instances or threats of manipulation, price distortion, and
disruptions.
The Commission also proposes certain non-substantive changes to
eliminate demonstration-based requirements under existing Sec. Sec.
37.401(c)-(d). As noted above, the Commission proposes to set forth an
affirmative monitoring requirement, rather than a demonstration
requirement. The Commission notes that demonstration of compliance
could otherwise be required upon Commission request under Sec.
37.5(b), which requires a SEF to provide a written demonstration that
it is in compliance with its obligations under the Act.\575\
---------------------------------------------------------------------------
\575\ 17 CFR 37.5(b).
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The Commission further proposes to eliminate duplicative language
and adopt various conforming changes to the guidance to Core Principle
4 in Appendix B.\576\
---------------------------------------------------------------------------
\576\ The Commission proposes these changes in paragraph (a)(1)
to the guidance to Core Principle 4 in Appendix B. 17 CFR part 37
app. B.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.401 and the associated guidance to Core Principle 4 in Appendix B.
In particular, the Commission requests comment on the following
question:
(70) The Commission has observed that SEFs may provide input into
market pricing information, such as third-party indexes, that is
available to market participants, which includes executed prices,
prices from executable or indicative bids and offers, views of trading
specialists, or prices from related instruments in other markets.
Should the Commission's general market monitoring requirements require
SEFs to monitor this type of information--for example, pricing provided
by its own trading specialists?
B. Sec. 37.402--Additional Requirements for Physical-Delivery Swaps
For swaps settled by physical delivery, Sec. 37.402 requires that
a SEF monitor each swap's terms and conditions as they relate to the
underlying commodity market and monitor the ``availability of supply''
of the underlying commodity, as specified by the swap's delivery
requirements.\577\ The Commission also provided additional guidance to
Core Principle 4 in Appendix B to specify that a SEF should monitor the
general ``availability'' of the commodity specified by the swap; the
commodity's characteristics; the delivery locations; and if available,
information related to the size and ownership of deliverable
supplies.\578\ In the SEF Core Principles Final Rule, the Commission
explained that using the phrase ``availability of supply'' and
providing the associated guidance was intended to provide a SEF with
additional flexibility in response to commenter feedback that the
proposed regulation was, among other things, duplicative, unmanageable,
and created the risk of conflicting conclusions.\579\
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\577\ 17 CFR 37.402.
\578\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(2)--``Physical-delivery swaps'').
\579\ See SEF Core Principles Final Rule at 33529 (explaining
the Commission's revision of the proposed requirement that a SEF
monitor whether the supply is ``adequate'' to the ``availability''
of the supply; and replacing detailed proposed requirements to
monitor the supply, marketing, and ownership of the commodity to be
physically delivered with similar guidance in Appendix B).
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The Commission proposes to clarify a SEF's monitoring obligations
with respect to physical-delivery swaps under Sec. 37.402 to be
consistent with the guidance in proposed Appendix C to part 37 and
ensure that the SEF can comply with Core Principles 3 and 4.\580\ Among
other things, a swap contract's terms and conditions should assure the
availability of adequate deliverable supplies, such that the contract
is not readily susceptible to price manipulation.\581\ To ensure that a
swap contract's terms and conditions remain appropriately designed,
Sec. 37.402 would require a SEF to (i) monitor the swap's terms and
conditions as they relate to the underlying commodity market by
reviewing the convergence between the swap's price and the price of the
underlying commodity, and make a good-faith effort to resolve
conditions that are interfering with convergence or notify the
Commission of such conditions; and (ii) monitor the availability of the
supply of the commodity specified by the delivery requirements of the
swap, and make a good-faith effort to resolve conditions that threaten
the adequacy of supplies or the delivery process or notify the
Commission of such conditions.\582\
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\580\ Proposed Appendix C to part 37, among other things,
provides related guidance on the design of physically-settled swap
contracts that should be adopted by a SEF to minimize their
susceptibility to manipulation. See paragraph (b) of the proposed
Appendix C to part 37--``Guidance for physically-settled swaps.'' 17
CFR part 37 app. C.
\581\ Proposed Appendix C to part 37 specifies that a SEF should
estimate the deliverable supply for which the swap is not readily
susceptible to price manipulation. To assure the availability of
adequate deliverable supplies, the swap contract terms and
conditions, in particular, should be designed based upon an adequate
assessment of the potential range of deliverable supplies and should
account for variations in the patterns of production, consumption,
and supply over a period of at least three years. See id. (paragraph
(b)(iii)--``Accounting for variations in deliverable supplies'').
\582\ The Commission also proposes to (i) amend the guidance to
Core Principle 4 in Appendix B to define ``price convergence'' as
the process whereby the price of a physically-delivered swap
converges to the spot price of the underlying commodity as the swap
nears expiration; and (ii) make conforming changes. 17 CFR part 37
app. B.
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The Commission notes that Core Principles 3 and 4 place affirmative
obligations on SEFs to permit trading only in swaps that are not
readily susceptible to manipulation and prevent manipulation, price
distortion, and disruptions of the delivery or cash-settlement process,
respectively. As such, proposed Sec. 37.402 places affirmative
obligations on a SEF to make a good-faith effort to resolve conditions
that are interfering with convergence or that threaten the adequacy of
supplies or the delivery process. The Commission recognizes, however,
that a SEF may not always be able to resolve these conditions;
therefore, proposed Sec. 37.402 allows the SEF to notify the
Commission of such conditions.\583\
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\583\ A SEF should provide electronic notification to the
Commission at [email protected] and DMO at
[email protected].
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The Commission further proposes corresponding amendments to the
associated guidance to Core Principle 4
[[Page 62015]]
in Appendix B.\584\ The Commission proposes a non-substantive revision
to clarify that a SEF should monitor physical-delivery swaps listed on
its facility. To conform to Core Principle 4, the Commission also
proposes to clarify that a SEF should monitor for conditions that may
cause a swap to become susceptible to manipulation, price distortion,
or disruptions; \585\ such conditions would include those that
influence the convergence between the swap's price and the price of the
underlying commodity. This proposed language would conform to the
proposed guidance for physically-settled swaps in the proposed Appendix
C to part 37, which states that a physically-settled swap contract's
terms and conditions should be designed to avoid any impediments to the
delivery of the commodity so as to promote convergence between the
value of the swap contract and the cash market value of the commodity
at the expiration of the swap contract.\586\
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\584\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(2)--``Physical-delivery swaps'').
\585\ Id.
\586\ See 17 CFR part 37 app. C (paragraph (b)(iv) of the
proposed Appendix C to part 37--``Contract terms and conditions'').
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The Commission also proposes a non-substantive change to eliminate
the demonstration-based requirement under Sec. 37.402. As noted above,
the Commission proposes to set forth an affirmative monitoring
requirement for SEFs, rather than a demonstration requirement. The
Commission notes that demonstration of compliance could otherwise be
required upon Commission request under Sec. 37.5(b), which requires a
SEF to provide a written demonstration that it is in compliance with
its obligations under the Act.\587\
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\587\ 17 CFR 37.5(b).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.402 and the associated guidance to Core Principle 4 in Appendix B.
C. Sec. 37.403--Additional Requirements for Cash-Settled Swaps
For cash-settled swaps, Sec. 37.403(a) requires that a SEF monitor
the pricing of the reference price used to determine cash flows or
settlement of a swap.\588\ Where the reference price is formulated or
computed by the SEF, Sec. 37.403(b) requires a SEF to demonstrate that
it monitors the continued appropriateness of its methodology for
deriving that price.\589\ Where the reference price relies on a third-
party index or instrument, Sec. 37.403(c) requires a SEF to
demonstrate that it monitors the continued appropriateness of the index
or instrument.\590\ The Commission provided additional guidance to Core
Principle 4 in Appendix B to specify that a SEF should monitor pricing
abnormalities in the index or instrument used to calculate the
reference price to avoid manipulation, price disruptions, or market
distortions.\591\ For self-formulated or self-computed reference
prices, the SEF should amend the existing methodology or impose new
methodologies where such threats exist. For pricing based on a third-
party index or instrument, a SEF should conduct due diligence to ensure
that the contract is not susceptible to manipulation.\592\
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\588\ 17 CFR 37.403(a).
\589\ 17 CFR 37.403(b).
\590\ 17 CFR 37.403(c).
\591\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(3)--``Cash-settled swaps''). See SEF Core Principles
Final Rule at 33529 (stating that market participants may have
incentives to disrupt or manipulate reference prices for cash-
settled swaps and stating that SEFs must monitor the pricing of the
reference price in order to comply with Core Principle 4's
requirement to prevent manipulation, price distortion, and
disruptions of the cash settlement process).
\592\ Id.
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Based on its experience, the Commission acknowledges that the
requirement imposed by Sec. 37.403(a) to monitor the methodologies
behind third-party indexes or instruments is not realistic due to the
proprietary nature of these indexes and instruments. The Commission has
observed that many SEFs offer swaps for which pricing is based on
benchmark prices or benchmark indices owned or administered by third
parties, such as the Intercontinental Exchange, Inc. (``ICE''),\593\
IHS Markit Ltd. (``IHS Markit''),\594\ and the European Money Markets
Institute (``EMMI'').\595\ For example, many SEFs offer IRS for trading
that rely on LIBOR or EURIBOR as the underlying benchmark, which are
based upon submissions from panel banks. The Commission believes that
requiring a SEF to monitor the inputs and calculations involved in
ICE's or EMMI's methodologies when calculating their respective
benchmarks on an ongoing basis is impractical.\596\ The Commission
understands that as a general matter, certain aspects of these
benchmarks remain proprietary in nature. Therefore, the Commission
acknowledges that SEFs do not necessarily have full access to the
information to monitor trading to detect disruptions or manipulations
of indexes or reference rates administered by other industry
participants. Further, the Commission notes that these entities are
subject to their own monitoring and oversight mechanisms.\597\
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\593\ ICE serves as the current administrator for ICE Swap Rate
(formerly known as ISDAFix), which serves as a benchmark for swap
rates and spreads for IRS. ICE, About ICE Swap Rate, https://www.theice.com/iba/ice-swap-rate. ICE also serves as the current
administrator for ICE LIBOR (formerly known as BBA LIBOR), which is
a widely-adopted benchmark for short-term interest rates that is
used to specify the floating rate for fixed-to-floating IRS. ICE,
ICE Libor-Overview, https://www.theice.com/iba/libor.
\594\ IHS Markit owns and operates several tradeable CDS indices
that are based on a basket of single-name CDS. IHS Markit, Indices,
https://ihsmarkit.com/products/indices.html.
\595\ EMMI, a non-profit making association whose members are
national banking associations in the EU-member states, serves as the
current administrator for Euribor and EONIA, which are widely-
adopted benchmarks for euro-denominated IRS. EMMI, 2 Benchmarks,
https://www.emmi-benchmarks.eu.
\596\ The Commission notes, however, that ICE and EMMI offer
general information on the methodologies for calculating their
respective benchmarks. For example, ICE states that it determines
the ICE Swap Rate benchmark, which represents the mid-price for the
fixed leg of IRS, based on tradeable quotes from regulated,
electronic, multilateral trading venues. See ICE, Calculation of ICE
Swap Rate from Tradeable Quotes, available at https://www.theice.com/publicdocs/ICE_Swap_Rate_Full_Calculation_Methodology.pdf; see also EMMI,
Euribor Code of Conduct, available at https://www.emmi-benchmarks.eu/assets/files/D2712J-2014-Euribor%20Code%20of%20Conduct%2001Oct2013%20-%20Revised%201%20June%202016-%20final%20new.pdf.
\597\ ICE maintains an oversight committee for LIBOR, which is
responsible for reviewing the methodology, scope, and definition of
the benchmark (including assessing its underlying market and usage);
overseeing any changes to the benchmark; and overseeing and
reviewing an associated code of conduct. ICE, Governance &
Oversight, https://www.theice.com/iba/libor#methodology. EMMI
maintains a Steering Committee, which is responsible for similar
functions with respect to Euribor. EMMI, Steering Committee, https://www.emmi-benchmarks.eu/euribor-org/steering-committee.html.
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Based on these considerations, the Commission proposes to eliminate
the requirement under Sec. 37.403(a) that SEFs monitor the ``pricing''
of the reference price used to determine cash flows or settlement.\598\
Where the reference price relies on a third-party index or instrument,
a SEF would continue to be required under proposed Sec. 37.403(b)
(existing Sec. 37.403(c)) to monitor the ``appropriateness'' of the
index or instrument; the Commission, however, proposes to amend this
requirement to additionally require a SEF to take appropriate action,
including selecting an alternate index or instrument for deriving the
reference price, where there is a threat of manipulation, price
[[Page 62016]]
distortion, or market disruption.\599\ The Commission believes that
sufficient information is generally available to SEFs to comply with
this proposed requirement. Based on this proposed requirement, the
Commission expects that a SEF would take action with respect to its use
of a third-party index or instrument for a listed swap contract that
would inhibit the SEF's ability to prevent manipulation pursuant to
Core Principles 3 and 4. Where a SEF formulates and computes the
reference price, the Commission proposes to amend Sec. 37.403(b) to
require a SEF to take appropriate action, including amending the
methodology, where there is a threat of manipulation, price distortion,
or market disruption.\600\ In contrast to the circumstances where a SEF
relies on a third-party index or instrument, the SEF could monitor its
own methodology for deriving the reference price.
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\598\ The Commission notes, however, that a SEF would be
required under proposed Sec. 37.401(b) to monitor trading in the
index or instrument used as a reference price.
\599\ The Commission proposes to renumber existing subsection
(c) to subsection (b) and amend the language as described.
\600\ The Commission proposes to renumber existing subsection
(b) to subsection (a) and amend the language as described.
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The Commission believes that these proposed amendments would
provide greater clarity and establish more practical requirements for
SEFs to monitor the reference prices, including the index or instrument
used to calculate them, in a manner that is consistent with Core
Principle 4. Further, the Commission believes that these proposed
amendments are consistent with the proposed guidance in Appendix C to
part 37 regarding the design of cash-settled swap contracts. Among
other things, that guidance specifies that the SEF should ensure that
the reference price used for its contract is not readily susceptible to
manipulation by assessing its reliability as an indicator of cash
market values in the underlying commercial market.\601\
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\601\ See 17 CFR part 37 app. C (paragraph (a)(ii) of the
proposed Appendix C to part 37--``Reference price susceptibility to
manipulation'').
---------------------------------------------------------------------------
The Commission also proposes a non-substantive change to eliminate
the demonstration-based requirements under Sec. 37.403. As noted
above, the Commission proposes to set forth an affirmative monitoring
requirement, rather than a demonstration requirement. The Commission
notes that demonstration of compliance could otherwise be required upon
Commission request under Sec. 37.5(b), which requires a SEF to provide
a written demonstration that it is in compliance with its obligations
under the Act.\602\
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\602\ 17 CFR 37.5(b).
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Given the changes to Sec. 37.403 proposed above, the Commission
proposes to delete the existing associated guidance in Core Principle 4
in Appendix B.\603\
---------------------------------------------------------------------------
\603\ The Commission proposes to eliminate paragraph (a)(3).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.403 and the elimination of the associated guidance to Core Principle
4 in Appendix B.
D. Sec. 37.404--Ability To Obtain Information
Section 37.404(a) provides that a SEF must demonstrate that it has
access to sufficient information to assess whether trading in swaps
listed on its market, in the index or instrument used as a reference
price, or in the underlying commodity for its listed swaps is being
used to affect prices on its market.\604\ Section 37.404(b) requires a
SEF to have rules that require its market participants to keep records
of their trading, including records of their activity in the index or
instrument used as a reference price, the underlying commodity, and
related derivatives markets; and make those records available to the
SEF, its regulatory service provider if applicable, and the
Commission.\605\ The Commission specified in the guidance to Core
Principle 4 in Appendix B that a SEF may limit the application of these
requirements to market participants who conduct ``substantial trading''
on its facility.\606\
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\604\ 17 CFR 37.404(a).
\605\ 17 CFR 37.404(b).
\606\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(4)--``Ability to obtain information'').
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The Commission proposes several amendments to the associated
guidance to Core Principle 4 in Appendix B. In particular, the
Commission proposes to eliminate a SEF's ability to limit the
application of proposed Sec. 37.404(a) and proposed Sec. 37.404(b) to
only those market participants who conduct ``substantial trading'' on
its facility. The Commission notes that it has not provided SEFs with
any additional guidance, e.g., volume-based metrics or similar factors,
as to what constitutes ``substantial trading'' by a market participant.
Eliminating this guidance would not only remove an ambiguity as to whom
Sec. 37.404 applies, but also promote a more comprehensive and
effective monitoring requirement that would require a SEF to have the
ability to obtain information from all of its market participants,
thereby better fulfilling the objectives of Core Principle 4.\607\ In
addition, based on its experience, the Commission believes that market
participants are keeping records of their related trading, so
eliminating the ``substantial'' requirement should not impose
additional burdens. In addition to this amendment, the Commission also
proposes several non-substantive amendments to the guidance.\608\
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\607\ The Commission notes, however, that the scope of this
requirement would be based on the proposed definition of ``market
participant'' under Sec. 37.2(b), which would limit Sec. 37.404 to
persons who access the SEF directly or through a third-party
functionality, or otherwise direct an intermediary to trade on their
behalf. See supra Section IV.B.2.a.--Applicability of Sec.
37.404(b) to Market Participants.
\608\ The Commission proposes to streamline and move the
guidance that currently specifies that a SEF can adopt information-
sharing agreements with other trading venues or a third-party
regulatory service provider where position and trading information
is not available directly from market participants. The Commission
proposes to move this guidance to paragraph (a) of the guidance to
Core Principle 5 because the applicable requirements for a SEF to
adopt information-sharing practices are addressed under proposed
Sec. 37.503, as discussed below.
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The Commission also proposes a non-substantive change to eliminate
the demonstration-based requirement under Sec. 37.404(a).\609\ As
noted above, the Commission proposes to set forth an affirmative
monitoring requirement, rather than a demonstration requirement. The
Commission notes that demonstration of compliance could otherwise be
required upon Commission request under Sec. 37.5(b), which requires a
SEF to provide a written demonstration that it is in compliance with
its obligations under the Act.\610\
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\609\ The Commission also proposes to eliminate similar
associated guidance to Core Principle 4 in Appendix B.
\610\ 17 CFR 37.5(b).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.404 and the associated guidance to Core Principle 4 in Appendix B.
E. Sec. 37.405--Risk Controls for Trading
Section 37.405 requires that a SEF establish and maintain risk
control mechanisms to prevent and reduce the potential risk of market
disruptions, including, but not limited to, market restrictions that
pause or halt trading in market conditions prescribed by the SEF.\611\
The associated guidance to Core Principle 4 in Appendix B, among other
things, provides examples of the different types of risk controls that
a SEF may adopt based on whether or not they are appropriate to the
characteristics of the trading platform or
[[Page 62017]]
market offered by the SEF.\612\ Among those types of controls, the
guidance specifies that a SEF may establish clear error-trade and order
cancellation policies.
---------------------------------------------------------------------------
\611\ 17 CFR 37.405.
\612\ 17 CFR part 37 app. B (guidance to Core Principle 4--
paragraph (a)(5)--``Risk controls for trading'').
---------------------------------------------------------------------------
The Commission proposes two amendments to Sec. 37.405 to align the
existing requirement with the proposed amendments to other Core
Principle 4 regulations. First, the Commission proposes to clarify that
a SEF is required to have risk control mechanisms to prevent and reduce
market disruptions, as well as price distortions on their facility.
This proposed change is consistent with Core Principle 4, which
requires a SEF to monitor trading to prevent price distortions and
disruptions to the delivery or cash settlement process.\613\ Second,
the Commission proposes to limit this requirement to swaps trading
activity occurring on a SEF's own facility, which would be consistent
with the proposed changes to Sec. 37.401(a).
---------------------------------------------------------------------------
\613\ 7 U.S.C. 7b-3(f)(4)(b).
---------------------------------------------------------------------------
The Commission also proposes several amendments to the associated
guidance to Core Principle 4 in Appendix B. First, the Commission
proposes to eliminate the reference to intraday position limit risk
controls, which generally do not apply to a SEF because the Commission
has yet to establish position limit rules for swaps. Second, the
Commission proposes to clarify that a SEF's risk controls should be
adapted to the swap contracts that it lists for trading; this amendment
does not reflect a substantive change, but rather would be consistent
with the proposed guidance in Appendix C to part 37, which provides
that a SEF may adapt certain risk controls for swap contracts based on
whether they are standardized or non-standardized.\614\ Third, the
Commission proposes to eliminate the language specifying that a SEF may
adopt an error trade policy; the Commission notes that, as described
above, proposed Sec. 37.203(e) would require a SEF to adopt an error
trade policy for trading on its facility. The Commission also proposes
to make several other non-substantive conforming and clarifying
amendments to the guidance.
---------------------------------------------------------------------------
\614\ See supra Section VIII.A.1.--Appendix C--Demonstration of
Compliance that a Swap Contract is Not Readily Susceptible to
Manipulation.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.405 and the associated guidance to Core Principle 4 in Appendix B.
F. Sec. 37.406--Trade Reconstruction
Section 37.406 requires that a SEF have the ability to
comprehensively and accurately reconstruct all trading on its facility,
and that audit-trail data and reconstructions be made available to the
Commission in a form, manner, and time that is acceptable to the
Commission.\615\
---------------------------------------------------------------------------
\615\ 17 CFR 37.406.
---------------------------------------------------------------------------
Given the proposed consolidation with Sec. 37.401(d), as described
above, the Commission proposes to eliminate Sec. 37.406.\616\ The
Commission also notes that the requirement to make information
available to the Commission is already addressed under Core Principle 5
regulations, discussed further below.\617\
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\616\ As discussed above, proposed Sec. 37.401(d) would require
a SEF to have the ability to comprehensively and accurately
reconstruct all trading activity on its facility for the purpose of
detecting instances or threats of manipulation, price distortion,
and disruptions.
\617\ See infra Section X.B.--Sec. 37.502--Provide Information
to the Commission.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.406.
G. Sec. 37.407--Regulatory Service Provider; Sec. 37.408--Additional
Sources for Compliance 618
---------------------------------------------------------------------------
\618\ The Commission proposes to renumber Sec. Sec. 37.407-408
to Sec. Sec. 37.406-407, given the proposed elimination of existing
Sec. 37.406.
---------------------------------------------------------------------------
The Commission is not proposing any amendments to Sec. Sec.
37.407-408.
X. Part 37--Subpart F: Core Principle 5 (Ability To Obtain Information)
Core Principle 5 requires a SEF to establish and enforce rules that
allow the facility to obtain any ``necessary information'' to perform
any of the functions described in CEA section 5h; provide the
information to the Commission upon request; and have the capacity to
carry out international information-sharing agreements as the
Commission may require.\619\ The Commission further implemented Core
Principle 5 under Sec. Sec. 37.501-504. Based on the Commission's
understanding of current SEF operational practices, the Commission is
proposing several amendments, including non-substantive changes, to
these implementing regulations, as described below.
---------------------------------------------------------------------------
\619\ 7 U.S.C. 7b-3(f)(5). The Commission codified Core
Principle 5 under Sec. 37.500. 17 CFR 37.500.
---------------------------------------------------------------------------
A. Sec. 37.501--Establish and Enforce Rules
Section 37.501 specifies that a SEF's rules must allow it to obtain
sufficient information to fulfill its functions and obligations under
part 37, including the capacity to carry out such international
information-sharing agreements as the Commission may require.\620\ The
Commission proposes a non-substantive amendment to eliminate the
duplicative language under Sec. 37.501 regarding a SEF's capacity to
carry out international information-sharing agreements. The Commission
notes that this requirement is already established under Core Principle
5.
---------------------------------------------------------------------------
\620\ 17 CFR 37.501.
---------------------------------------------------------------------------
B. Sec. 37.502--Provide Information to the Commission
Existing Sec. 37.502 requires a SEF to adopt rules that allow it
to collect information on a routine basis, allow for the collection of
non-routine data from its market participants, and allow for its
examination of books and records kept by its market participants.\621\
---------------------------------------------------------------------------
\621\ 17 CFR 37.502.
---------------------------------------------------------------------------
The Commission proposes to eliminate existing Sec. 37.502.\622\
The Commission notes that the language of this requirement is
duplicative of the general requirement that SEFs have the ability to
obtain information from their market participants, as already set forth
in Core Principle 5 and Sec. 37.501. Eliminating the requirement that
a SEF must have rules to allow it to examine books and records is also
consistent with the Commission's proposed amendment to Sec. 37.203(b),
which would replace a similar existing requirement with a more general
rule that would allow a SEF to tailor its rules for collecting books
and records from market participants.\623\
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\622\ The Commission proposes to renumber existing Sec. 37.503
to Sec. 37.502 and retitle the provision to ``Provide information
to the Commission'' from ``Collection of information'' based on the
proposed changes described below.
\623\ See supra Section VII.B.2.--Sec. 37.203(b)--Authority to
Collect Information (proposing an amendment to require that a SEF
have the authority to collect information required to be kept by
persons subject to the SEF's recordkeeping rules).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of existing Sec. 37.502.
C. Sec. 37.503--Information-Sharing 624
---------------------------------------------------------------------------
\624\ The Commission proposes to renumber existing Sec. 37.504
to Sec. 37.503 and retitle the provision to ``Information-sharing''
from ``Provide information to the Commission'' based on the proposed
changes described below.
---------------------------------------------------------------------------
Existing Sec. 37.504 requires a SEF to share information with
other regulatory organizations, data repositories, and third-party data
reporting services as required by the Commission or as otherwise
necessary and appropriate to fulfill its self-regulatory and reporting
[[Page 62018]]
responsibilities.\625\ Section 37.504 also states that appropriate
information-sharing agreements can be established with the specified
entities or the Commission can act in conjunction with the SEF to carry
out such information sharing.
---------------------------------------------------------------------------
\625\ 17 CFR 37.504.
---------------------------------------------------------------------------
The Commission proposes to establish a more straightforward and
streamlined information-sharing requirement by eliminating the
specifically enumerated list of entities with which a SEF must share
information and adopting conforming amendments. Instead, a SEF would be
required to generally share information, as required by the Commission,
or as appropriate to fulfill its self-regulatory and reporting
responsibilities. Rather than limiting the types of entities that a SEF
may share information with, however, a SEF would have the flexibility
to share information with third parties that it may utilize to carry
out those responsibilities, including affiliated entities. This broader
and more adaptive approach to information-sharing practices would
better accommodate, for example, a SEF's ability to use different types
of regulatory service providers pursuant to the proposed amendments
under Sec. 37.204. The Commission emphasizes, however, that SEFs would
not be required to share information with competitor entities. In
relevant situations where information or data may need to be shared
across different markets to help identify manipulation, price
distortions or other disruptions, for example, the Commission
anticipates that it will continue working in conjunction with SEFs to
help establish such information-sharing arrangements.
The Commission also proposes a non-substantive revision by moving
certain provisions from the existing guidance to Core Principle 4 to
the guidance to Core Principle 5 in Appendix B.\626\ This proposed
guidance would specify that if position and trading information is
available through information-sharing agreements with other trading
venues or a third-party regulatory service provider, then the SEF
should cooperate, to the extent practicable, in such information-
sharing agreements.
---------------------------------------------------------------------------
\626\ The Commission proposes to move this guidance from
paragraph (a)(4) to Core Principle 4 to paragraph (a) to Core
Principle 5 in Appendix B.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.503 and the associated guidance to Core Principle 5 in Appendix B.
D. Sec. 37.504--Prohibited Use of Data Collected for Regulatory
Purposes \627\
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\627\ The Commission proposes to retitle Sec. 37.504 to
``Prohibited use of data collected for regulatory purposes'' from
``Information-sharing agreements'' based on the proposed changes
described below.
---------------------------------------------------------------------------
Section 37.7--``Prohibited use of data collected for regulatory
purposes''--prohibits a SEF from using, for business or marketing
purposes, any proprietary data or personal information it collects or
receives, from or on behalf of any person, for the purpose of
fulfilling its regulatory obligations, unless the person clearly
consents to the SEF's use of such data or information in such
manner.\628\ The purpose of this provision is to protect customer
privacy and prevent a SEF from using information, obtained for
compliance purposes, to otherwise advance its commercial
interests.\629\ Section 37.7 also provides that a SEF, where necessary
for regulatory purposes, may share such data or information with one or
more SEFs or DCMs registered with the Commission.\630\
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\628\ 17 CFR 37.7.
\629\ SEF Core Principles Final Rule at 33492.
\630\ 17 CFR 37.7.
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The Commission proposes to create a more cohesive rule with respect
to information-sharing practices under Core Principle 5 by moving
existing Sec. 37.7 to a new proposed Sec. 37.504 and amending the
current language of the requirement. Consistent with the existing
prohibition, the Commission proposes that a SEF that shares such
proprietary data or personal information with a third party shall
ensure that that third party does not use the data or information for
business or marketing purposes, unless the person from whom such data
or information was obtained clearly consents to its use for business or
marketing purposes (including consent to use by those third parties
with whom the SEF may share such information). This proposed amendment
corresponds to the Commission's other proposed amendments that would
expand the scope of entities with whom a SEF may share information,
including Sec. 37.503, which would provide a SEF with greater
flexibility in selecting a third-party provider to fulfill its self-
regulatory and reporting responsibilities; and Sec. 37.204, which
would allow the SEF to utilize a broader scope of third-party entities,
including non-registered affiliates to provide regulatory services,
subject to Commission approval.\631\
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\631\ In this regard, the Commission notes that under its
proposed amendments to Sec. 37.204, a SEF would be permitted to
contract with any entity for the provision of services to assist in
complying with the Act and Commission regulations, subject to
Commission approval. See supra Section VII.C.1.--Sec. 37.204(a)--
Use of Regulatory Service Provider Permitted.
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In the course of using such a provider, a SEF may need to share
proprietary data or personal information with that third party. To the
extent that Sec. 37.504 would continue to limit SEFs from using this
type of information for non-regulatory purposes, the Commission
believes that the objective of protecting customer privacy and
preventing the use of data for commercial purposes should also equally
apply to third parties that obtain access to such data or information
from a SEF for regulatory purposes. The Commission believes that the
proposed amendments achieve this objective.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
37.504.
XI. Part 37--Subpart G: Core Principle 6 (Position Limits or
Accountability)
Core Principle 6 requires a SEF that is a trading facility to
adopt, as is necessary and appropriate, position limits or position
accountability levels for each swap contract to reduce the potential
threat of market manipulation or congestion.\632\ For contracts that
are subject to a federal position limit under CEA section 4a(a), the
SEF must set its position limits at a level that is no higher than the
limit established by the Commission; and monitor positions established
on or through the SEF for compliance with the Commission's limit and
the limit, if any, set by the SEF.\633\
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\632\ 7 U.S.C. 7b-3(f)(6). The Commission codified Core
Principle 6 under Sec. 37.600. 17 CFR 37.600.
\633\ Id.
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A. Sec. 37.601--Additional Sources for Compliance; Guidance to Core
Principle 6 in Appendix B
Section 37.601 further implements Core Principle 6 and specifies
that until such time that compliance is required under part 151 of the
Commission's regulations, a SEF may refer to the associated guidance
and/or acceptable practices set forth in Appendix B to part 37.\634\
The guidance to Core Principle 6 in Appendix B provides a SEF with
reasonable discretion to comply with Core Principle 6 and sets forth
how a SEF may demonstrate compliance for trading that occurs on its own
market.\635\ The Commission notes that it has proposed new language for
Sec. 37.601 and new corresponding guidance to Core Principle 6 in
Appendix B in a re-proposal of a position limits
[[Page 62019]]
rulemaking, pending further Commission action.\636\
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\634\ 17 CFR 37.601.
\635\ 17 CFR part 37 app. B (guidance to Core Principle 6--
paragraph (a)--``Guidance'').
\636\ Position Limits for Derivatives, 81 FR 96704 (proposed
Dec. 30, 2016).
---------------------------------------------------------------------------
The Commission proposes to eliminate the language of Sec. 37.601
and the existing corresponding guidance to Core Principle 6, based on
its intent to address this issue in a separate rulemaking. Until that
time, the Commission clarifies that SEFs have reasonable discretion to
determine how to comply with Core Principle 6 pursuant to Core
Principle 1.\637\ This approach is consistent with the existing
approach under Sec. 37.601 and the associated guidance to Core
Principle 6.
---------------------------------------------------------------------------
\637\ 7 U.S.C. 7b-3(f)(1).
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed
elimination of Sec. 37.601 and the associated guidance to Core
Principle 6 in Appendix B.
XII. Part 37--Subpart H: Core Principle 7 (Financial Integrity of
Transactions); Sec. 39.12--Participant and Product Eligibility
Core Principle 7 requires a SEF to establish and enforce rules and
procedures for ensuring the financial integrity of swaps entered on or
through the facilities of the SEF, including the clearance and
settlement of the swaps pursuant to CEA section 2(h)(1).\638\ As
described further below, Sec. Sec. 37.700-703 implement Core Principle
7 by establishing requirements for SEFs to facilitate the processing
and routing of swap transactions to a DCO for clearing. Section
39.12(b)(7), which implements Core Principle C for DCOs, sets forth
corresponding requirements for registered DCOs that specify the time
frame for acceptance or rejection of transactions submitted to the
registered DCO from DCMs and SEFs.\639\
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\638\ The Commission codified Core Principle 7 under Sec.
37.700. 17 CFR 37.700.
\639\ 17 CFR 39.12(b)(7). Core Principle C for DCOs, among other
things, requires that each DCO establish appropriate standards for
determining the eligibility of agreements, contracts, or
transactions submitted to the DCO for clearing. 7 U.S.C. 7a-
1(c)(2)(C)(i)(II). Section 39.12(b) implements Core Principle C for
DCOs by setting forth product eligibility requirements. 17 CFR
39.12(b).
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As described further below, the Commission is proposing several
amendments to the implementing regulations and Sec. 39.12(b)(7),
including amendments to certain ``straight-through processing''
obligations that apply to SEFs, DCMs, and DCOs.\640\
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\640\ The Commission notes that Sec. 39.12(b)(7) also applies
to the acceptance or rejection for clearing by a DCO of (i) futures
and options on futures transactions and (ii) swaps submitted by a
DCM. Accordingly, the Commission's proposed amendments to Sec.
39.12(b)(7) would also apply to those transactions. See infra
Section XII.B.2.b.(2)--Sec. 39.12(b)(7)(ii)--AQATP Standard for
Registered DCOs.
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A. Sec. 37.701--Required Clearing
Section 37.701 requires that transactions executed on or through a
SEF that are subject to the clearing requirement, or are voluntarily
cleared by the counterparties, must be cleared through a registered DCO
or an exempt DCO.\641\
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\641\ 17 CFR 37.701.
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The Commission proposes to amend Sec. 37.701 to require a SEF to
establish a direct and independent clearing agreement with each
registered DCO or exempt DCO to which the SEF submits swap transactions
for clearing.\642\ During the part 37 implementation, the Commission
observed that some SEFs would route swap transactions to certain exempt
DCOs for clearing without having established a direct clearing
agreement with those DCOs. Rather than enter a direct agreement with
the exempt DCO, the SEF would establish the capacity to route
transactions through the use of a third-party service provider. Such
routing arrangements occurred pursuant to a services agreement between
the SEF and the provider; the provider, in turn, maintained a separate
agreement with the exempt DCO.
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\642\ The Commission proposes to renumber the existing
requirement under Sec. 37.701 as subsection (a) based on a new
requirement proposed under subsection (b), described below.
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A SEF's use of a third-party service provider to route swap
transactions to a DCO for clearing may generally be appropriate, but
the Commission believes that the indirect routing of transactions for
clearing must occur pursuant to a direct and independent clearing
services agreement between the SEF and each DCO utilized by the SEF.
The Commission believes that maintaining a direct agreement between a
SEF and DCO, notwithstanding the use of a third-party provider, is
consistent with Sec. 37.702(b), which requires each SEF to coordinate
with a DCO to develop rules and procedures to facilitate prompt and
efficient processing of transactions in accordance with the DCO's
obligations under Sec. 39.12(b)(7)(i)(A).\643\ Such an agreement would
provide greater certainty to market participants that the SEF has the
appropriate processes to facilitate swaps clearing. The Commission also
believes that the terms established in a direct clearing agreement
between the SEF and DCO would help the SEF and DCO resolve any problems
that arise at the DCO that could diminish the SEF's ability to submit
transactions for clearing.
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\643\ Section 39.12(b)(7)(i)(A) requires each DCO to coordinate
with DCMs and SEFs to develop rules and procedures to facilitate
prompt, efficient, and accurate processing of transactions to the
DCO for clearing. 17 CFR 39.12(b)(7)(i)(A). As discussed below,
Sec. 39.12(b)(7)(i)(A), as amended, would apply to both the
processing and routing of transactions to the DCO for clearing. See
infra Section XII.B.2.b.(1)--Sec. 37.702(b)(1) and Sec.
39.12(b)(7)(i)(A)--``Prompt, Efficient, and Accurate'' Standard.
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The Commission also proposes a non-substantive amendment to Sec.
37.701 to eliminate ``or through'' from the language of the existing
requirement. The Commission notes that this proposed amendment is a
conforming change to other part 37 regulations and does not affect the
scope of transactions that are required to be cleared pursuant to the
clearing requirement in CEA section 2(h)(1)(A).\644\
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\644\ The Commission notes that Core Principle 7 refers to swaps
``entered on or through'' the SEF, but notes that the existing
requirement under Sec. 37.701 specifically applies to ``executed''
transactions, which are submitted for clearing.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.701.
B. Sec. 37.702--General Financial Integrity
1. Sec. 37.702(a)
Section 37.702(a) requires a SEF to establish minimum financial
standards for its members, which include at a minimum a requirement
that each member qualifies as an ECP pursuant to CEA section
1a(18).\645\ The Commission proposes a non-substantive amendment to
Sec. 37.702(a) to replace the term ``member'' with ``market
participant.'' The Commission notes that its proposed definition of
``market participant'' under Sec. 37.2(b) would capture the universe
of persons and entities that participate on SEFs and would be subject
to minimum financial requirements, including a SEF's members.\646\
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\645\ 17 CFR 37.702(a).
\646\ See supra Section IV.B.2.--Sec. 37.2(b)--Definition of
``Market Participant.'' The Commission notes that CEA section 2(e)
limits swaps trading to ECPs, as defined by section 1a(18) of the
Act. 7 U.S.C. 2(e).
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2. Sec. 37.702(b) and Sec. 39.12(b)(7)--Time Frame for Clearing
Existing Sec. 37.702(b) and Sec. 39.12(b)(7) require SEFs and
registered DCOs, respectively, to coordinate with one another to
facilitate the clearing of swap transactions executed on or through the
SEF.\647\ The two provisions are intended to ensure that SEFs and
registered DCOs coordinate and work together to
[[Page 62020]]
facilitate the ``straight-through processing'' of transactions from
execution through clearing,\648\ which the Divisions have described as
the ``near[-]instantaneous acceptance or rejection of each trade. . .
.'' \649\ In order for a DCO to clear a SEF swap transaction, existing
Sec. 37.702(b)(1) requires a SEF to ensure that it has the capacity to
route transactions to the DCO in a manner acceptable to the registered
DCO for purposes of clearing.\650\ Existing Sec. 37.702(b)(2) requires
a SEF to coordinate with each registered DCO to which it submits
transactions for clearing to develop rules and procedures to facilitate
``prompt and efficient'' transaction processing in accordance with the
requirements of Sec. 39.12(b)(7).\651\ Section 39.12(b)(7)(i)(A)
requires each registered DCO to coordinate with a relevant SEF or DCM
to develop rules and procedures to facilitate ``prompt, efficient, and
accurate'' processing of all transactions, including swaps submitted to
the registered DCO for clearing by the SEF or DCM (emphasis
added).\652\
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\647\ The Commission notes that part 39 only applies to
registered DCOs and does not apply to exempt DCOs. Accordingly, the
Commission notes that Sec. 37.702(b) only refers to registered
DCOs.
\648\ Customer Clearing Documentation, Timing of Acceptance for
Clearing, and Clearing Member Risk Management, 77 FR 21278, 21283
(Apr. 9, 2012) (``Timing of Acceptance for Clearing Final Rule'').
\649\ 2013 Staff STP Guidance at 2. See also infra notes 658-659
and accompanying discussion. The Commission has previously stated
that the ``acceptance or rejection for clearing in close to real
time is crucial for both effective risk management and for the
efficient operation of trading venues.'' Timing of Acceptance for
Clearing Final Rule at 21285. The Commission notes that Sec.
39.12(b)(7) applies to a DCO with respect to (i) futures and options
on futures transactions and (ii) swaps submitted by a DCM for
clearing. To the extent that the Commission is addressing the
proposed amendments to Sec. 39.12(b)(7), as discussed further
below, in conjunction with proposed amendments to Sec.
37.702(b)(2), the discussion focuses on swaps routed by a SEF to a
DCO for clearing. See also infra note 673 (noting that at this time
the Commission is not proposing corresponding amendments to Sec.
38.601(b), which establishes analogous processing and routing
requirements for DCMs). As discussed below, however, the proposed
amendments to Sec. 39.12(b)(7) would also apply to those
transactions, including swaps, futures, and options on futures,
submitted by a DCM to a DCO for clearing. See infra Section
XII.B.2.b.(2)--Sec. 39.12(b)(7)(ii)--AQATP Standard for Registered
DCOs.
\650\ 17 CFR 37.702(b)(1).
\651\ 17 CFR 37.702(b)(2).
\652\ 17 CFR 39.12(b)(7)(i)(A). The Commission notes that
``transactions'' refers to swaps submitted by a SEF or DCM, as well
as futures and options on futures submitted by a DCM.
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Sections 39.12(b)(7)(ii)-(iii) each further require a registered
DCO to establish standards to accept or reject transactions for
clearing as quickly as would be technologically practicable as if fully
automated systems were used (the ``AQATP'' standard).\653\ Section
39.12(b)(7)(ii) applies this standard to registered DCOs for
transactions, including swaps, that are ``executed competitively on or
subject to the rules'' of a SEF or DCM and requires the registered DCO
to accept or reject a transaction for clearing pursuant to the AQATP
standard ``after execution'' of the transaction.\654\ For swaps ``not
executed on or subject to the rules'' of a SEF or DCM or ``executed
non-competitively on or subject to the rules'' of a SEF or DCM, Sec.
39.12(b)(7)(iii) requires a registered DCO to accept or reject a swap
for clearing pursuant to the AQATP standard ``after submission'' of the
swap to the DCO.\655\ In adopting the AQATP standard, the Commission
noted that it intended for the requirement to track the evolving
industry standard, based on technological developments.\656\
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\653\ 17 CFR 39.12(b)(7).
\654\ 17 CFR 39.12(b)(7)(ii).
\655\ 17 CFR 39.12(b)(7)(iii).
\656\ Timing of Acceptance for Clearing Final Rule at 21285-86.
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The Divisions subsequently issued the 2013 Staff STP Guidance to
further clarify the application of ``straight-through processing''
obligations for swaps that apply to SEFs, DCMs, and DCOs under Sec.
37.702(b), Sec. 38.601(b),\657\ and Sec. 39.12(b)(7),
respectively.\658\ The Divisions stated that the standard for straight-
through processing, i.e., the ``near instantaneous acceptance or
rejection'' of a transaction by a DCO, is critical to providing
certainty of execution and clearing, which in turn would reduce costs
and reduce risk.\659\ To achieve that standard, the guidance expressed
the view that SEFs, DCMs, and registered DCOs must facilitate swap
transaction processing through several requirements. With respect to
SEFs, the guidance expressed the view that a SEF must ensure that a
clearing FCM has been identified in advance for each party on an order-
by-order basis; and facilitate the mandatory pre-execution screening of
orders by each clearing FCM for compliance with risk-based limits,
i.e., ``pre-execution credit screening,'' in accordance with a clearing
FCM's obligations under Sec. 1.73.\660\ The guidance also expressed
the view that a DCO must meet a specific time frame, i.e., ten seconds,
to satisfy its obligation under the AQATP standard.\661\
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\657\ Section 38.601(b) applies to DCMs and establishes
processing and routing requirements that are analogous to Sec.
37.702(b) for SEFs. 17 CFR 38.601.
\658\ 2013 Staff STP Guidance at 2. The 2013 Staff STP Guidance
also specified straight-through processing requirements for FCMs
under Sec. 1.74. Id. at 2-3. See infra note 660.
\659\ 2013 Staff STP Guidance at 2.
\660\ 2013 Staff STP Guidance at 3. Section 1.74 applies similar
straight-through processing requirements to FCMs, including the
requirement that a FCM to coordinate with any DCO to which it is a
clearing member to establish systems that enable the FCM, or the DCO
acting on its behalf, to accept or reject each trade submitted to
the DCO for clearing as quickly as would be technologically
practicable if fully automated systems were used. 17 CFR 1.74.
\661\ 2013 Staff STP Guidance at 5.
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a. ``Prompt and Efficient'' Standard and AQATP Standard
Based on data received by DCR, the 2013 Staff STP Guidance
expressed the view that compliance with the AQATP standard under Sec.
39.12(b)(7)(ii) means that a registered DCO must accept or reject such
trades for clearing within ten seconds after submission to the
DCO.\662\ Given that existing Sec. 37.702(b)(2) and Sec. 38.601(b)
require SEFs and DCMs, respectively, to coordinate with DCOs in
processing transactions for clearing, the 2013 Staff STP Guidance
accordingly expressed the view that a SEF or DCM must route swaps to a
DCO in compliance with the AQATP standard.\663\
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\662\ Id.
\663\ Id. at 4.
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The 2013 Staff STP Guidance also expressed the view that the AQATP
standard applies to swap transactions that are routed to a DCO through
a SEF's or DCM's use of a post-execution, third-party manual
affirmation hub (``affirmation hub'').\664\ The Divisions further
explained in a follow-up letter to the 2013 Staff STP Guidance (the
``2015 Supplementary Staff Letter'') that a SEF or DCM may send
executed trade terms to such a hub to be manually affirmed by the
counterparties prior to routing the transaction to the DCO for
clearing.\665\ According to market participants, this process may take
minutes or hours, or occasionally may occur overnight.\666\ The
Divisions acknowledged that such affirmation hubs can promote prompt
and efficient processing by helping counterparties identify and correct
potential errors in a transaction's terms prior to routing to a DCO for
clearing.\667\ The Divisions also stated their belief, however, that
the Commission intended the AQATP standard to account for the need to
[[Page 62021]]
refine and reduce errors to facilitate prompt and efficient
processing.\668\
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\664\ Id.
\665\ Straight Through Processing and Affirmation of SEF Cleared
Swaps, CFTC Letter No. 15-67 (Dec. 21, 2015) (``2015 Supplementary
Staff Letter'').
\666\ Id. at 2.
\667\ The Divisions noted that if an erroneous swap is cleared
immediately after execution, the counterparties would have to
address the errors after clearing, which may be difficult and
costly. Additionally, counterparties may have to bear significant
margin costs until an error is corrected because the swap may have
been cleared at the wrong DCO; the swap terms may contain the wrong
counterparty; or the swap may contain incorrect economic terms. Id.
\668\ Id. at 3. The Commission previously stated that the use of
an affirmation hub for routing a swap to a DCO for clearing would be
permissible, provided that such routing complies with Sec.
37.702(b) and the trade is processed in accordance with Sec. 39.12,
among other related Commission requirements. SEF Core Principles
Final Rule at 33535.
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The 2015 Supplementary Staff Letter expressed the view that the
AQATP standard for transactions routed to an affirmation hub would be
satisfied if the transactions were routed to and received by the
relevant DCO no more than ten minutes after execution.\669\ In
establishing this standard, the Divisions noted the interaction between
a DCO's requirements under Sec. 39.12(b)(7) with a SEF's or a DCM's
requirements under Sec. 37.702(b) and Sec. 38.601(b),
respectively.\670\ Accordingly, based on the interaction between these
respective requirements, the staff letter expressed the view that a SEF
or DCM is also obligated under the AQATP standard--at least to the
extent that the SEF uses a third-party affirmation hub acting as its
agent--to ensure that the DCO receives the transaction no later than
ten minutes after execution.\671\ The Divisions stated, however, that
they would continue to review this standard and take further action as
necessary, based in part on industry developments.\672\
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\669\ 2015 Supplementary Staff Letter at 3.
\670\ Id. at 1-2.
\671\ Id. at 3.
\672\ Id. The Commission also previously stated that it would
monitor the implementation of the AQATP standard and propose
amendments in the future. Timing of Acceptance for Clearing Final
Rule at 21286.
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b. Proposed Approach to Straight-Through Processing
The Commission notes that the Divisions provided views regarding
several aspects of straight-through processing in the 2013 Staff STP
Guidance and the 2015 Supplementary Staff Letter. The Commission also
understands that certain aspects of the guidance and staff letter may
be unclear when read in conjunction with existing regulations.
Therefore, the Commission seeks to provide clarity under the proposed
regulatory framework with respect to the straight-through processing
requirements for SEFs and DCOs through the proposed clarifications and
amendments described below.\673\
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\673\ Notwithstanding the fact that Sec. 39.12(b)(7), the 2013
Staff STP Guidance, and the 2015 Supplementary Letter also apply to
DCMs as described above, the scope of this proposed rule does not
include a similar proposed amendment to Sec. 38.601(b) for DCMs
that submit (i) futures and options on futures; and (ii) swaps to a
DCO for clearing. The Commission may propose a conforming amendment
in a future proposed rulemaking that applies to DCMs. As discussed
herein, however, a DCO's obligations under the proposed amendments
to Sec. 39.12(b)(7) would apply equally to futures and options on
futures and swaps executed on a SEF or DCM, or executed pursuant to
the rules of a DCM. See supra note 640.
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(1) Sec. 37.702(b)(1) and Sec. 39.12(b)(7)(i)(A)--``Prompt,
Efficient, and Accurate'' Standard
The Commission proposes several amendments to streamline and align
the straight-through processing requirements between SEFs and
DCOs.\674\ First, the Commission proposes to eliminate the duplicative
requirement under existing Sec. 37.702(b)(1) that requires SEFs to
have the capacity to route transactions to the DCO for purposes of
clearing. Accordingly, the Commission proposes to renumber existing
Sec. 37.702(b)(2) to a new proposed Sec. 37.702(b)(1) and revise the
existing ``prompt and efficient'' standard for SEFs to ``prompt,
efficient, and accurate'' to conform to the requirement for DCOs
(emphasis added). The Commission notes that this proposed amendment
would establish the same requirement for both SEFs and DCOs,
respectively, to coordinate with one another to facilitate the
processing of swaps for clearing. To clarify the functions that are
subject to straight-through processing requirements, the Commission
also proposes to specify under proposed Sec. 37.702(b)(1) that this
standard applies to the ``routing'' of swaps by a SEF to a DCO for
clearing.\675\ Further, the Commission proposes a non-substantive
amendment to specify that a SEF's obligation to coordinate with DCOs
should be in accordance with the DCOs' obligations under Sec.
39.12(b)(7)(i)(A).\676\
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\674\ To the extent that the Commission is addressing the
proposed amendments to Sec. 39.12(b)(7)(i)(A) in conjunction with
the proposed amendments to Sec. 37.702(b)(1), the discussion
focuses on swaps routed by a SEF to a DCO for clearing. See also
supra note 673 (noting that the Commission is not proposing
corresponding amendments to Sec. 38.601(b), which establishes
analogous processing and routing requirements for DCMs, at this
time). The proposed amendments to Sec. 39.12(b)(7)(i)(A), however,
would also apply to those transactions, including swaps, futures,
and options on futures submitted by a DCM to a DCO for clearing.
\675\ The Commission acknowledges that the term ``processing''
in the existing requirement may encompass the routing of swaps from
a SEF to a DCO, but proposes to amend the language to include
``routing'' for greater clarity and the avoidance of doubt.
\676\ The current language under Sec. 37.702(b)(2) requires
SEFs to work with each DCO in accordance with the requirements of
Sec. 39.12(b)(7). The Commission's proposal would amend the
requirement to specify Sec. 39.12(b)(7)(i)(A), which imposes a
corresponding obligation on DCOs to work with SEFs to develop rules
to facilitate the ``prompt, efficient, and accurate processing'' of
transactions.
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The Commission also notes that some uncertainty exists about the
interaction between the ``prompt, efficient, and accurate'' standard
\677\ and the AQATP standard for registered DCOs, based in part on the
2013 Staff STP Guidance and 2015 Supplementary Staff Letter.
Accordingly, the Commission proposes that the ``prompt, efficient, and
accurate'' standard applies to (i) each SEF, under proposed Sec.
37.702(b)(1), with respect to the processing and routing of
transactions to a DCO; and (ii) each registered DCO, under Sec.
39.12(b)(7)(i)(A), with respect to any coordination needed to assist a
SEF with implementing any procedures or systems to facilitate the
processing and routing of swaps to the DCO. For the avoidance of doubt,
the Commission proposes that the AQATP standard does not apply to the
processing and routing of transactions. As discussed further below, the
Commission proposes that the AQATP standard set forth under Sec. Sec.
39.12(b)(7)(ii)-(iii) specifically applies to a registered DCO's
acceptance or rejection of a transaction from a SEF or DCM, i.e., when
the DCO receives the transaction.\678\ The Commission believes that
this proposed approach establishes a requirement for a SEF that
addresses its functions--to process and route swaps to the DCO--that is
appropriately distinct from a DCO's functions--to accept or reject a
swap from clearing upon submission of the swap to the DCO, among other
things. For further clarity, the Commission specifies that the SEF's
requirement to process and route swaps in a prompt, efficient, and
accurate manner also includes the SEF's transmission and delivery of
the swap to the DCO; accordingly, the ``submission'' of a swap by the
SEF to the DCO is deemed to have occurred upon the DCO's receipt of the
swap.
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\677\ As noted above, the Commission is proposing to amend the
existing standard for SEFs under Sec. 37.702(b)(2) (renumbered as
Sec. 37.702(b)(1)) to ``prompt, efficient, and accurate.''
\678\ The Commission notes that it is proposing amendments to
streamline Sec. 39.12(b)(7)(ii)-(iii), as discussed below. See
infra Section XII.B.2.b.(2)--Sec. 39.12(b)(7)(ii)--AQATP Standard
for Registered DCOs.
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In particular, the Commission proposes that the ``prompt,
efficient, and accurate'' standard also applies to the processing and
routing of swaps from a SEF to a DCO via affirmation hubs.\679\ The
Commission acknowledges
[[Page 62022]]
the beneficial role of these mechanisms and intends to facilitate their
use to reduce error rates and related costs prior to routing a swap to
the DCO. Instead of the ten-minute time frame set forth in the 2015
Supplementary Staff Letter, however, the Commission proposes that the
``prompt, efficient, and accurate'' standard would allow swaps subject
to affirmation via third-party hubs to be processed and routed to the
DCO in a manner that accounts for existing market practices and
technology, as well as market conditions at the time of execution.
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\679\ The Commission notes that the 2015 Supplementary Staff
Letter expresses the view that the AQATP standard applies to a SEF's
use of affirmation hubs to process and route trades to a DCO. 2015
Supplementary Staff Letter at 3. As discussed further below,
however, the Commission proposes that the AQATP standard applies to
a registered DCO after submission of the trade to the DCO for
clearing. Proposed Sec. 37.702(b)(1) and Sec. 39.12(b)(7)(i)(A),
as amended, would require SEFs and DCOs to respectively coordinate
and work together to effect the ``prompt, efficient, and accurate''
standard.
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Based on the Divisions' experience with the ten-minute time frame,
the Commission believes that a qualitative interpretation of ``prompt,
efficient, and accurate'' is more appropriate than imposing a specific
time standard upon SEFs for processing and routing transactions to the
DCO. The Commission has observed that many SEFs, particularly those
that offer voice-based or voice-assisted trading systems or platforms,
have not been able to meet the time frame when using manual affirmation
hubs. Further, the Commission believes that maintaining a specific time
standard would be inconsistent with the proposed expansion of the trade
execution requirement and the availability of flexible execution
methods under the proposed framework. In particular, the expansion of
the trade execution requirement will lead to the trading of a broader
array of swaps on SEFs, many of which are likely more complex in nature
and require more time for affirmation to occur. The inability to comply
with a specific time frame could hinder the anticipated growth of
trading in additional products on SEFs and impede the ability to
utilize flexible means of execution. Further, a specific time frame may
also limit the use--and therefore the benefits--of affirmation hubs.
Therefore, the Commission believes that a rigid time frame for
processing and routing trades from a SEF to a DCO is inappropriate
under the proposed regulatory framework.
The ``prompt, efficient, and accurate'' standard may result in
varying lengths of time for transactions to be processed and routed to
a DCO, including some longer instances, e.g., a time period that
exceeds ten minutes. The Commission, however, expects that market and
technological developments will enable processing and routing through
affirmation hubs to occur in increasingly shorter time intervals.
Further, the Commission notes that under the qualitative standard,
transactions that can be reasonably affirmed on a fully automatic basis
after execution should be affirmed in that manner.\680\ In such cases,
the Commission believes that ``prompt, efficient, and accurate''
processing and routing would occur in a much shorter time frame, e.g.,
less than ten minutes.
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\680\ The Commission notes that this statement is consistent
with the views expressed by the Divisions in the 2015 Supplementary
Staff Letter. Id. at 3.
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Where affirmation hubs are not utilized, the Commission believes
that the ``prompt, efficient, and accurate'' standard would also result
in a trade being processed and routed from a SEF to a DCO in a much
shorter time frame. As noted above, that exact time frame would depend
on swap market practices and technology, as well as market conditions
at the time of execution. The Commission expects that the industry will
continue to reduce time frames for transaction processing and routing
to a DCO. The Commission emphasizes that it will continue to monitor
time frames and industry developments with respect to transaction
processing to ensure that SEFs and DCOs facilitate prompt, efficient,
and accurate transaction processing and routing.
(2) Sec. 39.12(b)(7)(ii)--AQATP Standard for Registered DCOs
In addition to specifying that the ``prompt, efficient, and
accurate'' standard applies to SEFs with respect to processing and
routing transactions, the Commission proposes to clarify that the AQATP
standard applies to a DCO's acceptance or rejection of a transaction
for clearing upon submission to the DCO, i.e., when the DCO receives
the transaction. The Commission also proposes to delete existing Sec.
39.12(b)(7)(iii) as unnecessary.\681\ The Commission notes that this
approach is generally consistent with the 2013 Staff STP Guidance with
respect to swaps, but this proposal specifies that the AQATP standard
applies exclusively to the DCO and is triggered upon submission of the
agreement, contract, or transaction \682\ to the DCO from a SEF, a DCM,
or counterparties that submit swaps directly to the DCO for clearing.
Therefore, a DCO's ability to comply with the AQATP standard for
accepting or rejecting a trade is distinct from the length of time it
takes an entity such as a SEF or DCM to process and route a trade to
the DCO.\683\ As discussed below, the DCO's obligation to comply with
the AQATP standard is also independent from the method of execution or
venue by which counterparties execute an agreement, contract, or
transaction, given that the DCO's obligation to accept or reject that
executed agreement, contract, or transaction only begins from the point
after which it has been submitted to the DCO, i.e., when the DCO
receives the transaction. If a SEF, DCM, or counterparty to a
bilaterally-executed agreement, contract, or transaction delays the
submission of a cleared swap to a DCO for clearing, then it would not
impact the DCO's obligation to accept or reject on an AQATP basis after
it has received the transaction.
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\681\ As discussed below, the Commission notes that it is
proposing amendments to streamline Sec. Sec. 39.12(b)(7)(ii)-(iii)
into a single provision.
\682\ The Commission notes that both CEA section 1a(15), which
defines a DCO, and Sec. 39.12(b)(1), which establishes product
eligibility for DCOs, refer to ``agreements, contracts, or
transactions.'' Similarly, CEA section 1a(47), which defines a
``swap,'' also refers to an ``agreement, contract, or transaction.''
To conform to these provisions, the Commission proposes non-
substantive amendments to Sec. Sec. 39.12(b)(7)(i)-(ii) to apply to
all ``agreements, contracts, and transactions.'' The Commission
notes that this conforming change does not alter the substantive
scope of a DCO's obligations under proposed Sec. 39.12(b)(7). Core
Principle 7 and its implementing regulations, however, refer to
``swaps'' and ``transactions'' interchangeably without intending to
impose a substantive distinction on a SEF's obligations. For
example, Sec. 37.700 refers to ``swaps'' while Sec. Sec. 37.701-
702 refer to ``transactions,'' but the Commission's use of
``transaction'' is intended to refer generally to transactions of
swaps on the SEF and not intended to differentiate among agreements,
contracts, or transactions that constitute swaps (emphasis added).
\683\ Under proposed Sec. 37.702(b)(1), a SEF's obligation to
submit swaps for clearing to the DCO includes the SEF's obligation
to process and route swaps and is subject to the prompt, efficient,
and accurate standard.
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In conjunction with clarifying that the AQATP standard applies to
registered DCOs, the Commission proposes to streamline and consolidate
Sec. Sec. 39.12(b)(7)(ii)-(iii) to establish one AQATP standard for
registered DCOs under a new proposed Sec. 39.12(b)(7)(ii) for all
agreements, contracts, and transactions, regardless of whether they (i)
are executed competitively or non-competitively; (ii) are executed on
or pursuant to the rules of a SEF or DCM; or (iii) are swaps, futures
contracts, or options on futures contracts.\684\ The Commission also
proposes that this AQATP standard would apply to all such agreements,
contracts, and transactions after submission to the DCO, rather than
after execution, as currently required for competitively executed
transactions on or subject to
[[Page 62023]]
the rules of a DCM or SEF under existing Sec. 39.12(b)(7)(ii)
(emphasis added). The Commission believes that a DCO should be able to
accept or reject a trade for clearing in a similar AQATP standard time
frame after receiving the transaction, regardless of the manner of
execution--competitive or non-competitive--or whether the trade has
been processed and routed by a SEF or DCM, a third-party affirmation
hub, or the counterparties themselves on a direct basis. As applied to
swaps, a DCO would be subject to the same AQATP standard, regardless of
whether the swap is subject to the trade execution requirement or
otherwise voluntarily cleared.
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\684\ Based on this consolidation, the Commission proposes to
eliminate the existing language of Sec. 39.12(b)(7)(iii).
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The AQATP standard reflects the Commission's belief that acceptance
or rejection for clearing in close to real time is crucial both for
effective risk management and for the efficient operation of trading
venues.\685\ While the Commission did not prescribe a rigid time frame
for acceptance or rejection for clearing when adopting existing
Sec. Sec. 39.12(b)(7)(ii)-(iii), the Commission did note that the
performance standard would require action in a matter of milliseconds
or seconds, or at most, a few minutes, not hours or days.\686\ The
Commission notes that Commission staff continues to monitor reports
from DCOs about their ability to accept or reject trades for clearing
in a timely matter. To date, the Commission has not been made aware of
significant delays or difficulties meeting the ten-second standard
articulated in the 2013 Staff STP Guidance. Accordingly, as DCOs have
been able to accept or reject trades within ten seconds after
submission by the SEF for the past five years, the Commission proposes
that this standard continue for registered DCOs under the AQATP
standard under proposed Sec. 39.12(b)(7)(ii).
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\685\ See Timing of Acceptance for Clearing Final Rule at 21285.
In recognizing that some trading venues may not be fully automated,
the Commission stated that the use of manual steps would be
permitted, as long as the process could operate within the same
timeframes as the automated systems. Id. The Commission also noted
that the timeframe for acceptance by clearing FCMs (outlined under
Sec. 1.74) and DCOs is stricter than the timeframes for submission
by SDs and MSPs. Id. The Commission noted that ``where execution is
bilateral and clearing is voluntary, the delay between execution and
submission to clearing is, of necessity, within the discretion of
the parties to some degree. The Commission believes, however, that
prudent risk management dictates that once a trade has been
submitted to a clearing member or a DCO, the clearing member or DCO
must accept or reject it as quickly as possible.'' Id.
\686\ See id. For example, IRS were executed and cleared with an
average time of 1.9 seconds on CME platforms in early 2012. Id.
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(3) Sec. Sec. 37.702(b)(2)-(3)--Pre-Execution Credit Screening
With respect to the pre-execution credit screening of orders for
compliance with risk-based limits, the 2013 Staff STP Guidance
expressed the view that (i) a clearing FCM must be identified in
advance for each counterparty on an order-by-order basis for trades
intended for clearing; and (ii) a SEF must facilitate pre-execution
screening by each clearing FCM in accordance with Sec. 1.73 on an
order-by-order basis.\687\ To facilitate such screening in practice,
SEFs have provided their respective clearing FCMs with a ``pre-trade
credit screening'' functionality that allows them to screen orders
executed on the facility.\688\ The Divisions have viewed pre-trade
credit screening functionalities as beneficial to facilitate ``prompt
and efficient'' transaction processing in accordance with straight-
through processing requirements.\689\
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\687\ 2013 Staff STP Guidance at 3.
\688\ SEFs have been able to facilitate the use of their pre-
trade credit screening functionalities by clearing FCMs for swap
block trades pursuant to time-limited no-action relief provided by
Commission staff, which allows market participants to execute swap
block trades on the SEF that are intended to be cleared. See infra
Section XXII.A.--Sec. 43.2--Definition--Block Trade; Sec.
37.203(a)--Elimination of Block Trade Exception to Pre-Arranged
Trading. As discussed below, the Commission is proposing to amend
the definition of ``block trade'' under Sec. 43.2 to continue to
allow clearing FCMs to comply with Sec. 1.73 by using pre-execution
credit screenings on the SEF.
\689\ 2013 Staff STP Guidance at 2-3. With respect to
establishing pre-execution credit screenings, the 2013 Staff STP
Guidance expressed the view that SEFs and FCMs should work together
to effect the risk-based limits to ensure straight-through
processing of swaps. Id.
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With respect to pre-execution screening by each clearing FCM, the
2013 Staff STP Guidance viewed Sec. Sec. 1.73(a)(2)(i)-(ii) as
requiring a clearing FCM to conduct pre-execution screening of orders
for execution on a SEF or DCM for compliance with risk-based
limits.\690\ The 2013 Staff STP Guidance further expressed the view
that Sec. 1.73 provides FCMs with the ability to reject orders before
execution; as a result, orders that have satisfied clearing FCMs' pre-
execution limits are deemed accepted for clearing and thereby subject
to a guarantee by the clearing FCM upon execution.\691\ Accordingly,
the 2013 Staff STP Guidance expressed the view that a clearing FCM may
not reject a trade that has passed its pre-execution credit screening
filter because this would violate the AQATP standard, under which
trades should be accepted or rejected for clearing as soon as
technologically practicable as if fully automated systems were
used.\692\
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\690\ 2013 Staff STP Guidance at 1-2. Section 1.73(a)(1)
requires each clearing FCM to establish risk-based limits for each
proprietary account and each customer account that are based on
position size, order size, margin requirements, or similar factors.
17 CFR 1.73(a)(1). Similarly, Sec. 1.73(a)(2)(i) states that when a
clearing FCM provides electronic market access or accepts orders for
automated execution, the FCM must use automated means to screen
orders for compliance with such risk-based limits. 17 CFR
1.73(a)(2)(i). Section 1.73(a)(2)(ii) states that when a clearing
FCM accepts orders for non-automated execution, the FCM must
establish and maintain systems of risk controls reasonably designed
to ensure compliance with the limits. 17 CFR 1.73(a)(2)(ii). Section
1.73(a)(2)(iii) states that when a clearing FCM accepts transactions
that were executed bilaterally and then submitted for clearing, the
FCM must establish and maintain systems of risk controls reasonably
designed to ensure compliance with the limits. 17 CFR
1.73(a)(2)(iii). The Commission notes that paragraph (a)(2)(i)-(ii)
apply to ``orders,'' while paragraph (a)(2)(iii) applies to
``transactions.'' In addition, paragraph (a)(2)(iii) is limited to
transactions executed ``bilaterally.'' In contrast, the Commission
stated in the final rule adopting Sec. 1.73 that paragraph
(a)(2)(i) refers to ``automated trading systems,'' such as CME's
Globex, while paragraph (a)(2)(ii) includes ``non-automated markets
such as open outcry exchanges or voice brokers.'' See Timing of
Acceptance for Clearing Final Rule at 21288. As the Commission
affirmatively included voice brokers in connection with paragraph
(a)(2)(ii), transactions executed through voice brokers do not fall
under paragraph (a)(2)(iii). Accordingly, Sec. 1.73(a)(2)(iii) only
applies where two parties transact directly with one another,
outside of a SEF or DCM.
\691\ 2013 Staff STP Guidance at 3.
\692\ Id.
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With respect to the requirement that a clearing FCM must be
identified in advance for trades intended for clearing, the 2013 Staff
STP Guidance noted that the Commission has already required parties to
have a clearing arrangement in place with a clearing FCM in advance of
execution and that in cases where more than one DCO offered clearing
services, the parties would also need to specify in advance where the
trade should be sent for clearing.\693\ Accordingly, the 2013 Staff STP
Guidance expressed the view that no trade intended for clearing may be
executed on or subject to the rules of a SEF unless a clearing FCM was
identified in advance for each party on an order-by-order basis.\694\
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\693\ See Timing of Acceptance for Clearing Final Rule at 21284.
\694\ 2013 Staff STP Guidance at 3.
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In conjunction with the Commission's proposal to clarify and amend
straight-through processing requirements, the Commission proposes to
adopt these two obligations--that each market participant identify a
clearing member in advance and that a SEF facilitate pre-execution
credit screening--under Sec. Sec. 37.702(b)(2)-(3), respectively. The
Commission believes that the proposed requirements are consistent with
the proposed approach to straight-through processing as described
above. In
[[Page 62024]]
particular, the use of pre-execution credit screening functionalities
help SEFs and DCOs to both meet their respective straight-through
processing requirements by reducing the number of transactions that are
rejected from clearing by a DCO. The Commission notes that pre-
execution credit screening has become a fundamental component of the
swaps clearing infrastructure.\695\
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\695\ As noted above, the 2013 Staff STP Guidance expressed the
view that a clearing FCM may not reject a trade that has passed its
pre-execution credit screening filter because such a rejection would
violate the AQATP requirement. 2013 Staff STP Guidance at 3. The
Commission expects that this practice which is beneficial to market
participants by providing trade certainty in as minimal a time delay
as possible, will continue. The screening of transactions by a
clearing FCM does not, however, prevent the DCO from rejecting a
swap for clearing.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.702 and Sec. Sec. 39.12(b)(7)(i)-(ii). In particular, the
Commission requests comment on the following questions:
(71) The proposed ``prompt, efficient, and accurate'' standard, as
applied to trades submitted to a DCO for clearing via third-party
affirmation hubs would take into consideration evolving swap market
practices and technology, as well as current market conditions at the
time of execution. Is the proposed approach appropriate? Why or why
not? Does the approach provide sufficient guidance regarding the
standard?
(72) Is the distinction sufficiently clear between (i) the
submission and related processing and routing of a swap by a SEF to a
DCO under the ``prompt, efficient, and accurate'' standard and (ii) the
DCO's decision to accept or not accept a swap under the AQATP standard?
Does the approach provide sufficient clarity regarding the distinct,
but interrelated, roles of SEFs and DCOs? Why or why not?
(73) The 2013 Staff STP Guidance and 2015 Supplementary Staff
Letter apply to ``intended to be cleared swaps,'' including swaps
subject to the clearing requirement and swaps that are voluntarily
cleared by the counterparties. Should these requirements apply to
voluntarily-cleared swaps?
(74) Proposed Sec. Sec. 39.12(b)(7)(ii) would eliminate the
distinction when applying the AQATP standard between (i) trades that
are executed competitively and (ii) trades that are not executed
competitively or are executed away from a SEF or DCM. Is the proposed
approach appropriate? Why or why not?
(75) Proposed Sec. 39.12(b)(7)(ii) would apply the AQATP standard
after submission to the DCO, rather than after execution. Is the
proposed approach appropriate? Why or why not?
(76) Proposed Sec. 39.12(b)(7)(ii) would apply the AQATP standard
after submission to the DCO, rather than after execution, for all
swaps, futures, and options on futures submitted for clearing. Proposed
Sec. 39.12(b)(7)(ii) would apply to all agreements, contracts, and
transactions submitted to the DCO for clearing. Is the proposed
approach appropriate? Why or why not?
(77) Should a DCO have the flexibility to have additional time to
address instances in which a clearing member has insufficient credit on
deposit for the DCO to accept an agreement, contract, or transaction
for clearing? If so, should the Commission require the DCO to have
rules and procedures for the DCO's process to address those instances?
3. Applicability of Sec. 37.702(b) to SEFs That Do Not Facilitate
Clearing
The Commission proposes to amend the introductory language under
proposed Sec. 37.702(b) to specify that its requirements apply only to
those transactions routed through a SEF to a registered DCO for
clearing rather than, as currently required, to any transaction cleared
by a DCO. While not meant to reflect a substantive change, the
Commission believes that this amendment would clarify that the
requirements of Sec. 37.702(b) do not apply to a SEF that does not
facilitate the clearing of applicable listed swaps that are not subject
to the clearing requirement. The requirements would apply, however, if
the SEF offers to facilitate the clearing of such swaps.\696\
Therefore, to the extent counterparties choose to voluntary clear such
transactions through a SEF that offers to facilitate clearing for such
swaps, Sec. 37.702(b) would then apply to the SEF.
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\696\ The Commission notes that certain SEFs, such as those that
facilitate trading in FX non-deliverable forward products, do not
hold themselves out as offering services to facilitate clearing with
a DCO. As a result, the straight-through processing requirements,
including the ``prompt, efficient, and accurate'' standard and pre-
execution credit screening requirements, would not apply to such
SEFs, even if the counterparties subsequently voluntarily clear a
swap away from the SEF. The Commission notes that a SEF could offer
to facilitate the clearing of certain listed swaps, to which Sec.
37.702(b)'s requirements would apply, while not offering to
facilitate the clearing of other of its listed swaps, to which Sec.
37.702(b)'s requirements would not apply. The Commission notes,
however, that the requirements of Sec. 39.12(b)(7)(ii) apply to all
agreements, contracts, and transactions submitted to a DCO for
clearing, regardless of whether a particular swap is subject to the
clearing requirement pursuant to section 2(h)(1) of the CEA.
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C. Sec. 37.703--Monitoring for Financial Soundness
Section 37.703(a) requires a SEF to monitor its members to ensure
that they continue to qualify as an ECP pursuant to CEA section
1a(18).\697\ The Commission proposes a non-substantive amendment to
proposed Sec. 37.703 to replace the term ``member'' with ``market
participant.'' The Commission notes that its proposed definition of
``market participant'' under Sec. 37.2(b) would capture the universe
of persons and entities that participate on SEFs and would be subject
to minimum financial requirements, including a SEF's members.\698\
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\697\ 17 CFR 37.703.
\698\ See supra Section IV.B.2.--Sec. 37.2(b)--Definition of
``Market Participant.'' The Commission notes that CEA section 2(e)
limits swaps trading to ECPs, as defined by section 1a(18) of the
Act. 7 U.S.C. 2(e).
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XIII. Part 37--Subpart I: Core Principle 8 (Emergency Authority)
Core Principle 8 requires a SEF to adopt rules to provide for the
exercise of emergency authority, in consultation or cooperation with
the Commission, as is necessary and appropriate, including the
authority to liquidate or transfer open positions in any swap or to
suspend or curtail trading in a swap.\699\
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\699\ 7 U.S.C. 7b-3(f)(8). The Commission codified Core
Principle 8 under Sec. 37.800. 17 CFR 37.800.
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A. Sec. 37.801--Additional Sources for Compliance
Section 37.801 further implements Core Principle 8 by referring
SEFs to associated guidance and/or acceptable practices set forth in
Appendix B to comply with Sec. 37.800.\700\ The guidance to Core
Principle 8 specifies, among other things, the types of emergency
actions that a SEF should take in particular to address perceived
market threats, and states that the SEF should promptly notify the
Commission of its exercise of emergency action.
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\700\ 17 CFR 37.801.
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The Commission proposes to amend the guidance to Core Principle 8
by eliminating references to certain emergency actions that the
Commission understands a SEF, as a matter of general market practice,
would not be able to adopt, including imposing special margin
requirements and transferring customer contracts and the margin. Since
SEFs do not own the contracts, they do not have the ability to impose
margin or transfer contracts. Additionally, the Commission proposes
[[Page 62025]]
several non-substantive amendments to the guidance.\701\
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\701\ For example, the Commission proposes to eliminate the
reference to Sec. 40.9, as this section is currently reserved by
the Commission.
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Request for Comment
The Commission requests comment on all aspects of the proposed
associated guidance to Core Principle 8 in Appendix B.
XIV. Part 37--Subpart J: Core Principle 9 (Timely Publication of
Trading Information)
The Commission is not proposing any amendments to the regulations
under Core Principle 9.
XV. Part 37--Subpart K: Core Principle 10 (Recordkeeping and Reporting)
Core Principle 10 requires a SEF, among other things, to maintain
records of all activities related to the business of the facility,
including a complete audit trail, in a form and manner acceptable to
the Commission for a period of five years.\702\ Section 37.1001
implements this requirement by requiring a SEF to maintain an audit
trail for all swaps executed on or subject to the rules of the SEF,
among other types of records. The Commission proposes a non-substantive
amendment to Sec. 37.1001 to eliminate ``or subject to the rules of''
from the existing requirement. This proposed amendment confirms to
conforms to the proposed amendment to the ``block trade'' definition
under Sec. 43.2, discussed further below.\703\
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\702\ 7 U.S.C. 7b-3(f)(10). The Commission codified Core
Principle 10 under Sec. 37.1000. 17 CFR 37.1000.
\703\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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XVI. Part 37--Subpart L: Core Principle 11 (Antitrust Considerations)
The Commission is not proposing any amendments to the regulations
under Core Principle 11.
XVII. Part 37--Subpart M: Core Principle 12 (Conflicts of Interest)
The Commission has not adopted any regulations under Core Principle
12 and is not proposing any regulations at this time.
XVIII. Part 37--Subpart N: Core Principle 13 (Financial Resources)
Core Principle 13 requires a SEF to have adequate financial,
operational, and managerial resources to discharge each of its
responsibilities.\704\ To achieve financial resource adequacy, a SEF
must maintain financial resources sufficient to cover its operating
costs for a period of at least one year, calculated on a rolling
basis.\705\ The Commission implemented Core Principle 13 by adopting
Sec. Sec. 37.1301-1307 to specify (i) the eligible types of financial
resources that may be counted toward compliance (Sec. 37.1302); (ii)
the computation of projected operating costs (existing Sec. 37.1303);
(iii) valuation requirements (existing Sec. 37.1304); (iv) a liquidity
requirement for those financial resources that is equal to six months
of a SEF's operating costs (existing Sec. 37.1305); and (v) reporting
obligations to the Commission (Sec. 37.1306).
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\704\ 7 U.S.C. 7b-3(f)(13). The Commission codified Core
Principle 13 under Sec. 37.1300. 17 CFR 37.1300.
\705\ Id.
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The Commission implemented these regulations to ensure a SEF's
financial strength so that it could discharge its responsibilities,
ensure market continuity, and withstand unpredictable market
events.\706\ During the part 37 implementation, the Commission has
continued to receive feedback from several SEFs that the existing
requirements impose impractical financial and operating burdens.\707\
Among other things, these SEFs have contended that the amount of
financial resources that a SEF is required to maintain has proven to be
unnecessary and confines resources that could otherwise be allocated
toward operational growth and further innovation. To address some of
these concerns, Commission staff issued two guidance documents
regarding the calculation of operating costs.\708\
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\706\ When the Commission adopted Sec. 37.1301(a), it
recognized that a ``SEF's financial strength is vital to ensure that
the SEF can discharge its core principle responsibilities. . . .''
SEF Core Principles Final Rule at 33538-39.
\707\ See WMBAA, Re: Project KISS at 5 (Sept. 29, 2017) (``2017
WMBAA Letter'').
\708\ CFTC Letter No. 17-25; CFTC Letter No. 15-26, Division of
Market Oversight Guidance on Calculating Projected Operating Costs
by Swap Execution Facilities (Apr. 23, 2015) (``CFTC Letter No. 15-
26'').
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Based on its experience with overseeing the financial resources
requirements, the Commission proposes several amendments to the Core
Principle 13 regulations that would achieve a better balance between
ensuring SEF financial stability, promoting SEF growth and innovation,
and reducing unnecessary costs. The Commission's proposed amendments,
which include the addition of acceptable practices to Core Principle 13
in Appendix B, are based in part on existing Commission staff guidance,
feedback received from SEFs, and Commission experience gained from
ongoing oversight. As discussed in detail further below, the
Commission's proposed changes consist of (i) clarification of the scope
of operating costs that a SEF must cover with adequate financial
resources; (ii) acceptable practices, based on existing Commission
staff guidance, that address the discretion that a SEF has when
calculating projected operating costs pursuant to proposed Sec.
37.1304; (iii) amendments to the existing six-month liquidity
requirement for financial resources held by a SEF; and (iv) streamlined
requirements with respect to financial reports filed with the
Commission. The proposed changes also would include non-substantive
amendments to clarify certain existing requirements, including the
renumbering of several provisions to present the requirements in a more
cohesive manner.
A. Sec. 37.1301--General Requirements
1. Sec. 37.1301(a)
Existing Sec. 37.1301(a) requires a SEF to maintain financial
resources that are sufficient to enable it to perform its functions in
compliance with the SEF core principles set forth in section 5h of the
Act (emphasis added).\709\ Existing Sec. 37.1301(c) relates to this
requirement and specifies that a SEF's financial resources are
sufficient if their value is ``at least equal to'' the SEF's operating
costs for a one-year period, on a rolling basis.\710\
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\709\ 17 CFR 37.1301(a).
\710\ 17 CFR 37.1301(c).
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Certain SEFs have stated that existing Sec. 37.1301(a), when read
in conjunction with Sec. existing 37.1301(c), can be construed to
state that operational costs incurred for functions that are not
germane to discharging SEF core principle responsibilities must be
included in a financial resources calculation. According to those SEFs,
requiring those costs to be included would require a SEF to allocate
additional resources to comply with the requirement, which would hinder
its ability to allocate that capital to operational growth and
innovation, thereby creating unnecessary burdens.\711\
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\711\ See 2017 WMBAA Letter at 6 (stating that the financial
resource requirements should focus on fixed costs required for
compliance, rather than variable costs and staff-related costs that
are not essential).
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The Commission proposes to consolidate the requirement under
existing Sec. 37.1301(c) into a new proposed Sec. 37.1301(a) and
adopt several amendments. First, the Commission proposes to amend the
types of operating costs that must be included in a SEF's financial
resources determination. As proposed, a SEF would be required to
maintain adequate financial resources to cover the
[[Page 62026]]
operating costs that a SEF needs to ``comply'' with the SEF core
principles and any applicable Commission regulations, rather than
``perform its functions in compliance with'' the core principles. For
example, under the current requirement, a SEF must maintain financial
resources to continue to afford all of its existing activities (for
example, activities such as product research or business development),
even if such activities are not mandated by any core principle or
regulatory requirement. Under the proposed amendment, a SEF would not
need to include costs that are not necessary to comply with the SEF
core principles and any applicable Commission regulations when
calculating its operating costs.
The Commission believes that the proposed regulation represents a
better and more balanced regulatory approach to implementing the Core
Principle 13 requirements. Some SEF operational costs may not be
necessary for discharging core principle and regulatory
responsibilities, and therefore, should not be included when
calculating a SEF's financial resources. Rather than require a SEF to
allocate capital to account for such operating costs, the proposed
amendment permits SEFs to allocate their capital to other areas,
thereby furthering the goal of promoting SEF growth and
innovation.\712\ Therefore, proposed Sec. 37.1301(a) would achieve a
better balance between ensuring that a SEF is financially stable, while
also providing the SEF with greater discretion to allocate its limited
resources.\713\ Further, the proposed amendment would remove a
potential barrier for new SEF entrants who may otherwise have been
deterred by the relatively higher capital costs posed by a broad
reading of the existing requirement.
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\712\ The Commission understands that businesses, particularly
nascent SEFs or SEFs developing new product lines, may incur
relatively greater expenses in growing new business, compared to
established SEFs or existing product lines. The Commission notes
that under the proposed acceptable practices to Core Principle 13 in
Appendix B, costs related to marketing and business development
could be excluded from a SEF's projected operating cost
calculations. See infra Section XVIII.D.1.--Acceptable Practices to
Core Principle 13 in Appendix B.
\713\ The Commission believes that the proposed financial
resources obligations in the aggregate would better ensure market
stability and the financial viability of SEFs. While proposed Sec.
37.1301(a), along with the associated acceptable practices to Core
Principle 13, may reduce the total amount of financial resources
that a SEF must hold under Sec. 37.1301(a), the Commission believes
that such a change should not affect market integrity or the
financial viability of SEFs. SEFs may include illiquid financial
assets, as opposed to cash or cash equivalents, towards satisfying
this requirement. The Commission, however, has also recognized that
based on its experience, illiquid resources are less effective for
ensuring an entity's viability, especially in times of market
volatility where it may be difficult to timely sell illiquid assets
or avoid a significant haircut on such assets. Consequently, the
Commission believes that the amount of liquid assets that a SEF must
hold, which the Commission addresses under proposed Sec. 37.1303,
more effectively protects market integrity and the financial
viability of SEFs. As discussed below, proposed Sec. 37.1303 would
explicitly require SEFs to maintain sufficient liquidity to cover
their projected wind-down costs, with a minimum liquidity level in
an amount no less than three months of projected operating costs
where wind-down costs would be less than three months of projected
operating costs. See infra Section XVIII.C.--Sec. 37.1303--
Liquidity of Financial Resources.
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The Commission also proposes several non-substantive changes to
align proposed Sec. 37.1301(a) more closely to Core Principle 13
requirements. To reflect the ongoing nature of the Core Principle 13
requirements, the Commission proposes to specify that a SEF must
maintain adequate financial resources on an ``ongoing basis.'' For
consistency purposes with Core Principle 13, the Commission also
proposes to replace the word ``sufficient'' with ``adequate'' and adopt
additional language to specify that a SEF's financial resources will be
considered ``adequate'' if their value ``exceeds,'' rather than is ``at
least equal to,'' one year's worth of operating costs,\714\ calculated
on a rolling basis pursuant to the requirements for calculating such
costs under proposed Sec. 37.1304.\715\
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\714\ The Commission notes that it is also proposing a non-
substantive amendment to refer to ``projected operating costs''
instead of ``operating costs'' to conform to existing Sec. 37.1304
and Sec. 37.1307, both of which refer to ``projected operating
costs.'' The Commission notes that during informal discussions with
SEFs, Commission staff and SEFs have generally referred to SEFs'
``projected'' operating costs.
\715\ As discussed below, proposed Sec. 37.1304 (which the
Commission proposes to renumber from existing Sec. 37.1303) would
continue to provide SEFs with reasonable discretion to calculate
their projected operating costs to determine their financial
resources requirement under Sec. 37.1301(a) and their liquidity
requirement under proposed Sec. 37.1303.
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Further, as noted above, the Commission proposes to adopt
additional language to clarify that a SEF's financial resources must be
adequate to comply with the SEF core principles and any ``applicable
Commission regulations.'' This amendment is intended to clarify that a
SEF's resource adequacy obligation under proposed Sec. 37.1301(a) also
applies to any resources needed for complying with any additional
regulatory requirements that the Commission has promulgated.\716\ The
Commission notes that SEFs are already complying with this
clarification in practice.
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\716\ The Commission notes that under Core Principle 1, a SEF
must comply with any rule or regulation promulgated by the
Commission pursuant to section 8a(5) of the Act. 17 CFR 37.100. For
a SEF to discharge its responsibilities pursuant to Core Principle
13, which include complying with the SEF core principles, it is
required to ensure that its financial resources are adequate to
comply with those rules or regulations.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1301(a). In particular, the Commission requests comment on the
following question:
(78) To what extent does a requirement for SEFs to maintain
financial resources to cover operational costs needed only for core
principle and regulatory compliance reduce the financial resources that
a SEF needs to maintain, as opposed to the current requirement? Would
such a reduction, if any, impair the stability of either the SEF or the
marketplace or the marketplace's confidence in the SEF market
structure? Would this proposed change encourage innovation or new
entrants into the marketplace?
2. Sec. 37.1301(b)
Section 37.1301(b) requires a SEF that also operates as a DCO to
also comply with the financial resource requirements for DCOs under
Sec. 39.11.\717\ The Commission proposes to amend Sec. 37.1301(b) to
permit SEFs that also operate as DCOs to file a single financial report
under Sec. 39.11 that covers both the SEF and DCO.\718\ This proposed
approach would streamline and simplify the SEF financial report filing
process set forth under Sec. 37.1306 and would also be consistent with
the requirement for DCMs under Sec. 38.1101(a)(3), which permits DCMs
that operate as a DCO to file a single financial report.\719\
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\717\ 17 CFR 37.1301(b).
\718\ See Derivatives Clearing Organization General Provisions
and Core Principles, 76 FR 69334 (Nov. 8, 2011). Section 39.11
establishes requirements that a DCO will have to meet in order to
comply with Core Principle B (Financial Resources) for DCOs. Core
Principle B requires a DCO to possess financial resources that, at a
minimum, exceed the total amount that would enable the DCO to meet
its financial obligations to its clearing members, notwithstanding a
default by a clearing member creating the largest financial exposure
for the DCO in extreme but plausible conditions; and enable the DCO
to cover its operating costs for a period of one year, as calculated
on a rolling basis. 7 U.S.C. 7a-1(c)(2)(B)(ii).
\719\ 17 CFR 38.1101(a)(3).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1301(b).
[[Page 62027]]
3. Sec. 37.1301(c)
Given the proposed consolidation with Sec. 37.1301(a), as
described above, the Commission proposes to eliminate Sec. 37.1301(c).
B. Sec. 37.1302--Types of Financial Resources
Section 37.1302 sets forth the types of financial resources
available to SEFs to satisfy the general financial resources
requirement.\720\ These resources include the SEF's own capital,
meaning its assets minus liabilities calculated in accordance with U.S.
generally accepted accounting principles; and any other financial
resource deemed acceptable by the Commission.\721\ The Commission
proposes a non-substantive amendment to the current language by
referring to generally accepted accounting principles ``in the United
States'' to conform to the proposed amendments to Sec. 37.1306
described further below.\722\
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\720\ 17 CFR 37.1302.
\721\ Id.
\722\ See infra Section XVIII.F.1.--Sec. 37.1306(a).
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C. Sec. 37.1303--Liquidity of Financial Resources \723\
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\723\ The Commission proposes to renumber existing Sec. 37.1305
to Sec. 37.1303 and amend the requirement as described.
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Existing Sec. 37.1305--``Liquidity of financial resources''--
currently requires a SEF to maintain unencumbered, liquid financial
assets, i.e., cash and/or highly liquid securities, that are equal to
at least six months of a SEF's operating costs.\724\ If any portion of
a SEF's financial resources is not sufficiently liquid, then a SEF is
permitted to take into account a committed line of credit or similar
facility to meet this requirement.\725\ In adopting this rule, the
Commission explained that the liquidity requirement is intended to
ensure that a SEF could continue to operate and wind down its
operations in an orderly fashion, if necessary.\726\ The Commission
also determined that a six-month period would be an accurate assessment
of how long it would take for a SEF to wind down in an orderly manner,
absent support for alternative time frames.\727\
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\724\ 17 CFR 37.1305.
\725\ Id.
\726\ The Commission stated that ``the purpose of the liquidity
requirement is so that all SEFs have liquid financial assets to
allow them to continue to operate and to wind down in an orderly
fashion'' and that the Commission ``view[ed] a six month period as
appropriate for a wind-down period . . . .'' SEF Core Principles
Final Rule at 33540.
\727\ Id.
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The Commission proposes to amend the minimum amount of liquid
financial resources that a SEF must include from six months of
operating costs to the greater of (i) three months of a SEF's projected
operating costs or (ii) the projected costs for a SEF to wind down its
business, as determined by the SEF.\728\ The Commission acknowledges
that in the SEF Core Principles Final Rule, it rejected a three-month
requirement based on a lack of cited support for a shorter time
frame.\729\ Based on its own past oversight of SEFs and DCMs and
feedback from registered SEFs since the adoption of part 37, however,
the Commission recognizes that the existing six-month requirement is
not necessary. Rather, the Commission believes that the proposed
requirement, which sets the minimum amount of unencumbered, liquid
financial assets that a SEF must maintain at three months of projected
operating costs, would be sufficient to fulfill the goal of ensuring
that a SEF can continue to operate and, if necessary, wind down its SEF
operations in an orderly fashion.
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\728\ The Commission notes that it is proposing to specify
``projected'' operating costs for consistency with the cost
calculation requirement under Sec. 37.1304, discussed below. See
infra Section XVIII.D.--Sec. 37.1304--Computation of Costs to Meet
Financial Resources Requirement.
\729\ SEF Core Principles Final Rule at 33540.
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Since the adoption of part 37, many SEFs have continued to maintain
that a six-month minimum requirement is not necessary and that some of
their liquid assets would be better applied toward growth
initiatives.\730\ Consistent with that feedback, the Commission has
observed over time that the wind downs or ownership changes of several
registered trading platforms, including SEFs and DCMs, have occurred
within a much shorter time frame.\731\ Based on this experience, the
Commission acknowledges that a SEF may be better positioned to
determine the amount of liquid financial resources needed to continue
its operations and to conduct an orderly wind down. Under the proposed
change, SEFs would be able to use the additional resources to invest in
other areas of their operations. Accordingly, compared to the existing
static six-month requirement, the Commission believes that a liquid
resources requirement of the ``greater of'' either (i) three months of
projected operating costs or (ii) projected wind-down costs would
better ensure an orderly wind down for SEFs and ensure a more efficient
allocation of resources for SEFs that require a wind-down period of
less than six months. Further, by explicitly requiring a SEF to
maintain sufficient liquidity to conduct an orderly wind down of its
business, this approach would also better protect against the risk of
failure in the unlikely event that a SEF would require a wind-down
period of longer than six months.
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\730\ See 2017 WMBAA Letter at 5 (citing argument that a shorter
liquidity requirement would allow for a SEF to allocate capital for
innovation).
\731\ For example, the Commission notes that the DCM Green
Exchange LLC had its designation vacated and ceased operations.
Similarly, the DCM Kansas City Board of Trade was acquired by CME
Group and had its designation vacated; it ultimately ceased
operations. Likewise, Javelin SEF, LLC was acquired by Bats Global
Markets, Inc., which in turn was subsequently acquired by CBOE SEF,
LLC. In each case, the Commission observed a relatively efficient
process.
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The Commission also proposes a non-substantive amendment to clarify
that if a SEF has a deficiency in satisfying this requirement, then it
may overcome that deficiency by obtaining a committed line of credit or
similar facility in an amount at least equal to that deficiency.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1303. In particular, the Commission requests responses to the
questions below.
(79) Is the Commission's proposed requirement for a SEF to have
liquid assets equal to the greater of either three months of projected
operating costs or projected wind-down costs an appropriate approach?
If not, then what should the Commission adopt as a more appropriate
liquidity requirement and why? Would a SEF's wind-down period generally
be longer or shorter than three months?
(80) Would the change to the liquidity requirement under proposed
Sec. 37.1303 impair the stability of either the SEF or the
marketplace? Would proposed Sec. 37.1303 encourage innovation or new
entrants into the marketplace?
D. Sec. 37.1304--Computation of Costs To Meet Financial Resources
Requirement 732
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\732\ The Commission also proposes to renumber existing Sec.
37.1303 to Sec. 37.1304 and amend the requirement as described.
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Existing Sec. 37.1303--``Computation of projected operating costs
to meet financial resource requirement''--currently requires a SEF to
make a reasonable calculation of its projected operating costs for each
fiscal quarter over a twelve-month period to determine the amount of
financial resources needed to comply with the financial resource
requirement.\733\ Existing Sec. 37.1303 further provides that a SEF
has reasonable discretion to determine the methodology that it uses to
compute its projected operating costs, although the Commission may
review
[[Page 62028]]
the SEF's methodology and require the SEF to make changes as
appropriate.\734\
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\733\ 17 CFR 37.1303.
\734\ Id.
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The Commission proposes to amend the existing requirement to
specify that a SEF must also make a reasonable calculation of projected
wind-down costs, but would have reasonable discretion in adopting the
methodology for calculating such costs. This proposed addition is
consistent with the reasonable discretion already provided for
calculating projected operating costs and corresponds to Sec. 37.1303,
which incorporates the calculation of a SEF's wind-down costs into the
liquidity determination. The Commission also proposes two non-
substantive amendments that would add a reference to Sec. 37.1303,
given that a SEF must calculate projected operating costs to determine
how to comply with the liquidity requirement; and eliminate the twelve-
month requirement, given that proposed Sec. 37.1301(a) already
establishes that the financial resource requirement applies on a one-
year, rolling basis.
1. Acceptable Practices to Core Principle 13 in Appendix B
To help SEFs comply with Core Principle 13, which requires a SEF to
calculate its operating costs as part of a financial resources
determination, the Commission is proposing acceptable practices to Core
Principle 13 in Appendix B associated with Sec. 37.1304. The proposed
acceptable practices expound upon the reasonable discretion that SEFs
have for computing projected operating costs in determining their
financial resource requirements. Among other things, these acceptable
practices would further explain which operating costs are not necessary
to comply with the SEF core principles and the Commission's
regulations. The Commission notes that these acceptable practices
generally incorporate existing guidance provided by Commission
staff.\735\
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\735\ The proposed acceptable practices to Core Principle 13 in
Appendix B are based in part upon existing DMO staff guidance. See
CFTC Letter No. 17-25 and CFTC Letter No. 15-26.
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The proposed acceptable practices state that calculations of
projected operating costs, i.e., those that are necessary for the SEF
to comply with the SEF core principles and any applicable Commission
regulations, should be based on a SEF's current business model and
anticipated business volume.\736\ In particular, if the SEF offers more
than one bona fide execution method, then a SEF would be allowed to
include the costs of only one of those methods in calculating projected
operating costs.\737\ A bona fide method refers to a method actually
used by SEF participants and not established by a SEF on a pro forma
basis merely for the purpose of complying with--or evading--the
financial resources requirement.
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\736\ In determining a SEF's projected operating costs under
Sec. 37.1301(a) or Sec. 37.1303, a calculation based upon a
hypothetical business model that has lower associated costs or lower
business volume, and is intended to underestimate or minimize the
level of required financial resources, would not be appropriate. As
stated in the proposed acceptable practices, however, a SEF may
account for any projected modification to its business model, e.g.,
the addition or subtraction of business lines or operations or other
changes, in its calculations and therefore any projected increase or
decrease in revenue or operating costs from those changes over the
next 12 months.
\737\ For example, if a SEF offers both an order book and RFQ
system, then the SEF may include the costs associated with one of
those methods and exclude the costs associated with the other
method.
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This approach would still require SEFs to maintain sufficient
financial resources to ensure their financial viability, but also
provide greater flexibility to SEFs to compute operating costs,
consistent with the reasonable discretion provided under proposed Sec.
37.1304. Although neither the CEA nor the Commission's regulations
require a SEF to have more than one execution method, this flexibility
could encourage SEFs to innovate and experiment in offering a variety
of trading systems or platforms compared to the current requirements.
Accordingly, this flexibility would mitigate possible disincentives for
a SEF to limit the number and types of execution methods that it might
otherwise develop and offer, were it required to account for the
associated operating costs for all offered execution methods in a
calculation. In excluding any of these expenses, however, a SEF would
need to document and justify those exclusions pursuant to proposed
requirements under Sec. 37.1306, discussed further below.\738\
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\738\ See infra Section XVIII.F.3.--Sec. 37.1306(c).
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The proposed acceptable practices would also specify that a SEF may
exclude certain expenses in making a ``reasonable'' calculation of
projected operating costs. These expenses include, in part, marketing
and development costs; variable commissions paid to SEF trading
specialists, the payment of which is contingent on whether the SEF
collects associated revenue from transactions on its systems or
platforms; \739\ and costs for other SEF personnel who are not
necessary to enable a SEF to comply with the core principles, based on
its current business model and business volume.\740\ Further, a SEF may
exclude any non-cash costs, including depreciation and amortization.
The Commission notes that excluding these expenses would be consistent
with the proposed financial resource requirement and proposed liquidity
requirement because they do not reflect costs necessary for a SEF to
comply with the SEF core principles or Commission regulations.
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\739\ See CFTC Letter No. 17-25.
\740\ For example, if a SEF requires a certain amount of SEF
trading specialists to operate a voice-based or voice-assisted
trading system or platform, but hires additional personnel to
enhance its operations to benefit market participants, then the SEF
would only need to include the minimum number of trading specialists
needed to operate the trading system or platform based on its
current business volume and take into account any projected increase
or decrease in business volume in its projected operating cost
calculations.
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In addition to allowing a SEF to exclude certain projected
operating costs, the proposed acceptable practices further specify that
a SEF may pro-rate, but not exclude, certain expenses in calculating
projected operating costs. The Commission recognizes that some costs
may be only partly attributable to a SEF's ability to comply with the
SEF core principles and the Commission's regulations; therefore, only
those attributed costs would need to be included in a SEF's projected
operating costs. Accordingly, a SEF may pro-rate expenses that are
shared with affiliates, e.g., the costs of administrative staff or
seconded employees that a SEF shares with affiliates. Further, a SEF
may also pro-rate expenses that are attributable in part to operational
aspects that are not required to comply with the SEF core principles,
e.g., costs of a SEF's office rental space, to the extent that it is
also used to house marketing personnel. In pro-rating any such
expenses, however, a SEF would need to document and justify those pro-
rated expenses pursuant to proposed requirements under Sec. 37.1306,
discussed further below.\741\
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\741\ See infra Section XVIII.F.3.--Sec. 37.1306(c).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1304 and the associated acceptable practices to Core Principle 13 in
Appendix B. In particular, the Commission requests comment on the
following question:
(81) The proposed acceptable practices would permit a SEF to
include only the costs related to one of the bona fide execution
methods that it offers. Should a SEF instead be required to include in
its projected operating costs the expenses related to all of its
execution methods? Why or why not?
[[Page 62029]]
E. Sec. 37.1305--Valuation of Financial Resources 742
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\742\ The Commission proposes to renumber Sec. 37.1304 to Sec.
37.1305 and amend the requirement as described.
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Section 37.1304--``Valuation of financial resources''--currently
requires a SEF, at least once each fiscal quarter, to compute the
current market value of each financial resource used to meet its
financial resources requirement under Sec. 37.1301.\743\ The
requirement is designed to address the need to update valuations when
there may have been material fluctuations in market value that could
impact a SEF's ability to satisfy its financial resource
requirement.\744\ When valuing a financial resource, the SEF must
reduce the value, as appropriate, to reflect any market or credit risk
specific to that particular resource, i.e., apply a haircut.\745\
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\743\ 17 CFR 37.1304.
\744\ SEF Core Principles Final Rule at 33539.
\745\ A ``haircut'' is a deduction taken from the value of an
asset to reserve for potential future adverse price movement in such
asset. Id. at 33539 n.772.
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The Commission proposes a non-substantive amendment to add an
applicable reference to Sec. 37.1303. The Commission notes that in
addition to calculating the current market value of each financial
resource used to satisfy its financial resource requirement, compliance
with the liquidity requirement would require a SEF to utilize the
current market value of the applicable financial resources.
F. Sec. 37.1306--Reporting to the Commission
1. Sec. 37.1306(a)
Section 37.1306 establishes a SEF's financial reporting
requirements to the Commission. Section 37.1306(a)(1) currently
requires that at the end of each fiscal quarter or upon Commission
request, a SEF must report to the Commission (i) the amount of
financial resources necessary to meet the financial resources
requirement of Sec. 37.1301; and (ii) the value of each financial
resource available to meet those requirements as calculated under Sec.
37.1304.\746\ Section 37.1306(a)(2) additionally requires a SEF to
provide the Commission with a financial statement, including a balance
sheet, income statement, and statement of cash flows of the SEF or its
parent company.\747\ In lieu of submitting its own financial
statements, a SEF may submit the financial statements of its parent
company.\748\
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\746\ 17 CFR 37.1306(a)(1).
\747\ 17 CFR 37.1306(a)(2).
\748\ Id.
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The Commission proposes several amendments to Sec. 37.1306(a)(2).
First, the Commission proposes to require a SEF to prepare its
financial statements in accordance with generally accepted accounting
principles in the United States (``GAAP''). For a SEF that is not
domiciled in the U.S. and is not otherwise required to prepare its
financial statements in accordance with GAAP, the Commission would
allow that SEF to prepare its statements in accordance with either the
International Financial Reporting Standards issued by the International
Accounting Standards Board, or a comparable international standard as
the Commission may accept in its discretion. The Commission notes that
the quality and transparency of SEF financial reports submitted under
the existing requirement have varied and believes that the GAAP-based
requirement would promote consistency and better ensure a minimum
reporting standard across financial submissions.
The Commission also proposes to require a SEF to provide its own
financial statements, rather than allow a SEF the option of submitting
the statements of its parent company. The Commission notes that it may
lack jurisdiction over a SEF's parent company or its affiliates; in
such instances, the Commission could not consider the parent company's
financial resources in determining whether the SEF itself possesses
adequate financial resources. Therefore, the Commission believes that a
separate SEF financial statement would more clearly demonstrate
evidence of the SEF's compliance with Core Principle 13.
In addition to the proposed amendments to Sec. 37.1306(a)(2), the
Commission proposes non-substantive revisions to Sec. 37.1306(a)(1) to
add appropriate references to Sec. 37.1303 to Sec. 37.1305, as
discussed above. In addition to specifying the amount of financial
resources necessary to comply with Sec. 37.1301, a SEF's quarterly
report must include the amount of financial resources necessary to
comply with the liquidity requirement. Further, the amounts specified
in the report must be based on the current market value of each
financial resource and computed as reasonable calculations of the SEF's
projected operating costs and wind-down costs.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(a). In particular, the Commission requests comment on the
questions below:
(82) Should the Commission require a SEF's financial reports to be
audited? Would requiring an audited annual financial report improve
Commission oversight? What costs would be associated with an audit
requirement?
(83) Instead of submitting four financial reports as currently
required, should the Commission require a semi-annual report and an
audited annual report?
(84) Would providing the Commission with the discretionary
authority to request that SEFs provide audited financial statements, as
necessary or appropriate, help the Commission meet its oversight
responsibilities?
(85) Financial statements currently submitted by SEFs do not need
to comply with GAAP. What are the costs and benefits of requiring GAAP-
compliant financial submissions?
2. Sec. 37.1306(b)
Section 37.1306(b) currently requires a SEF to make its financial
resource calculations on the last business day of its fiscal
quarter.\749\ The Commission proposes a non-substantive amendment to
Sec. 37.1306(b) that would add the word ``applicable'' before ``fiscal
quarter'' in the existing rule text.
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\749\ 17 CFR 37.1306(b).
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3. Sec. 37.1306(c)
Section 37.1306(c) sets forth documentation requirements for a
SEF's financial reporting obligations. Section 37.1306(c)(1) requires a
SEF to provide the Commission with sufficient documentation explaining
the methodology used to calculate its financial resource requirements
under Sec. 37.1301.\750\ Section 37.1306(c)(2) requires a SEF to
provide sufficient documentation explaining the basis for its valuation
and liquidity determinations.\751\ To provide such documentation, Sec.
37.1306(c)(3) requires SEFs to provide copies of certain agreements
that evidence or otherwise support its conclusions.\752\
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\750\ 17 CFR 37.1306(c)(1)
\751\ 17 CFR 37.1306(c)(2).
\752\ 17 CFR 37.1306(c)(3).
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Based on the proposed amendments to the Core Principle 13
regulations described above, the Commission proposes conforming
amendments to Sec. 37.1306(c) to require a SEF to specify the
methodology used to compute its financial resource and liquidity
requirements. The documentation to be provided must be sufficient for
the Commission to determine that the SEF has made reasonable
calculations of projected operating costs and wind-down costs under
Sec. 37.1304. As
[[Page 62030]]
proposed, Sec. Sec. 37.1306(c)(2)(i)-(iv) \753\ would require that the
SEF, at a minimum (i) list all of its expenses, without exclusion; (ii)
identify all of those expenses that the SEF excluded or pro-rated in
its projected operating cost calculations and explain the basis for
excluding or pro-rating any expenses; (iii) include documentation
related to any committed line of credit or similar facility used to
meet the liquidity requirement; \754\ and (v) identify estimates of all
of the costs and the projected amount of time required for any wind
down of operations, including the basis for those estimates.
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\753\ The Commission proposes to consolidate paragraphs (c)(1)-
(3) into paragraphs (c)(1)-(2) and adopt the proposed requirements
as described.
\754\ The Commission notes that it is also proposing a non-
substantive change to eliminate the current language in paragraph
(c)(3) regarding copies of insurance coverage or other arrangement
evidencing or otherwise supporting the SEF's conclusions. The
Commission notes that subsection (c) still requires a SEF to provide
sufficient documentation explaining the methodology used to compute
its financial resource requirements; therefore, if insurance
coverage or other arrangements are necessary to explain a SEF's
methodology, then the SEF must submit such documentation. The
Commission also notes, however, that such documentation may not be
required in all cases; proposed paragraph (c)(2) provides minimum
requirements.
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The proposed requirement does not necessarily create new
obligations, but rather clarifies a SEF's existing obligations based
upon existing guidance provided by Commission staff.\755\ Further, the
proposed requirement is specifically intended to ensure that a SEF has
sufficient financial resources, particularly in light of the discretion
provided to SEFs to compute their projected operating costs and wind-
down costs. Therefore, the Commission believes that maintaining the
general obligation for each SEF to identify all of its expenses in its
financial report, including those that correspond to activities that
are not needed for compliance or otherwise are excluded or pro-rated
from projected operating costs, is appropriate on an ongoing basis.
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\755\ See CFTC Letter No. 17-25 at 4.
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The Commission further believes that proposed Sec. Sec.
37.1306(c)(2)(i)-(iv) would address the current lack of adequate
documentation or insufficient identification of excluded or pro-rated
expenses by some SEFs in submitting their projected operating costs
based on Commission staff guidance. Absent the guidance, the Commission
notes that the existing rule has created burdens for Commission staff
when determining whether a SEF complies with Core Principle 13. In its
experience thus far, the Commission recognizes that Commission staff
has devoted additional effort to obtain the appropriate documentation
from SEFs. Therefore, the Commission believes that adding greater
specificity to the existing requirement would mitigate the time and
resources required to determine a SEF's compliance with the financial
resource requirements.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(c).
4. Sec. 37.1306(d)
Section 37.1306(d) requires a SEF to file its financial report no
later than forty calendar days after the end of each of the SEF's first
three fiscal quarters and no later than sixty calendar days after the
end of the SEF's fourth fiscal quarter, or at such later time as the
Commission may permit.\756\
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\756\ 17 CFR 37.1306(d).
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The Commission proposes to extend the due date for each SEF's
fourth fiscal quarter report from sixty to ninety days following the
end of the quarter. This new proposed due date conforms with the due
date for the SEF annual compliance report under proposed Sec.
37.1501(e)(2).\757\ The Commission recognizes that preparing multiple
year-end reports, which includes a fourth-quarter financial report and
an annual compliance report, for concurrent submission imposes resource
constraints on a SEF.\758\ Therefore, the Commission believes that such
potential constraints justify an additional thirty days to prepare and
concurrently file the SEF's fourth quarter financial report along with
its annual compliance report.
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\757\ See infra Section XX.A.5.--Sec. 37.1501(e)--Submission of
Annual Compliance Report and Related Matters.
\758\ The Commission also notes that it is proposing to require
a SEF to submit an updated Technology Questionnaire under Sec.
37.1401(g) at the same time on an annual basis. See infra Section
XIX.B.--Sec. 37.1401(g)--Program of Risk Analysis and Oversight
Technology Questionnaire.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(d).
5. Sec. 37.1306(e)
The Commission proposes to add a new requirement under Sec.
37.1306(e) for each SEF to provide notice to the Commission of its non-
compliance with the financial resource requirements no later than
forty-eight hours after the SEF knows or reasonably should have known
of its non-compliance.\759\ Each SEF has an ongoing obligation to
comply with the requirements under Core Principle 13. The proposed
requirement would clarify that the SEF cannot wait until filing its
quarterly financial reports to notify the Commission that it no longer
satisfies the Core Principle 13 financial resources requirements. In
some instances, the Commission has not been informed of a SEF's non-
compliance with the financial resource requirements until the filing of
a quarterly financial report. The Commission believes, however, that
prompt notification of non-compliance is necessary for the Commission
to conduct proper market oversight and ensure market stability on an
ongoing basis.
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\759\ For example, if a SEF knows or reasonably should know that
its assets will no longer cover its projected operating costs for
the next twelve months, as calculated on a rolling basis, then the
SEF should notify the Commission within forty-eight hours.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1306(e).
G. Sec. 37.1307--Delegation of Authority
Section 37.1307(a) currently delegates authority to the Director of
DMO, or other staff as the Director may designate, to perform certain
functions that are reserved to the Commission under the Core Principle
13 regulations, including reviewing the methodology used to compute
projected operating costs.\760\
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\760\ 17 CFR 37.1307(a).
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The Commission proposes to amend Sec. 37.1307(a)(2) to clarify
that the Commission may additionally delegate the authority to review
and make changes to the methodology used by a SEF to determine the
market value of its financial resources under Sec. 37.1305 and the
methodology that SEFs use to determine their wind-down costs under
Sec. 37.1304. Further, the Commission would delegate the ability to
request the additional documentation related to the calculation
methodologies used under Sec. 37.1306(c) and the notification of non-
compliance under Sec. 37.1306(e). The proposed amendments also include
several additional non-substantive amendments based on the proposed
amendments to Core Principle 13 regulations, as described above.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1307.
XIX. Part 37--Subpart O: Core Principle 14 (System Safeguards)
Core Principle 14 requires that SEFs (i) establish and maintain a
program of risk analysis and oversight to identify and minimize sources
of operational risk, through the development of
[[Page 62031]]
appropriate controls and procedures, and automated systems that are
reliable, secure, and have adequate scalable capacity; (ii) establish
and maintain emergency procedures, backup facilities, and a plan for
disaster recovery that allow for the timely recovery and resumption of
operations and the fulfillment of the SEFs' responsibilities and
obligations; and (iii) periodically conduct tests to verify that backup
resources are sufficient to ensure continued order processing and trade
matching, price reporting, market surveillance, and maintenance of a
comprehensive and accurate audit trail.\761\ The Commission promulgated
rules under Sec. 37.1401 to further implement those requirements.\762\
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\761\ 7 U.S.C. 7b-3(f)(14). The Commission codified Core
Principle 14 under Sec. 37.1400. 17 CFR 37.1400.
\762\ 17 CFR 37.1401.
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The Commission is not proposing any amendments to existing
Sec. Sec. 37.1401(a)-(b), (e)-(f), (g)-(i), or (k)-(m), other than
non-substantive changes to paragraph references that are based on the
changes described below.
A. Sec. 37.1401(c)
Section 37.1401(c) requires each SEF to maintain a business
continuity-disaster recovery plan and resources, emergency procedures,
and backup facilities sufficient to enable timely recovery, resumption
of its operations, and resumption of its ongoing fulfillment of its
responsibilities and obligations as a SEF following any disruption of
its operations.\763\ A SEF's business continuity-disaster recovery plan
and resources generally should enable resumption of trading and
clearing of swaps executed on or pursuant to the rules of the SEF
during the next business day following the disruption.
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\763\ 17 CFR 37.1401(c).
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As noted above, the Commission proposes to move the existing
requirement under Sec. 37.205(b)(4)--``Safe storage capability''--that
a SEF must protect audit trail data from unauthorized alteration,
accidental erasure, or other loss to a more appropriate provision under
proposed Sec. 37.1401(c).\764\ The Commission also proposes additional
non-substantive amendments to Sec. 37.1401(c). First, the Commission
proposes to eliminate the sentence that references ``critical financial
markets'' and Sec. 40.9, which do not exist.\765\ Second, the
Commission proposes to replace the reference to ``designated clearing
organization'' with ``derivatives clearing organization,'' which is the
appropriate term under the Commission's regulations. Finally, the
Commission proposes to eliminate the reference to swaps executed
``pursuant to the rules of'' a SEF, which conforms to the proposed
amendment to the ``block trade'' definition under Sec. 43.2, discussed
further below.\766\
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\764\ See supra Section VII.D.2.a.--Sec. 37.205(b)(1)--Original
Source Documents; Sec. 37.205(b)(2)--Transaction History Database;
Sec. 37.205(b)(3)--Electronic Analysis Capability.
\765\ The Commission further proposes to eliminate the reference
to ``critical financial market'' under Sec. 37.1401(d).
\766\ See infra Section XXII.--Part 43--Sec. 43.2--Definition
of ``Block Trade.''
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B. Sec. 37.1401(g)--Program of Risk Analysis and Oversight Technology
Questionnaire
Existing Exhibit V to Form SEF in Appendix A requires an applicant
for SEF registration to file an Operational Capability Technology
Questionnaire (``Questionnaire'') in order to demonstrate compliance
with Core Principle 14 and Sec. 37.1401.\767\ The current version of
the Questionnaire requests documents and information pertaining to the
following eight areas of an applicant's program of risk analysis and
oversight: (i) Organizational structure, system descriptions, facility
locations, and geographic distribution of staff and equipment; (ii)
risk analysis and oversight; (iii) system operations; (iv) systems
development methodology; (v) information security; (vi) physical
security and environmental controls; (vii) capacity planning and
testing; and (viii) business continuity and disaster recovery. The
current version of the Questionnaire is located on the Commission's
website.\768\
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\767\ 17 CFR part 37 app. A.
\768\ SEF Operational Capability Technology Questionnaire,
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@industryoversight/documents/file/seftechnologyquestionnaire.pdf.
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The Commission proposes a new provision under Sec. 37.1401(g) to
require each SEF to annually prepare and submit an up-to-date
Questionnaire to Commission staff not later than 90 calendar days after
the SEF's fiscal year-end.\769\ The Commission notes that where
information previously submitted on the Questionnaire remains current,
the annual update may note that fact, rather than fully describe the
same information again.
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\769\ The Commission notes that based on the proposed amendments
to Form SEF in Appendix A discussed above, Exhibit V would be re-
designated as Exhibit Q of Form SEF. The up-to-date questionnaire
would be called the ``Program of Risk Analysis and Oversight
Technology Questionnaire'' and would be located in Appendix A to
part 37. See supra note 169 and accompanying discussion. Based on
the proposed addition of subsection (g), the Commission proposes to
renumber the existing provisions under subsections (g)-(i) to
subsections (h)-(j), respectively. Based on the renumbering of these
provisions, the Commission also proposes conforming non-substantive
amendments to update applicable cross-references to these provisions
in proposed paragraphs (a)(3), (h)(5), (i)(1)-(i)(7), and subsection
(m).
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The updated version of the Questionnaire requests documents and
information in the following nine areas to assist the Commission in
assessing a SEF's compliance with the Act and Commission regulations:
(i) Organizational structure, system descriptions, facility locations,
and geographic distribution of staff and equipment, including
organizational charts and diagrams; (ii) enterprise risk management
program and governance, including information regarding the Board of
Directors, audits, and third-party providers; (iii) information
security, including storage of records, access controls, and
cybersecurity threat intelligence capabilities; (iv) business
continuity and disaster recovery plan and resources, including testing
and recovery time objectives; (v) capacity planning and testing; (vi)
system operations, including configuration management and event
management; (vii) systems development methodology, including quality
assurance; (viii) physical security and environmental controls; and
(ix) testing, including vulnerability, penetration, and controls
testing. While the majority of the updated Questionnaire is unchanged
from the current version, the Commission is making certain amendments,
including the addition of enterprise technology risk assessments, board
of director and committee information, third-party service provider
information, and cybersecurity threat intelligence capabilities to keep
up-to-date with the rapidly changing field of system safeguards and
cybersecurity.
The proposed annual update is designed to reduce overall
compliance-related burdens and enhance internal operational efficiency
for SEFs. First, the Commission would use the Questionnaire as the
basis for Systems Safeguards Examination (``SSE'') document requests.
The Commission believes that maintaining an updated Questionnaire would
limit SSE document requests and the effort required to respond to these
requests--a SEF would be able to provide updated information and
documents for sections of the Questionnaire that have changed since the
last annual filing.\770\ Second,
[[Page 62032]]
the Commission would use the Questionnaire to conduct required system
safeguards oversight and maintain a current profile of the SEF's
automated systems.\771\ Annual updates would reduce the need for
separate requests and the burden of responding to these requests.
Third, annual updates would assist a SEF's obligation to provide timely
advance notice of all material (i) planned changes to automated systems
that may impact the reliability, security, or adequate scalable
capacity of such systems; and (ii) planned changes to the SEF's program
of risk analysis and oversight.\772\ Fourth, annual updates, which a
SEF would submit concurrently with its annual compliance report, could
provide information and documents that are potentially useful in
preparing that report.\773\
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\770\ To the extent that still-current information and documents
were provided in the most recent update to the Questionnaire, a SEF
responding to an SSE document request would be able to reference
that fact, rather than resubmit such information and documents.
\771\ The Commission notes that proposed subsection (h)
(renumbered from existing subsection (g)) requires a SEF to provide
to the Commission system safeguards-related books and records,
including (i) current copies of its business continuity-disaster
recovery plans and other emergency procedures; (ii) all assessments
of its operational risks or system safeguards-related controls;
(iii) all reports concerning system safeguards testing and
assessment required by this chapter; and (iv) all other books and
records requested by Commission staff in connection with Commission
oversight of system safeguards or maintenance of a current profile
of the SEF's automated systems. Id.
\772\ 17 CFR 37.1401(f)(1)-(2).
\773\ The Commission is proposing under Sec. 37.1306(d) and
Sec. 37.1501(e)(2), respectively, to require a SEF to submit its
fourth quarter financial report and annual compliance report no
later than ninety days after the SEF's fiscal year end.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1401(g).
C. Sec. 37.1401(j)
Section 37.1401(j) specifies that for registered entities deemed by
the Commission to be ``critical financial markets,'' Sec. 40.9 sets
forth requirements for maintaining and dispersing disaster recovery
resources in a manner sufficient to meet a same-day recovery time
objective in the event of a wide-scale disruption. The Commission
proposes to eliminate this provision, given that the Commission has not
defined ``critical financial markets'' and such requirements do not
exist under Sec. 40.9.
XX. Part 37--Subpart P: Core Principle 15 (Designation of Chief
Compliance Officer)
Core Principle 15 requires each SEF to designate a CCO and sets
forth its corresponding duties.\774\ Among other responsibilities, a
CCO is required to ensure that the SEF complies with the CEA and
applicable rules and regulations, as well as establish and administer
required policies and procedures.\775\ Core Principle 15 also requires
the CCO to prepare and file an annual compliance report (``ACR'') to
the Commission.\776\ The Commission further promulgated requirements
under Sec. 37.1501 to implement these requirements.\777\ Based on its
experience during part 37 implementation, the Commission proposes
several amendments to Sec. 37.1501, in particular to streamline
requirements related to the composition of the ACR and provide more
useful information to the Commission.
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\774\ 7 U.S.C. 7b-3(f)(15). The Commission codified Core
Principle 15 under Sec. 37.1500. 17 CFR 37.1500.
\775\ 7 U.S.C. 7b-3(f)(15)(B)(iv)-(v).
\776\ 7 U.S.C. 7b-3(f)(15)(D).
\777\ 17 CFR 37.1501.
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A. Sec. 37.1501--Chief Compliance Officer
1. Sec. 37.1501(a)--Definitions
Core Principle 15 requires a CCO to report directly to the SEF's
``board [of directors]'' or the SEF's ``senior officer'' \778\ and
consult either the board or the senior officer to resolve conflicts of
interest.\779\ Section 37.1501(a) defines ``board of directors,'' \780\
but does not define ``senior officer.'' \781\ In the SEF Core
Principles Final Rule, the Commission noted that it would not adopt a
definition of ``senior officer,'' but noted that the statutory term
would only include the most senior executive officer of the legal
entity registered as a SEF.\782\
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\778\ 7 U.S.C. 7b-3(f)(15)(B)(i). The Commission also notes that
the CEA does not define ``senior officer.''
\779\ 7 U.S.C. 7b-3(f)(15)(B)(iii).
\780\ Section 37.1501(a) defines ``board of directors'' as the
board of directors of a SEF, or for those SEFs whose organizational
structure does not include a board of directors, a body performing a
function similar to a board of directors. 17 CFR 37.1501(a).
\781\ 17 CFR 37.1501(a).
\782\ SEF Core Principles Final Rule at 33544.
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The Commission proposes to define a ``senior officer'' under Sec.
37.1501(a) as the chief executive officer or other equivalent officer
of the SEF. Across the various organizational structures that SEFs have
established, the Commission has observed that a senior officer often
may be the appropriate individual to whom a CCO would report regarding
SEF activities. Therefore, this proposed definition would clarify the
permissible reporting lines for the CCO and would provide specificity
to the Commission's proposed amendments to the Core Principle 15
regulations, as described below. Among other things, the proposed
requirements would enable the senior officer to have greater oversight
responsibilities over the CCO consistent with Core Principle 15.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(a). In particular, the Commission requests comment on the
questions below.
(86) Is the Commission's proposed definition of ``senior officer''
sufficiently clear and complete? If not, then please provide an
explanation of those aspects of the definition that you believe are
insufficiently clear or inadequately addressed.
(87) Are there any officers that may meet the definition of
``senior officer,'' but pose a potential conflict of interest? If so,
identify such officers and the types of conflicts that may arise.
(88) Should the Commission add any other definitions to proposed
Sec. 37.1501(a)?
2. Sec. 37.1501(b)--Chief Compliance Officer \783\
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\783\ The Commission proposes to retitle Sec. 37.1501(b) to
``Chief compliance officer'' from ``Designation and qualifications
of chief compliance officer'' based on the proposed changes
described below.
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Sections 37.1501(b)-(c) set forth certain baseline requirements for
the SEF CCO position. Section 37.1501(b)--``Designation and
qualifications of chief compliance officer''-- requires a SEF to
designate an individual to serve as the CCO; requires the CCO to have
the authority and resources to help fulfill the SEF's statutory and
regulatory duties, including supervisory authority over compliance
staff; and establishes minimum qualifications for the designated
CCO.\784\ Section 37.1501(c)--``Appointment, supervision, and removal
of chief compliance officer''--establishes the respective authorities
of the SEF board of directors and senior officer to designate,
supervise, and remove the CCO; and requires the CCO to meet with the
SEF's board and regulatory oversight committee (``ROC'') on an annual
and quarterly basis, respectively, and provide them with information as
requested.\785\
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\784\ 17 CFR 37.1501(b).
\785\ 17 CFR 37.1501(c).
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The Commission proposes to amend, clarify, and eliminate various
existing requirements under Sec. Sec. 37.1501(b)-(c) and consolidate
the remaining provisions into Sec. 37.1501(b), as described below. The
Commission proposes to eliminate duplicative rules to Core Principle
15, including requirements that a SEF designate a
[[Page 62033]]
CCO \786\ and the CCO report directly to the board or the senior
officer.\787\ With respect to the CCO's obligations to a ROC, Core
Principle 15 does not require a SEF to establish a ROC and the
Commission has not finalized a rule that establishes requirements for a
ROC; therefore, the Commission proposes to eliminate the existing ROC-
related requirements from part 37.\788\
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\786\ The Commission proposes to eliminate this requirement
under existing paragraph (b)(1), which the Commission proposes to
retitle to ``Authority of chief compliance officer'' from ``Chief
compliance officer required.''
\787\ The Commission proposes to eliminate this requirement
under existing paragraph (c)(2).
\788\ These requirements include a mandatory quarterly meeting
with the ROC under existing subparagraph (c)(1)(iii); and the
requirement that the CCO provide self-regulatory program information
to the ROC under existing subparagraph (c)(1)(iv). Conflicts of
Interest Proposed Rule at 36741-42.
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Consistent with Core Principle 15, which requires the CCO to report
to the SEF's board or senior officer, the Commission also proposes
amendments to the consolidated requirement under Sec. 37.1501(b) to
allow the SEF's senior officer to have the same oversight
responsibilities over the CCO as the board. First, the Commission
proposes to allow a CCO to consult with the board of directors or
senior officer of the SEF as the CCO develops the SEF's policies and
procedures.\789\ Second, the Commission also proposes to allow a CCO to
meet with the senior officer of the SEF, in addition to the board of
directors, on an annual basis.\790\ Third, the Commission further
proposes to allow the CCO to provide self-regulatory program
information to the SEF's senior officer, in addition to the board of
directors.\791\
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\789\ The Commission proposes the amendment under proposed
subparagraph (b)(1)(i).
\790\ The Commission proposes to renumber existing subparagraph
(c)(1)(iii) to paragraph (b)(5), based on the proposed consolidation
of existing subsections (b)-(c), and amend the requirement as
described.
\791\ The Commission proposes to renumber existing subparagraph
(c)(1)(iv) to paragraph (b)(6), based on the proposed consolidation
of existing subsections (b)-(c), and amend the requirement as
described.
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The Commission further proposes to eliminate the limitations on
authority to remove a CCO, which currently restricts that removal
authority to a majority of the board, or in the absence of a board, a
senior officer.\792\ Instead, the Commission proposes a more simplified
requirement under proposed Sec. 37.1501(b) to establish that (i) the
board or the senior officer may appoint or remove the CCO; \793\ and
(ii) the SEF must notify the Commission within two business days of the
appointment or removal (on an interim or permanent basis) of the
CCO.\794\ Based on its experience, the Commission recognizes that in
many instances, the senior officer may be better positioned than the
board to provide day-to-day oversight of the SEF and the CCO, as well
as to determine whether to remove a CCO. Therefore, consistent with
Core Principle 15, the Commission believes that a SEF's senior officer
should have the same CCO oversight authority as the SEF's board of
directors. This proposed amendment is consistent with Core Principle
15, which does not mandate a voting percentage to approve or remove the
CCO. The Commission also believes that these proposed amendments would
not only allow a SEF to more appropriately designate, appoint,
supervise, and remove a CCO based on the SEF's particular corporate
structure, size, and complexity, but also continue to ensure a level of
independence for its CCO that is appropriate to comply with Core
Principle 15.
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\792\ The Commission proposes to eliminate this requirement
under existing paragraph (c)(3).
\793\ The Commission proposes to consolidate and amend the
requirements under existing subparagraph (c)(1)(i) in part, which
addresses the appointment of a CCO by the board or senior officer,
with existing subparagraph (c)(3)(i), which currently addresses the
removal of a CCO. Based on the proposed consolidation of existing
subsections (b)-(c), the Commission proposes to renumber this
consolidated provision to paragraph (b)(3) and retitle the
consolidated provision to ``Appointment and removal of chief
compliance officer.''
\794\ The Commission notes that notification to the Commission
of the appointment and removal of a CCO is currently required under
existing subparagraph (c)(1)(i) and existing subparagraph
(c)(3)(ii), respectively. Based on the proposed consolidation of
existing subsections (b)-(c), the Commission proposes to consolidate
and amend these notification requirements, and renumber the
consolidated requirement to subparagraph (b)(3)(i).
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Based on the proposed consolidation of existing Sec. Sec.
37.1501(b)-(c), the Commission also proposes several non-substantive
amendments to the remaining provisions under proposed Sec. 37.1501(b),
including the renumbering of certain existing provisions.\795\
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\795\ The Commission proposes to renumber the requirements under
existing paragraph (b)(2)--``Qualifications of chief compliance
officer''--to proposed subparagraphs (b)(2)(i)-(ii). The Commission
also proposes to retitle existing subparagraph (c)(1)(ii), which
specifies that the board or the senior officer must approve the
CCO's compensation, to ``Compensation of the chief compliance
officer.'' Based on the proposed consolidation of existing
subsections (b)-(c), the Commission is proposing to renumber this
requirement to paragraph (b)(4).
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a. Acceptable Practices to Core Principle 15 in Appendix B
The Commission proposes a new acceptable practice to Core Principle
15 in Appendix B associated with Sec. 37.1501(b)(2)(i), which requires
a CCO to have the background and skills appropriate to the
position.\796\ The proposed acceptable practice would provide a non-
exclusive list of factors that a SEF may consider when evaluating an
individual's qualifications to be a CCO and state that a SEF may make a
determination based on the totality of a person's qualifications. The
Commission believes that a non-exclusive list provides the clarity that
SEFs have sought as to a CCO's requisite qualifications, but still
allows a board and senior officer reasonable flexibility in appointing
a CCO.
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\796\ The Commission proposes to add this provision in paragraph
(b)(1) of the acceptable practices to Core Principle 15 in Appendix
B. 17 CFR part 37 app. B.
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The proposed acceptable practice also states that a SEF should be
especially vigilant regarding potential conflicts of interest when
appointing a CCO. The Commission notes that the preamble to the SEF
Core Principles Final Rule stated ``a conflict of interest may
compromise a CCO's ability to effectively fulfill his or her
responsibilities as a CCO . . . .'' \797\ The Commission continues to
believe that conflicts of interest could affect a CCO's ability to
effectively fulfill his or her responsibilities. Accordingly, a SEF
should be especially vigilant in this regard when appointing a CCO. The
Commission also continues to believe that a SEF should have policies
and procedures in place to handle instances where its CCO has conflicts
of interest.
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\797\ SEF Core Principles Final Rule at 33543-44.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(b) and the associated acceptable practices to Core Principle 15
in Appendix B.
3. Sec. 37.1501(c)--Duties of Chief Compliance Officer \798\
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\798\ The Commission proposes to renumber existing subsection
(d) to subsection (c).
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Section 37.1501(d)--``Duties of chief compliance officer''--
currently requires a CCO, at a minimum, to (i) oversee and review the
SEF's compliance with the Act and Commission regulations; \799\ (ii)
resolve any conflicts of interest that may arise, including in certain
enumerated circumstances; \800\ (iii) establish and administer written
policies and procedures reasonably designed to prevent violations of
the Act and
[[Page 62034]]
Commission regulations; \801\ (iv) take reasonable steps to ensure
compliance with the Act and Commission regulations; \802\ (v) establish
procedures for the remediation of noncompliance issues identified by
the CCO through certain specified protocols; \803\ (vi) establish and
follow appropriate procedures for the handling, management response,
remediation, retesting, and closing of noncompliance issues; \804\
(vii) establish and administer a compliance manual and a written code
of ethics; \805\ (viii) supervise a SEF's self-regulatory program;
\806\ and (ix) supervise the effectiveness and sufficiency of any
regulatory services provided to the SEF in accordance with Sec.
37.204.\807\
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\799\ 17 CFR 37.1501(d)(1).
\800\ 17 CFR 37.1501(d)(2). A CCO is specifically required to
address conflicts between (i) business considerations and compliance
requirements; (ii) business considerations and the requirement that
the SEF provide fair, open, and impartial access under Sec. 37.202;
and (iii) a SEF's management and board members. 17 CFR
37.1501(d)(2)(i)-(iii).
\801\ 17 CFR 37.1501(d)(3).
\802\ 17 CFR 37.1501(d)(4).
\803\ 17 CFR 37.1501(d)(5).
\804\ 17 CFR 37.1501(d)(6).
\805\ 17 CFR 37.1501(d)(7).
\806\ 17 CFR 37.1501(d)(8).
\807\ 17 CFR 37.1501(d)(9).
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The Commission proposes to adopt several substantive and non-
substantive amendments to clarify and streamline these duties. The
Commission proposes to consolidate certain existing provisions and
specify that the CCO may identify noncompliance matters through ``any
means,'' in addition to the currently prescribed means; and clarify
that the procedures followed to address noncompliance issues must be
``reasonably designed'' by the CCO to handle, respond, remediate,
retest, and resolve noncompliance issues identified by the CCO.\808\
These proposed amendments acknowledge that a CCO may not be able to
design procedures that detect all possible noncompliance issues and
reflect that a CCO may utilize a variety of resources to identify
noncompliance issues beyond a limited set of means.
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\808\ Existing paragraph (d)(5) requires a CCO to establish
procedures for remediation of noncompliance issues identified
through a compliance office review, look-back, internal or external
audit finding, self-reported error, or validated complaint. Existing
paragraph (d)(6) requires a CCO to establish and follow appropriate
procedures for the handling, management response, remediation,
retesting, and closing of non-compliance issues. The Commission
proposes to consolidate and amend these requirements and renumber
the consolidated requirement to paragraph (c)(5).
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The Commission also proposes to amend a CCO's duty to resolve
conflicts of interest.\809\ First, the Commission proposes to limit a
CCO's duty to address only ``material'' conflicts of interest. This
proposed amendment reflects the Commission's view that the current
requirement is overly broad and impractical because a CCO cannot
reasonably be expected to resolve every potential conflict of interest
that may arise. Consistent with this view, the Commission also proposes
to refine the scope of the CCO's duty to taking only ``reasonable
steps'' to resolve ``material'' conflicts of interest that may
arise.\810\ The Commission further proposes to eliminate the existing
enumerated conflicts of interest to avoid any inference that they are
an exhaustive list of conflicts that a CCO must address.\811\
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\809\ The Commission proposes to renumber existing paragraph
(d)(2), which addresses the CCO's duty to resolve conflicts of
interest, to paragraph (c)(2) and amend the requirement as
described.
\810\ The Commission also proposes to eliminate ``a body
performing a function similar to the board of directors'' under
proposed paragraph (c)(2) (existing paragraph (d)(2)), as this
phrase is already included in the definition of ``board of
directors'' under Sec. 37.1501(a).
\811\ These provisions are currently set forth under existing
subparagraphs (d)(2)(i)-(iii). See supra note 800.
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The Commission believes that these proposed amendments do not
weaken a CCO's statutory duty to address conflicts of interest, but
rather reflect the CCO's practical ability to detect and resolve
conflicts. Moreover, the proposed amendments reflect the Commission's
belief that a CCO should have discretion to determine the conflicts
that are material to his or her SEF's ability to comply with the Act
and the Commission's regulations. The Commission believes that these
proposed changes are consistent with Core Principle 15.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(c).
4. Sec. 37.1501(d)--Preparation of Annual Compliance Report \812\
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\812\ The Commission proposes to renumber existing subsection
(e) to subsection (d).
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Existing Sec. 37.1501(e)--``Preparation of annual compliance
report''--currently requires the CCO to annually prepare and sign an
ACR that, at a minimum (i) describes the SEF's written policies and
procedures, including the code of ethics and conflicts of interest
policies; \813\ (ii) reviews the SEF's compliance with the Act and
Commission regulations in conjunction with the SEF's policies and
procedures; \814\ (iii) provides a self-assessment of the effectiveness
of the SEF's policies and procedures, including areas of improvement
and related recommendations for the SEF's compliance program or
resources; \815\ (iv) lists material changes to the policies and
procedures; \816\ (v) describes the SEF's financial, managerial, and
operational resources, including compliance program staffing and
resources, a catalogue of investigations and disciplinary actions, and
a review of the disciplinary committee's performance; \817\ (vi)
describes any material compliance matters identified through certain
enumerated mechanisms, e.g., compliance office review or lookback, and
explains how they were resolved; \818\ and (vii) certifies that, to the
best of the CCO's knowledge and reasonable belief and under penalty of
law, the ACR report is accurate and complete.\819\
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\813\ 17 CFR 37.1501(e)(1).
\814\ 17 CFR 37.1501(e)(2)(i).
\815\ 17 CFR 37.1501(e)(2)(ii)-(iii).
\816\ 17 CFR 37.1501(e)(3).
\817\ 17 CFR 37.1501(e)(4).
\818\ 17 CFR 37.1501(e)(5).
\819\ 17 CFR 37.1501(e)(6).
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During part 37 implementation, the Commission has gained experience
and received feedback with respect to the ACR requirements. The
Commission notes that some of the required ACR content has provided the
Commission with minimal meaningful insight into a SEF's compliance
program. For example, some of the content is duplicative of information
obtained by the Commission from other reporting channels, such as the
system-related information that a SEF must file pursuant to Core
Principle 14 \820\ and rule certifications filed pursuant to part 40 of
the Commission's regulations.\821\ Various SEF CCOs have also provided
feedback that certain ACR content requires substantial time to prepare
and includes some information that does not change frequently.\822\
They have requested that the Commission simplify these requirements and
provide additional time to file the reports. The Commission also notes,
however, that many SEFs have not provided sufficient details that
describe and assess whether their respective policies and procedures
[[Page 62035]]
(e.g., rulebooks, compliance manuals, conflict of interest policies,
code of ethics, governance documentation, and third-party service
agreements) comply with the Act and Commission regulations.
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\820\ The Commission notes that proposed subsection (h)
(existing subsection (g)) requires a SEF to produce system
safeguards-related books and records that include current copies of
its business continuity-disaster recovery plans and emergency
procedures, assessments of its operational risks and controls, and
reports concerning system safeguards testing and assessments.
\821\ Among other information required to be submitted to the
Commission pursuant to part 40, a SEF is required to provide the
Commission with amendments to its rulebook and compliance manual.
\822\ See CFTC Letter No. 17-61, No-Action Relief for Swap
Execution Facilities from Compliance with the Timing Requirements of
Commission Regulation 37.1501(f)(2) Relating to Chief Compliance
Officer Annual Compliance Reports and Commission Regulation
37.1306(d) Relating to Fourth Quarter Financial Reports at 2-3 (Nov.
20, 2017) (``NAL No. 17-61'') (citing testimonials from SEFs that
the preparation of an ACR requires an extensive information
gathering process, including a review and documentation of
information gathered on an entity-wide basis).
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Based upon its experience in reviewing ACRs, the Commission is
proposing certain amendments that would eliminate duplicative or
unnecessary information requirements and streamline existing
requirements. These amendments would reduce unnecessary regulatory
burdens and compliance costs associated with certain aspects of ACRs.
The Commission is also proposing certain amendments to enhance the
usefulness of ACRs by enabling the Commission to assess the
effectiveness of a SEF's compliance and self-regulatory programs. The
proposed revisions represent a simplified approach that continues to
effectuate Core Principle 15.
The Commission proposes to refine the scope of some of the required
ACR content that it believes is otherwise duplicative, unnecessary, or
burdensome. Under the proposed approach, a SEF would no longer need to
include in its ACR either a review of all the Commission regulations
applicable to a SEF or an identification of the written policies and
procedures designed to ensure compliance with the Act and Commission
regulations.\823\ The Commission believes that instead requiring an ACR
to include a description and self-assessment of the effectiveness of
the SEF's written policies and procedures to ``reasonably ensure''
compliance with the Act and applicable Commission regulations is more
closely aligned with the corresponding provisions of Core Principle 15
and would still allow the Commission to properly assess the SEF's
compliance and self-regulatory programs.\824\ Similarly, the Commission
also proposes to eliminate a required discussion of the SEF's
compliance staffing and structure; a catalogue of investigations and
disciplinary actions taken over the last year; and a review of
disciplinary committee and panel performance.\825\ An ACR would
continue to be required to describe a SEF's financial, managerial, and
operational resources set aside for compliance, which the Commission
believes is sufficient information to assess a SEF's self-regulatory
program.\826\ By refining the scope of information required to be
included in the ACR, the Commission anticipates that a SEF will be to
devote its resources in providing more detailed, and ultimately better
quality, information that will better help assess its compliance.
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\823\ The Commission proposes to eliminate these requirements in
existing subparagraph (e)(2)(i) and the introductory language of
existing paragraph (e)(2).
\824\ As proposed, a SEF would continue to be required to
describe the SEF's written policies and procedures, consistent with
Core Principle 15. In addition to the required description, the
Commission proposes to consolidate and amend existing subparagraph
(e)(2)(ii), which requires a SEF to provide a self-assessment as to
the effectiveness of its policies and procedures in the ACR, with
existing paragraph (e)(1), and renumber the consolidated requirement
to paragraph (d)(1). Further, the Commission proposes to consolidate
and amend existing subparagraph (e)(2)(iii), which requires an ACR
to discuss areas for improvement and recommend potential or
prospective changes or improvements to a SEF's compliance program
and resources, with existing paragraph (e)(3) and renumber the
consolidated requirement to paragraph (d)(2). The Commission expects
that the CCO will provide more nuanced and in-depth discussions
through these consolidated provisions, rather than merely providing
generalized responses.
\825\ The Commission proposes to eliminate these requirements
under existing paragraph (e)(4).
\826\ The Commission proposes to renumber the remaining
requirements under existing paragraph (e)(4) to paragraph (d)(3) and
adopt minor non-substantive amendments.
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To facilitate the Commission's ability to assess a SEF's written
policies and procedures regarding compliance matters, the Commission
also proposes to require a SEF to discuss only material noncompliance
matters and explain the corresponding actions taken to resolve such
matters.\827\ The Commission believes that requiring SEFs to focus on
describing material non-compliance matters, rather than describing all
compliance matters in similar depth, will streamline this requirement
and provide more useful information to the Commission. Further, the
Commission proposes to eliminate the enumerated mechanisms for
identifying non-compliance issues, which conforms to the ability of a
CCO to establish procedures to address non-compliance issues through
``any means,'' as described above.\828\
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\827\ The Commission proposes to renumber this requirement under
existing paragraph (e)(5) to paragraph (d)(4) and adopt the
amendments as described above and other non-substantive amendments.
\828\ The Commission proposes to eliminate these enumerated
mechanisms under existing paragraph (e)(5).
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Consistent with these proposed amendments, the Commission also
proposes to limit a SEF CCO's certification of an ACR's accuracy and
completeness to ``all material respects'' of the report.\829\ The
Commission recognizes that CCOs have been hesitant to certify that an
entire ACR is accurate and complete under the penalty of the law,
without regard to whether a potential inaccuracy or omission would be a
material error or not. Therefore, the Commission believes this proposed
change will provide an appropriate balance between the SEF CCOs'
concerns of potential liability with the material accuracy of an ACR
submitted to the Commission.
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\829\ The Commission proposes to renumber existing paragraph
(e)(6) to paragraph (d)(5) and amend the requirement as described.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(d). In particular, the Commission requests comment to the
questions below.
(89) Are the proposed revisions to the required content for ACRs
appropriate? If not, then how should the Commission modify the required
content?
(90) Are there any unintended consequences to removing the specific
requirements regarding a description of a SEF's self-regulatory
program's staffing and structure, a catalogue of investigations and
disciplinary actions taken since the last ACR, and a review of the
performance of the disciplinary committees and panels?
(91) Is it appropriate to limit the discussion of non-compliance
matters to only those that are material in nature? If not, then why?
5. Sec. 37.1501(e)--Submission of Annual Compliance Report and Related
Matters \830\
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\830\ The Commission proposes to renumber existing subsection
(f) to subsection (e). The Commission also proposes to retitle
subsection (e) to ``Submission of annual compliance report and
related matters'' from ``Submission of annual compliance report''
based on the proposed changes described below.
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Existing Sec. 37.1501(f)(1) currently requires a CCO to provide an
ACR to the board or, in the absence of a board, the senior officer for
review.\831\ The board of directors and senior officer may not require
the CCO to change the ACR.\832\ The SEF's board minutes or a similar
written record must reflect the submission of the ACR to the board of
directors or senior officer and any subsequent discussion of the
report.\833\ Additionally, the SEF must concurrently file the ACR and
the fourth quarter financial statements with the Commission within 60
calendar days of the end of the SEF's fiscal year end.\834\ The CCO
must certify and promptly file an amended ACR with the Commission upon
the discovery of any material error or omission in the report.\835\ A
SEF may
[[Page 62036]]
request an extension to file the ACR with the Commission based on
substantial, undue hardship in filing the ACR on time.\836\
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\831\ 17 CFR 37.1501(f)(1).
\832\ Id.
\833\ Id.
\834\ 17 CFR 37.1501(f)(2).
\835\ 17 CFR 37.1501(f)(3).
\836\ 17 CFR 37.1501(f)(4).
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The Commission proposes several amendments to simplify the ACR
submission procedures. First, the Commission proposes to provide SEFs
with an additional thirty days to file the ACR with the Commission, but
no later than ninety calendar days after a SEF's fiscal year end.\837\
This proposed extension is consistent with the basis provided by
Commission staff in granting current no-action relief to SEFs that
provides an additional thirty days to prepare and file an ACR.\838\ In
particular, the Commission recognizes that in addition to the ACR, a
CCO has other reporting obligations, such as the fourth quarter
financial report required to be submitted under Core Principle 13 and
other year-end reports; SEFs have indicated that these multiple
reporting obligations present resource constraints on SEFs and their
CCOs.\839\ In addition to an extended deadline, the Commission proposes
to replace the ``substantial and undue hardship'' standard required for
filing ACR extensions with a ``reasonable and valid'' standard.\840\
Further, the Commission proposes to eliminate the requirement that each
SEF must document the submission of the ACR to the SEF's board of
directors or senior officer in board minutes or some other similar
written record; \841\ the Commission notes that the Core Principle 15
recordkeeping requirement under proposed Sec. 37.1501(f), as discussed
further below, would incorporate this requirement.\842\ The Commission
also proposes to require a CCO to submit an amended ACR to the SEF's
board of directors or, in the absence of a board of directors, the
senior officer of the SEF, for review prior to submitting the amended
ACR to the Commission; this approach is the same as the requirements
that exist for submitting an initial ACR.\843\
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\837\ The Commission proposes to renumber existing paragraph
(f)(2) to paragraph (e)(2) and amend the requirement as described.
The Commission also proposes to add a title to this paragraph--
``Submission of annual compliance report to the Commission.''
\838\ NAL No. 17-61 at 4.
\839\ Id. at 2-3.
\840\ The Commission proposes to renumber existing paragraph
(f)(4) to paragraph (e)(4) and amend the provision as described. The
Commission also proposes to add a title--``Request for extension.''
\841\ The Commission proposes to eliminate this requirement
under existing paragraph (f)(1).
\842\ The Commission notes that existing Sec. 37.1501(g) sets
forth recordkeeping requirements for SEFs related to the CCO's
duties. As discussed below, the Commission is proposing to amend
those requirements. See infra Section XX.A.6.--Sec. 37.1501(f)--
Recordkeeping.
\843\ The Commission proposes to renumber existing paragraph
(f)(3) to paragraph (e)(3) and add a title--``Amendments to annual
compliance report.'' The Commission proposes to adopt this
requirement under subparagraph (e)(3)(i). The Commission notes that
under proposed subparagraph (e)(3)(ii), an amended ACR would be
subject to the amended certification requirement, i.e., a CCO must
certify that the ACR is accurate and complete in all material
respects.
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In addition to the proposed amendments described above related to
submitting the ACR, the Commission proposes certain non-substantive
amendments to the remaining provisions under proposed Sec.
37.1501(e).\844\
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\844\ The Commission proposes to renumber existing paragraph
(f)(1) to paragraph (e)(1), adopt non-substantive amendments to the
existing language, and add a title--``Furnishing the annual
compliance report prior to submission to the Commission.''
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
37.1501(e).
6. Sec. 37.1501(f)--Recordkeeping \845\
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\845\ The Commission proposes to renumber existing subsection
(g) to subsection (f).
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Existing Section 37.1501(g)(1) currently requires a SEF to maintain
a copy of written policies and procedures adopted in furtherance of
compliance with the Act and the Commissions regulations; \846\ copies
of all materials created in furtherance of the CCO's duties under
existing Sec. Sec. 37.1501(d)(8)-(9); \847\ copies of all materials in
connection with the review and submission of the ACR; \848\ and any
records relevant to the ACR.\849\ Existing Sec. 37.1501(g)(2) requires
the SEF to maintain these records in accordance with Sec. 1.31 and
part 45 of the Commission's regulations.\850\
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\846\ 17 CFR 37.1501(g)(1)(i).
\847\ 17 CFR 37.1501(g)(1)(ii).
\848\ 17 CFR 37.1501(g)(1)(iii).
\849\ 17 CFR 37.1501(g)(1)(iv).
\850\ 17 CFR 37.1501(g)(2).
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The Commission proposes streamline the recordkeeping requirements
that pertain to the CCO's duties and the preparation and submission of
the ACR. Accordingly, the Commission proposes a revised general
requirement under proposed Sec. 37.1501(f) that would require the SEF
to keep all records demonstrating compliance with the duties of the CCO
and the preparation and submission of the ACR consistent with the
recordkeeping requirements under Sec. Sec. 37.1000-1001.
7. Sec. 37.1501(g)--Delegation of Authority \851\
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\851\ The Commission proposes to renumber existing subsection
(h) to subsection (g) based on the changes described above.
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Section 37.1501(h)--``Delegation of authority''--currently
delegates the authority to grant or deny a SEF's request for an
extension of time to file its ACR to the Director of DMO.\852\ In
addition to renumbering the provision based on the amendments described
above, the Commission proposes to adopt non-substantive amendments that
conform to the proposed amendments to the Core Principle 15 regulations
discussed above.
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\852\ 17 CFR 37.1501(h).
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XXI. Part 36--Trade Execution Requirement
The Commission is proposing regulations under part 36 to address
the broadened scope of swaps that will become subject to the trade
execution requirement based on the proposed interpretation of ``makes
the swap available to trade'' in CEA section 2(h)(8). In addition to an
implementing regulation, the Commission proposes several exemptions
from the requirement for certain types of swap transactions, as
discussed below. Further, the Commission proposes to require that SEFs
and DCMs file a standardized form with the Commission that details the
swaps that they respectively list for trading that are subject to the
requirement. The Commission also proposes a new provision to compel the
Commission to establish a centralized registry on its website that
reflects (i) the SEFs and DCMs that list swaps subject to the
requirement; and (ii) the particular swaps listed on each of those
entities. To transition trading of additional swaps onto SEFs or DCMs
pursuant to the requirement, the Commission additionally proposes a
revised compliance schedule.
A. Sec. 36.1--Trade Execution Requirement
1. Sec. 36.1(a)--Trade Execution Requirement
The Commission proposes Sec. 36.1(a) to codify the statutory
language of the trade execution requirement, which requires
counterparties to execute a swap that is subject to the clearing
requirement on a DCM, a SEF or an exempt SEF unless no such entity
``makes the swap available to trade'' or the swap is subject to a
clearing exception in CEA section 2(h)(7).\853\ The
[[Page 62037]]
Commission believes that the statutory phrase ``makes the swap
available to trade'' specifies the listing of a swap by a DCM, a SEF,
or an exempt SEF on its facility for trading.\854\ Accordingly, Sec.
36.1(a) would specify that counterparties must execute a transaction
subject to the clearing requirement on a DCM, a SEF, or an Exempt SEF
that lists the swap for trading.\855\
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\853\ 7 U.S.C. 2(h)(8)(B). The Commission interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g). See supra note 10. See also supra Section IV.I.4.a.--
Sec. 36.1(a)--Trade Execution Requirement.
\854\ See supra Section IV.I.4.a.--Sec. 36.1(a)--Trade
Execution Requirement. As discussed below, the Commission is
proposing an exemption from the requirement for swap transactions
involving swaps that are listed for trading only by an Exempt SEF.
See infra Section XXI.A.2.--Sec. 36.1(b)--Exemption For Certain
Swaps Listed Only By Exempt SEFs.
\855\ See supra Section IV.I.4.a.--Sec. 36.1(a)--Trade
Execution Requirement.
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The Commission also proposes to exempt certain types of swap
transactions from the trade execution requirement pursuant to its
exemptive authority in CEA section 4(c). For the purposes of promoting
responsible economic or financial innovation and fair competition, CEA
section 4(c)(1) provides the Commission with the authority to exempt
any agreement, contract, or transaction from any CEA provision, subject
to specified factors.\856\ CEA section 4(c)(2) prohibits the Commission
from providing an exemption from any requirements in CEA section
4(c)(1), unless the Commission determines that (i) the requirement
should not be applied to the agreement, contract, or transaction for
which the exemption is sought; (ii) the exemption would be consistent
with the public interest and the purposes of the Act; (iii) the
agreement, contract, or transaction at issue will be entered into
solely between appropriate persons; \857\ and (iv) the agreement,
contract, or transaction at issue will not have a material adverse
effect on the ability of the Commission or exchange to discharge its
regulatory or self-regulatory duties under the Act.\858\
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\856\ 7 U.S.C. 6(c)(1). CEA section 4(c)(1) is intended to allow
the Commission to ``provid[e] certainty and stability to existing
and emerging markets so that financial innovation and market
development can proceed in an effective and competitive manner.''
House Conf. Report No. 102-978, 102d Cong. 2d Sess. at 81 (Oct. 2,
1992), reprinted in 1992 U.S.C.C.A.N. 3179, 3213.
\857\ 7 U.S.C. 6(c)(3). CEA section 4(c)(3) includes a number of
specified categories of persons within ``appropriate persons'' that
are deemed as appropriate to enter into swaps exempted pursuant to
CEA section 4(c). This includes persons the Commission determines to
be appropriate in light of their financial profile or other
qualifications, or the applicability of appropriate regulatory
protections. For purposes of considering the CEA section 4(c)
exemptions within this proposal, the Commission believes that ECPs
would qualify as ``appropriate persons.''
\858\ 7 U.S.C. 6(c)(2). Notwithstanding the adoption of
exemptions from the Act, the Commission emphasizes that their use is
subject to the Commission's antifraud and anti-manipulation
enforcement authority. In this connection, Sec. 50.10(a) prohibits
any person from knowingly or recklessly evading or participating in,
or facilitating, an evasion of CEA section 2(h) or any Commission
rule or regulation adopted thereunder. 17 CFR 50.10(a). Further,
Sec. 50.10(c) prohibits any person from abusing any exemption or
exception to CEA section 2(h), including any associated exemption or
exception provided by rule, regulation, or order. 17 CFR 50.10(c).
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As discussed below, the Commission specifically proposes exemptions
from the trade execution requirement for the following transactions
that would otherwise be subject to that requirement: (i) Swap
transactions involving swaps that are listed for trading only by an
Exempt SEF; (ii) swap transactions for which the clearing exceptions in
CEA section 2(h)(7) or the clearing exceptions or exemptions under part
50 apply; (iii) swap transactions that are executed as a component of a
package transaction that includes a component that is a new issuance
bond; and (iv) swap transactions between ``eligible affiliate
counterparties'' (``inter-affiliate counterparties'') that elect to
clear such transactions, notwithstanding their ability to elect the
relevant clearing exemption under Sec. 50.52.
2. Sec. 36.1(b)--Exemption For Certain Swaps Listed Only By Exempt
SEFs
The Commission proposes Sec. 36.1(b) to establish an exemption
from the trade execution requirement that may be elected by
counterparties to a swap that is subject to the trade execution
requirement, but is listed for trading only by Exempt SEFs.\859\ The
Commission believes that exempting these types of transactions from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c).
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\859\ The Commission notes, however, that once a swap subject to
the clearing requirement is listed by a SEF or a DCM, then
counterparties may not use this exemption and would be required to
comply with the trade execution requirement.
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As noted above, CEA section 2(h)(8)(A) provides that counterparties
to transactions involving a swap subject to the clearing requirement
must execute the transaction on a DCM designated under CEA section 5, a
SEF registered under CEA section 5h or a SEF that is exempt from
registration under CEA 5h(g).\860\ CEA section 2(h)(8)(B), however,
specifies that this requirement does not apply if no DCM or swap
execution facility makes the swap available to trade (emphasis
added).\861\ The Commission interprets the phrase ``swap execution
facility'' in CEA section 2(h)(8)(B) to include both registered SEFs
and SEFs that are exempt from registration pursuant to section 5h(g),
given the references in section 2(h)(8)(A) and the applicability of
section 5h to both types of entities.\862\ Therefore, under the
Commission's proposed interpretation of ``makes the swap available to
trade,'' either a registered SEF or an Exempt SEF that lists a swap
subject to the clearing requirement for trading can make the swap
``available to trade,'' thereby triggering the trade execution
requirement for that swap.
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\860\ 7 U.S.C. 2(h)(8)(A).
\861\ 7 U.S.C. 2(h)(8)(B).
\862\ See supra note 10.
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While the Commission interprets CEA section 2(h)(8) to mean that
the listing of a swap by an Exempt SEF would trigger the trade
execution requirement, the Commission believes that it would be
appropriate to exempt such listings from the requirement, given that
the Commission does not oversee the listing of swaps by Exempt SEFs. To
list new contracts SEFs submit their products for Commission review
pursuant to the part 40 filing requirements.\863\ The Commission
reviews a new swap contract to ensure that it is consistent with the
CEA and applicable Commission regulations, including the requirement
that the contract not be susceptible to manipulation. Upon listing, a
SEF, under Commission oversight, remains responsible for ensuring that
the contract continues to comport with the CEA and applicable
Commission regulations. In contrast, the Commission does not have
oversight authority with respect to the listing of new contracts by
Exempt SEFs.
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\863\ 17 CFR 40.2-3.
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The Commission believes that exempting swaps subject to the
clearing requirement that are listed exclusively by Exempt SEFs should
have little practical impact on the number of products that become
subject to the trade execution requirement. Given the internationally
competitive nature of the swaps industry, the Commission believes that
SEFs and DCMs will likely list many of the same swaps listed by Exempt
SEFs. The Commission also emphasizes that once the trade execution
requirement is triggered for a particular swap by a SEF or DCM that
lists the swap, the requirement may be satisfied by executing the swap
on not only a SEF or DCM, but also on an Exempt SEF as well.
[[Page 62038]]
a. Discussion of CEA Section 4(c) Enumerated Factors
For the reasons stated above, the Commission believes that
exempting a swap subject to the clearing requirement that is listed for
trading only on an Exempt SEF from triggering the trade execution
requirement would be consistent with the objectives of CEA section
4(c).
Given that the number of swaps that are subject to the clearing
requirement and only listed by Exempt SEFs is likely small, the
Commission believes that the proposed exemption is appropriate and
would be consistent with the public interest and purposes of the CEA.
The Commission believes that the proposed regulation would not have a
material adverse effect on the ability of the Commission or any SEF or
DCM to discharge its regulatory or self-regulatory duties under the
Act. The Commission notes that under the proposed exemption, swap
agreements, contracts, and transactions would still be entered into
solely between ECPs,\864\ who the Commission believes, for purposes of
this proposal, to be appropriate persons.
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\864\ As noted above, pursuant to CEA section 2(e), it is
unlawful for any U.S. person other than an ECP, as defined in CEA
section 1a(18), to enter into a swap unless the swap is entered into
on, or subject to the rules of, a DCM. 7 U.S.C. 2(e).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.1(b), including whether the proposed exemptive relief is consistent
with the public interest and the other requirements of CEA section
4(c). In particular, the Commission requests comment on the following
question:
(92) Pursuant to its authority in CEA section 4(c), should the
Commission exempt swaps that are subject to the clearing requirement
and listed for trading only by an Exempt SEF from the trade execution
requirement, until such swaps are listed by a SEF or DCM?
3. Sec. 36.1(c)--Exemption for Swap Transactions Excepted or Exempted
From the Clearing Requirement Under Part 50
The Commission proposes Sec. 36.1(c) to establish an exemption to
the trade execution requirement for swap transactions for which an
exception or exemption has been elected pursuant to part 50. The
proposed exemption would apply to any transaction for which (i) a
clearing exception under Sec. 50.50 or a clearing exemption under
Sec. 50.51 or Sec. 50.52 has been elected; or (ii) a future exemption
that has been adopted by the Commission under part 50 would apply. The
Commission has determined that exempting these types of transactions
from the trade execution requirement would be consistent with the
objectives of CEA section 4(c).
The Act and the Commission's regulations specify that certain
transactions that are not subject to the clearing requirement are not
subject to the trade execution requirement. CEA section 2(h)(8) clearly
establishes that transactions that are not subject to the clearing
requirement pursuant to a clearing exception in CEA section 2(h)(7) are
not subject to the trade execution requirement.\865\ CEA section
2(h)(7), i.e., the end-user exception, provides a clearing exception to
a swap transaction if one of the counterparties (i) is not a financial
entity; (ii) is using the swap to hedge or mitigate commercial risk;
and (iii) notifies the Commission about how it generally meets its
financial obligations associated with entering into uncleared
swaps.\866\ The Commission adopted requirements under Sec. 50.50 to
implement this exception.\867\
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\865\ 7 U.S.C. 2(h)(8)(B).
\866\ 7 U.S.C. 2(h)(7).
\867\ 7 U.S.C. 2(h)(7). Among other things, Sec. 50.50
establishes when a swap transaction is considered to hedge or
mitigate commercial risk; specifies how to satisfy the reporting
requirement; and exempts small financial institutions from the
definition of ``financial entity.'' 17 CFR 50.50.
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In contrast to swaps that are eligible for the end-user exception,
however, swaps that are not subject to the clearing requirement based
on other statutory authority are currently not expressly exempted from
the trade execution requirement. Pursuant to its exemptive authority in
CEA section 4(c), the Commission has provided additional exemptions
from the clearing requirement for swaps between certain types of
entities, as well as for certain types of swap transactions. Section
50.51 allows certain cooperatives--those that otherwise consist
entirely of entities that would qualify for the end-user exception--to
elect a clearing exemption for swaps executed with a member of an
exempt cooperative.\868\ Section 50.52 allows inter-affiliate
counterparties who have ``eligible affiliate counterparty status'' to
elect a clearing exemption for swaps that are entered into between the
affiliated parties.\869\ The Commission notes that it has also
proposed, pursuant to CEA section 4(c), to exempt transactions by
eligible bank holding companies, savings and loan holding companies,
and community development financial institutions from the clearing
requirement.\870\
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\868\ 17 CFR 50.51. The exemption applies to swaps that are
executed in connection with originating a loan or loans for the
member of the cooperative, or hedging or mitigating commercial risk
related to member loans or arising from swaps related to originating
loans for members. 17 CFR 50.51(b)(1)-(2).
\869\ 17 CFR 50.52. Counterparties have ``eligible affiliate
counterparty status'' if one counterparty, directly or indirectly,
holds a majority ownership interest in the other counterparty; or a
third party, directly or indirectly, holds a majority ownership
interest in both counterparties. 17 CFR 50.52(a)(1)(i)-(ii). To
elect the exemption, such counterparties must also meet additional
conditions, including reporting requirements. 17 CFR 50.52(b)-(c).
\870\ Amendments to Clearing Exemption for Swaps Entered Into by
Certain Bank Holding Companies, Savings and Loan Holding Companies,
and Community Development Financial Institutions, 83 FR 44001
(proposed Aug. 29, 2018).
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The Commission believes that applying the trade execution
requirement to swaps that are eligible for a clearing exception or
clearing exemption potentially mitigates the benefits that are
associated with that exception or exemption. For example, a
counterparty that determines not to clear a swap pursuant to a clearing
exemption, but otherwise remains subject to the trade execution
requirement, would be limited in where it may trade or execute that
swap and may incur additional costs related to SEF onboarding.
Therefore, in order to fully preserve the benefits of a clearing
exception or clearing exemption, the Commission believes swaps that are
excepted or exempted from the clearing requirement should not be
subject to the trade execution requirement.
a. Discussion of CEA Section 4(c) Enumerated Factors
For the reasons stated above, the Commission believes that
exempting a swap transaction, for which a clearing exception or
clearing exemption have been elected pursuant to part 50, from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c).
Given that the scope of this proposed exemption is limited and
applies to transactions that are already excepted or exempted from the
clearing requirement, the Commission believes that the proposed
regulation would not have a material adverse effect on the ability of
the Commission or any SEF or DCM to discharge its regulatory or self-
regulatory responsibilities under the CEA and the Commission's
regulations. The Commission believes that under the proposed exemption,
swap transactions would still be entered into solely between ECPs, who
the Commission believes, for purposes of this proposal, to be
appropriate persons.\871\
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\871\ See supra note 857 (discussing the scope of ``appropriate
persons'').
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[[Page 62039]]
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.1(c), including whether the proposed exemptive relief is consistent
with the public interest and the other requirements of CEA section
4(c). In particular, the Commission requests comment on the following
question:
(93) Pursuant to its authority in CEA section 4(c), should the
Commission exempt swap transactions that are subject to a clearing
exception or clearing exemption under part 50 from the trade execution
requirement?
4. Sec. 36.1(d)--Exemption for Swaps Executed With Bond Issuance
The Commission proposes Sec. 36.1(d) to establish an exemption to
the trade execution requirement for swap transactions that are
components of a ``New Issuance Bond'' package transaction. The
Commission believes that exempting these types of transactions from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c). This proposed approach is consistent with the time-
limited no-action relief provided by Commission staff for this category
of package transactions.\872\
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\872\ See supra note 334 (describing the no-action relief from
the trade execution requirement provided by Commission staff for
categories of package transactions).
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New Issuance Bond package transactions include at least one
individual swap component that is subject to the trade execution
requirement and at least one individual component that is a bond \873\
issued and sold in the primary market.\874\ An underwriter (on behalf
of an issuer) arranges the issuance of a bond packaged with a fixed-to-
floating IRS that features the issuer as a counterparty. The terms of
the IRS, which include tenor and payment terms, typically match the
terms of the bond issuance. By issuing a bond with a fixed-to-floating
IRS, issuers are able to effectively turn fixed-rate liabilities into
variable rate liabilities, or vice versa.\875\ To correspond the terms
between these two components and facilitate the bond issuance in an
efficient and cost-effective manner, the IRS component is customized
and negotiated in a manner that closely corresponds to the bond
issuance process.
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\873\ The Commission notes that this proposed exemption would
not apply to swap components of package transactions that include
sovereign debt, such as U.S. Treasury bonds, notes, and bills.
\874\ The Commission understands that a bond issued and sold in
the primary market that may constitute part of a package transaction
is a ``security,'' as defined in section 2(a)(1) of the Securities
Act of 1933 or section 3(a)(10) of the Securities Exchange Act of
1934. To the extent that counterparties may be facilitating package
transactions that involve a security, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
\875\ For example, a bond issuer seeks to pay variable rates on
its bonds, but prospective investors may seek a fixed rate of
return. By arranging a New Issuance Bond package transaction, the
bond issuer can issue a fixed-rate bond and simultaneously enter
into an offsetting IRS. The IRS enables the issuer to receive a
fixed rate that matches the fixed rate on its bond to be issued,
while paying the variable rate that it originally sought.
Ultimately, this arrangement may allow the bond issuer to issue the
fixed-rate bond at a lower cost.
---------------------------------------------------------------------------
Given the role of the issuer in the package transaction--both as
issuer of the bond and a counterparty to the swap--and the process
under which the swap is negotiated,\876\ this type of package
transaction has not been conducive to execution on a SEF trading system
or platform. The Commission notes that the no-action relief that has
been provided by Commission staff for these swaps components reflects
the ongoing lack of an available execution method on an appropriate
venue.\877\ Based on the integral role of the bond issuance in
facilitating the component swap execution, the Commission believes that
the IRS component is not suitable for execution on a SEF, even where a
SEF may offer flexible means of execution.
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\876\ The Commission notes that these types of package
transactions differ from other package transactions that involve the
purchase or sale of a security in the secondary market, given that
they involve the issuance of a new security.
\877\ NAL No. 17-55 at 2-3.
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Therefore, consistent with current no-action relief provided by
Commission staff, the Commission proposes to exempt swap components of
a New Bond Issuance package transaction from the trade execution
requirement. The proposed exemption would establish that a ``package
transaction'' consists of two or more component transactions executed
between two or more counterparties, where (i) execution of each
component transaction is contingent upon the execution of all other
components transactions; and (ii) the component transactions are priced
or quoted together as one economic transaction with simultaneous or
near simultaneous execution of all components. The Commission
recognizes the inherent challenges in trading or executing these swap
components on a SEF or DCM and, therefore, recognizes the benefits of
continuing to allow market participants to maintain established market
practices with respect to this type of package transaction.
a. Discussion of CEA Section 4(c) Enumerated Factors
The Commission believes that exempting swap components of New
Issuance Bond package transactions from the trade execution requirement
would be consistent with the objectives of CEA section 4(c).
The Commission recognizes the importance of new bond issuances in
helping market participants to raise capital and fund origination loans
for businesses and homeowners. Accordingly, the Commission recognizes
that allowing the swap components of New Bond Issuance package
transaction to be executed away from a SEF or DCM--consistent with
current market practice--is integral to facilitating the bond issuance.
Further, the Commission recognizes that the proposed exemption is
limited in nature, i.e., the swap transaction remains subject to all
other applicable Commission rules and regulations.
The Commission believes, therefore, that the proposed exemption
from the trade execution requirement for swap components of New
Issuance Bond package transactions is appropriate and would be
consistent with the public interest and purposes of the CEA. The
Commission further believes that the proposed regulation would not have
a material adverse effect on the ability of the Commission or any SEF
or DCM to discharge its regulatory or self-regulatory duties under the
CEA. The Commission notes that under the proposed exemption, swap
transactions would still be entered into solely between ECPs, who the
Commission believes, for purposes of this proposal, to be appropriate
persons.
Request for Comment
The Commission requests comment on all aspects of the proposed
exemption of swap components of New Issuance Bond package transactions
from the trade execution requirement under proposed Sec. 36.1(d),
including whether the proposed exemptive relief is consistent with the
public interest and the other requirements of CEA section 4(c). The
Commission specifically requests comment on the following questions:
(94) Pursuant to its authority in CEA section 4(c), should the
Commission exempt the swap components of a New Issuance Bond package
transaction from the trade execution requirement?
(95) Is the proposed definition of ``package transaction'' in
proposed Sec. 36.1(d)(1) appropriate?
[[Page 62040]]
(96) Are there additional package transactions that should be
exempt from the trade execution requirement? If so, then please
describe in detail why such package transactions should be exempt from
the trade execution requirement, especially in light of the flexible
means of execution the Commission is proposing to allow for all swaps
listed by a SEF.
5. Sec. 36.1(e)--Exemption for Swaps Executed Between Affiliates That
Elect To Clear
The Commission proposes Sec. 36.1(e) to establish an exemption
from the trade execution requirement that may be elected by inter-
affiliate counterparties to a swap that is submitted for clearing.
Counterparties would be eligible to elect the exemption by meeting the
conditions set forth under Sec. 50.52(a) for ``eligible affiliate
counterparty'' status.\878\ The Commission notes that this proposed
exemption would apply to transactions that inter-affiliate
counterparties elect to clear, notwithstanding their ability to elect
the clearing exemption.
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\878\ See supra note 869 (describing requirements for meeting
``eligible affiliate counterparty'' status).
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Based on time-limited no-action relief granted by Commission staff,
inter-affiliate counterparties that do not elect the Sec. 50.52
clearing exemption are executing swaps away from a SEF or DCM that are
otherwise subject to the trade execution requirement.\879\ The relief
has been granted to address the difficulty cited by market participants
in executing inter-affiliate swap transactions through the required
methods of execution prescribed for swaps subject to the trade
execution requirement under Sec. 37.9, i.e., Order Book and RFQ
System. In particular, executing these transactions via competitive
means of execution would be difficult because inter-affiliate swaps are
generally not intended to be executed on an arm's-length basis or based
on fully competitive pricing.\880\ Rather, such swaps are used as tools
to manage risk between affiliates and are carried out through internal
accounting processes.\881\ Market participants have asserted that
forcing these transactions to be executed through a SEF would impose
unnecessary costs and inefficiencies without any related benefits.\882\
The Commission believes that requiring these types of transactions to
be executed on a SEF would likely confer less benefit to the overall
swaps markets and inhibit inter-affiliate counterparties from
efficiently executing these types of transactions for operational
purposes.
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\879\ CFTC Letter No. 17-67, Re: Extension of No-Action Relief
from Commodity Exchange Act Section 2(h)(8) for Swaps Executed
Between Certain Affiliated Entities that Are Not Exempt from
Clearing Under Commission Regulation 50.52 (Dec. 14, 2017) (``NAL
No. 17-67''); CFTC Letter No. 16-80, Re: Extension of No-Action
Relief from Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities that Are Not Exempt
from Clearing Under Commission Regulation 50.52 (Nov. 28, 2016);
CFTC Letter No. 15-62, Re: Extension of No-Action Relief from
Commodity Exchange Act Section 2(h)(8) for Swaps Executed Between
Certain Affiliated Entities that Are Not Exempt from Clearing Under
Commission Regulation 50.52 (Nov. 17, 2015); CFTC Letter No. 14-136,
Re: Extension of No-Action Relief from Commodity Exchange Act
Section 2(h)(8) for Swaps Executed Between Certain Affiliated
Entities that Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Nov. 7, 2014); CFTC Letter No. 14-26, Time-Limited
No-Action Relief from the Commodity Exchange Act Section 2(h)(8) for
Swaps Executed Between Certain Affiliated Entities Not Electing
Commission Regulation Sec. 50.52 (Mar. 6, 2014). As discussed
above, the Commission previously stated that transactions subject to
the inter-affiliate exemption from clearing would also be exempt
from the trade execution requirement. See supra Section XXI.A.3.--
Sec. 36.1(c)--Exemption for Swap Transactions Excepted or Exempted
from the Clearing Requirement under Part 50.
\880\ See NAL No. 17-67 at 2.
\881\ In the 2013 Inter-Affiliate Final Rule, commenters
explained that corporate groups can use a single conduit in the
market on behalf of multiple affiliates within the group, which
permits the corporate group to net affiliates' trades. This netting
effectively reduces the overall risk of the corporate group and the
number of open positions with external market participants, which in
turn reduces operational, market, counterparty credit, and
settlement risk. Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21750, 21753-54 (Apr. 11, 2013).
\882\ NAL No. 17-67 at 2.
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a. Discussion of CEA Section 4(c) Enumerated Factors
The Commission believes that exempting a swap executed between
inter-affiliate counterparties that is submitted for clearing from the
trade execution requirement would be consistent with the objectives of
CEA section 4(c).
As noted above, these transactions are not intended to be arm's-
length, market-facing, or competitively executed under any
circumstance, irrespective of the type of swap involved. Therefore, the
nature of these transactions mitigates the potential benefits of their
execution on a SEF or a DCM. The Commission believes this proposed
exemption would ensure that inter-affiliate counterparties would be
able to efficiently utilize the risk management approach that best
suits their individual needs, such as clearing inter-affiliate swaps,
without being unduly influenced by whether that choice would require
them to execute swaps on a SEF. Notably, the Commission's proposed
rules would allow SEFs to provide more flexible means of execution and,
thus, could address some of the issues currently cited with respect to
executing inter-affiliate transactions on a SEF. Nevertheless, the
Commission believes that the policy justifications described above
support an exemption for such inter-affiliate swap transactions from
the trade execution requirement.
The Commission believes, therefore, that the proposed exemption
from the trade execution requirement for inter-affiliate counterparties
is appropriate, and it would be consistent with the public interest and
purposes of the CEA. Given the limited applicability of this proposed
exemption to transactions only executed between inter-affiliates, the
Commission believes that the proposed regulation would not have a
material adverse effect on the ability of the Commission or any SEF or
DCM to discharge its regulatory or self-regulatory duties under the
CEA. Finally, the Commission notes that under the proposed exemption,
swap transactions would still be entered into solely between ECPs, who
the Commission believes, for purposes of this proposal, to be
appropriate persons.\883\
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\883\ See supra note 857 (discussing the scope of ``appropriate
persons'').
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.1(e), including whether the proposed exemptive relief is consistent
with the public interest and the other requirements of CEA section
4(c). In particular, the Commission requests comment on the following
questions:
(97) Pursuant to its authority in CEA section 4(c), should the
Commission exempt transactions between inter-affiliate counterparties
who do not elect the inter-affiliate clearing exemption from the trade
execution requirement?
(98) Should the Commission also consider exempting end-users that
meet the criteria for a clearing exception in CEA section 2(h)(7) from
the trade execution requirement regardless of whether they elect to use
the end-user clearing exception?
B. Sec. 36.2--Registry of Registered Entities Listing Swaps Subject to
the Trade Execution Requirement; Appendix A to Part 36--Form TER
The Commission currently provides information on its website
regarding the swaps that are subject to the trade execution
requirement. In addition to providing a chart that identifies those
swaps,\884\ the Commission also posts the
[[Page 62041]]
corresponding MAT determinations submitted pursuant to part 40's rule
filing procedures.\885\ While this approach has been effective in
informing market participants about the limited number of swaps
currently subject to the trade execution requirement, the Commission
expects that the number of swaps that would be subject to the
requirement will increase. To ensure that market participants have
notice of the swaps that are subject to the trade execution requirement
and the venues listing those swaps, the Commission proposes to create a
registry under Sec. 36.2(a) that will set forth the swaps that are
subject to the trade execution requirement, and the SEFs and DCMs that
list such swaps.\886\
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\884\ CFTC, Industry Filings--Swaps Made Available to Trade,
available at https://www.cftc.gov/idc/groups/public/@otherif/documents/file/swapsmadeavailablechart.pdf.
\885\ CFTC, Industry Filings--Swaps Made Available to Trade
Determination, available at https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination.
\886\ The Commission notes that the proposed registry would not
include information regarding the swaps subject to the trade
execution requirement that are listed by Exempt SEFs. The
Commission, however, anticipates that it will provide a list of the
Exempt SEFs on which market participants may execute those swaps,
subject to their availability on those facilities.
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To help the Commission publish and maintain such a registry, the
Commission also proposes a requirement under Sec. 36.2(b) and Appendix
A to part 36 that SEFs and DCMs submit a standardized Form TER. Form
TER would detail the swaps that they list that are subject to or
subsequently become subject to the clearing requirement. The Commission
further proposes to require that a SEF or DCM submit a Form TER
concurrently with any Sec. 40.2 or Sec. 40.3 product filing that
consists of a swap that is subject to the clearing requirement. In
addition, the Commission proposes that SEFs and DCMs file a Form TER,
for any swaps they currently list that are subject to the clearing
requirement, ten business days prior to the effective date of any final
rule adopted from this notice. To effectuate this proposed change
initially, the Commission is proposing that the effective date for
proposed Sec. 36.2 occur twenty days prior to effective date for the
rest of this proposed rule. The Commission believes that this earlier
effective period would provide SEFs and DCMs sufficient time to file
their initial Form TERs and give Commission staff sufficient time to
review and process these initial Form TERs. Finally, for swaps that are
listed by a SEF or DCM that subsequently become subject to the clearing
requirement, the Commission proposes to require that SEFs and DCMs file
Form TER ten business days prior to the effective date of that
requirement for such swaps. By requiring SEFs and DCMs to file Form TER
prior to the effective date of such requirements, Commission staff
would have sufficient time to review, compile Form TERs, and publish
its trade execution requirement registry on its website.
Form TER in Appendix A to part 36 would require a SEFs or DCM to
provide the specific relevant economic terms of the swaps that it lists
for trading. Each SEF or DCM that lists a swap that is subject to or
becomes subject to the clearing requirement would be required to file
an initial Form TER that details all such listed swaps. Any subsequent
changes to a SEF's or DCM's listing of such swaps, such as additional
listed swaps that later become subject to the clearing requirement,
would require the SEF or DCM to amend its Form TER to reflect that
scope. For IRS listed for trading, Form TER would require a SEF or DCM
to specify (i) product class/specification; (ii) currency; (iii)
floating rate index; (iv) stated termination date; (v) optionality;
(vi) dual currencies; and (vii) conditional notional amounts. For CDS
listed for trading, Form TER would require a SEF or DCM to specify (i)
product class/specification; (ii) reference entities; (iii) region;
(iv) indices; (v) tenor; (vi) applicable series; and (vii) tranche. The
Commission notes that the scope of required information corresponds to
the scope of information provided under Sec. 50.4 for IRS and CDS that
are subject to the clearing requirement.
The Commission believes that Form TER would provide the information
needed to efficiently produce a trade execution requirement registry
under Sec. 36.2. Given the potentially large number of filings and
swaps that would comprise the trade execution requirement registry, the
Commission believes that uniform submissions through a standardized
Form TER will foster efficient processing of the submissions and
uniform presentation of relevant information in the registry.
The Commission also proposes to require under Sec. 36.2(c) that
DCMs and SEFs publicly post their respective Form TER filings on their
respective websites, and promptly amend any inaccurate Form TERs.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
36.2 and proposed Form TER in Appendix A to part 36. In particular, the
Commission requests comment on the following questions:
(99) Does the proposed Form TER request appropriate and sufficient
information? If not, then what information should the Commission
request, and why?
(100) What information should the Commission include in the trade
execution requirement registry, and why?
C. Sec. 36.3--Trade Execution Requirement Compliance Schedule
The Commission observes that with the proposed elimination of the
existing MAT determination process and the expanded scope of swaps that
would be subject to the trade execution requirement under proposed
Sec. 36.1, counterparties may require additional time to prepare and
update their business practices and technological and operational
capabilities to trade and execute these swaps on a SEF or DCM. For
example, market participants would have to directly on-board to a SEF
or DCM, or otherwise avail themselves of other means of access, to
continue trading those swaps that become newly subject to the trade
execution requirement. Therefore, the Commission proposes to eliminate
the existing trade execution requirement compliance schedule \887\ and
to replace it with a new compliance schedule, based on participant
type, for the additional swaps that become subject to the expanded
trade execution requirement. The proposed compliance schedule would be
triggered on the effective date of any final rule adopted from this
notice. The Commission has designed this proposed compliance schedule
to ensure a smooth and timely implementation of the expanded
requirement.
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\887\ 17 CFR 37.12, 38.11.
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In formulating the proposed compliance schedule, the Commission
considered the expanded scope of swaps that would become subject to the
trade execution requirement. The Commission also referred to the
compliance schedule previously established for the initial
implementation of the clearing requirement, with a focus on the defined
categories of market participants and respective levels of swap trading
activity.\888\ Accordingly, the proposed approach recognizes that
different categories of counterparties have different abilities and
resources for achieving compliance and is designed to provide
counterparties with sufficient time to adapt to the expanded trade
execution requirement.
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\888\ 17 CFR 50.25.
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[[Page 62042]]
The proposed schedule would establish different compliance dates
for different categories of counterparties, as described below. As
specified under proposed Sec. 36.3(d), however, nothing in this
proposed compliance schedule should be construed to prohibit
counterparties from voluntarily complying with the trade execution
requirement sooner than prescribed in the proposed compliance schedule.
Finally, the Commission notes that pursuant to proposed Sec. 36.3(b),
the compliance schedule would not apply to swaps that are already
subject to the trade execution requirement before the effective date of
any final rule. Accordingly, market participants must continue to
comply with the existing trade execution requirement for those swaps.
1. Sec. 36.3(c)(1)--Category 1 Entities
Under Sec. 36.3(c)(1), a Category 1 entity, which would include
swap dealers, major swap participants, security-based swap dealers, or
major security-based swap participants, would have ninety days to
comply with the expanded trade execution requirement when it executes a
swap transaction with another Category 1 entity or a non-Category 1
entity that voluntarily seeks to execute the swap on a SEF, a DCM, or
an Exempt SEF. The Commission believes that a ninety-day time frame
would be a reasonable period for these entities because they possess
experience in the swaps market and resources to comply with the
requirement sooner than other counterparties. Further, the Commission
believes that Category 1 entities are generally the most active
participants in the swaps market, often serving as market makers and
liquidity providers to other participants. As the initial category of
participants that are required to comply with the expanded trade
execution requirement, the Commission believes that Category 1 entities
are best equipped to work internally and with the trading venues, i.e.,
SEFs and DCMs, to operate under the expanded trade execution
requirement.
The Commission also believes that ninety days is a reasonable
period of time for SEFs and DCMs to prepare to facilitate trading in
additional swaps that would become subject to the expanded trade
execution requirement. In particular, the Commission notes that some
SEFs already list many of the types of swaps that would become subject
to the expanded requirement.\889\ Therefore, the Commission expects
that the SEFs and DCMs that list these types of swaps would be both
technologically and operationally ready to offer the expanded number of
swaps within ninety days.
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\889\ See supra note 280.
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2. Sec. 36.3(c)(2)--Category 2 Entities
The Commission proposes Sec. 36.3(c)(2) to provide Category 2
entities with 180 days to comply with the expanded trade execution
requirement when they execute swap transactions with a Category 1
entity, another Category 2 entity, or other counterparties that
voluntarily seek to execute the swap on a SEF, a DCM, or an Exempt SEF.
Category 2 entities would include commodity pools; private funds as
defined in section 202(a) of the Investment Advisers Act of 1940; or
persons predominantly engaged in activities related to the business of
banking, or in activities that are financial in nature as defined in
section 4(k) of the Bank Holding Company Act of 1956.
The Commission believes that a significant amount of swaps trading
would migrate to SEFs or DCMs upon the compliance date for Category 2
entities because they consist of many active liquidity takers.
Nevertheless, the Commission believes that an additional ninety days to
comply with the expanded trade execution requirement would be
reasonable for Category 2 entities, given that they may not have the
same level of swaps trading expertise or resources as Category 1
entities. The Commission believes that it is essential for these
entities to have sufficient time to transition their trading to venue-
based environments.
3. Sec. 36.3(c)(3)--Other Counterparties
The Commission proposes Sec. 36.3(c)(3) to provide all entities
that are not either Category 1 entities or Category 2 entities with 270
days to comply with the expanded trade execution requirement. The
Commission believes that entities that do not qualify as either a
Category 1 entity or Category 2 entity should be provided the greatest
amount of time to comply with the expanded trade execution requirement
because they likely have less sophistication in swaps trading. Of all
of the participants in the swaps market, the Commission believes that
the participants in this category are least likely to have on-boarded
to or have experience trading swaps through SEFs or DCMs. Further, the
Commission understands that onboarding onto such venues can be an
intensive and time-consuming process. Therefore, the Commission
believes that this additional time will help ensure that these
participants have sufficient time to onboard or establish means of
access and are prepared to trade on a SEF or DCM.
4. Sec. 36.3(e)--Future Compliance Schedules
Under proposed Sec. 36.3(e), the Commission would devise an
appropriate compliance schedule when additional swaps listed by a SEF
or DCM are subject to the trade execution requirement in the future
i.e., after the effective date of any final rules that are associated
with this part and upon the issuance of additional clearing requirement
determinations. The Commission believes that this approach will provide
it with sufficient flexibility to promote compliance in a manner that
balances the Commission's policy goal of promoting trading on SEFs and
DCMs while also accounting for different considerations, such as the
nature of the swap products, their availability on multiple trading
venues, and the readiness of relevant market participants to trade
those products through a SEF or DCM.
Request for Comment
The Commission requests comment on all aspects of the proposed
compliance schedule in proposed Sec. 36.3. The Commission specifically
requests comment on the following questions:
(101) Are the proposed compliance schedules for Category 1
Entities, Category 2 Entities, and all other entities appropriate? If
not, then should the Commission consider longer or shorter compliance
time frames and why?
(102) Are the entities included in Category 1 and Category 2
appropriate? If not, then please explain why. Should additional
entities be included within either Category 1 or Category 2 and why?
(103) Are the compliance schedule time frames adequate for SEFs and
DCMs to be technologically and operationally ready for the expanded
trade execution requirement? If not, then what alternative compliance
schedule time frame should the Commission consider and why?
(104) How should the Commission handle the compliance schedules for
any future expansions of the trade execution requirement?
XXII. Part 43--Sec. 43.2--Definition of ``Block Trade''
Section 43.2 defines a swap ``block trade'' as a publicly
reportable swap transaction that (i) involves a swap that is listed on
a SEF or DCM; (ii) occurs away from the SEF's or DCM's trading system
or platform and is executed pursuant to the SEF's or DCM's rules
[[Page 62043]]
and procedures; (iii) has a notional or principal amount at or above
the appropriate minimum block trade size applicable to such swap; and
(iv) is reported subject to the rules or procedures of the SEF or DCM
and the rules set forth under part 43, including the appropriate time
delay requirements set forth under Sec. 43.5.\890\ In specifying these
elements, the Commission considered the treatment of block trades in
various swap and non-swap markets.\891\ In particular, the Commission
looked to the futures markets, where futures block trades are
``permissible, privately-negotiated transaction[s] that equal[ ] or
exceed[ ] a DCM's specified minimum quantity of futures or options
contracts and is executed away from the DCM's centralized market but
pursuant to its rules.'' \892\ Accordingly, the Commission's regulatory
definition of a ``block trade'' for swaps closely tracks this futures
market concept of a block trade.
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\890\ 17 CFR 43.2.
\891\ Real-Time Public Reporting of Swap Transaction Data, 75 FR
76140, 76159 (proposed Dec. 7, 2010) (discussion of block trades
with respect to futures).
\892\ Id.
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Similar to futures block trades, the Commission requires that swap
block trades ``occur away'' from a SEF's or a DCM's trading system or
platform, but pursuant to the SEF's or a DCM's rules and
procedures.\893\ The Commission clarified the ``block trade''
definition by stating that ``[a]ny swap that is executed on a SEF or a
DCM's trading system or platform, regardless of whether it is for a
size at or above the appropriate minimum block size for such swap, is
not a block trade under this definition. . . .'' \894\ Accordingly, to
receive the fifteen-minute public reporting delay that block trades are
entitled to under Sec. 43.5(d), the swap transaction not only must
have a notional amount at or above the appropriate minimum block size,
but must also ``occur away'' from the SEF's or the DCM's trading system
or platform.\895\
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\893\ 17 CFR 43.2.
\894\ Procedures To Establish Appropriate Minimum Block Sizes
for Large Notional Off-Facility Swaps and Block Trades, 78 FR 32866,
32904 n.425 (May 31, 2013).
\895\ CEA section 2(a)(13) requires the Commission to establish
rules that govern the real-time reporting of swap transaction and
pricing data to the public, but also directs the Commission, among
other things, to prescribe rules that specify the appropriate
reporting time delay for block trades, including the criteria for
determining what constitutes a block trade. 7 U.S.C. 2(a)(13).
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Given that block trades must occur away from a SEF's or a DCM's
trading system or platform, the enumerated prohibition on pre-arranged
trading as an abusive trading practice under Sec. 37.203(a) allows
block trades as an exception.\896\ This exception allows transactions
that meet or exceed the requisite block size to be privately negotiated
to avoid potentially significant, adverse price impacts that would
occur if traded on trading systems or platforms that offer pre-trade
price transparency.
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\896\ ``Pre-arranged trading'' is prohibited as an abusive
trading practice under Sec. 37.203(a). This prohibition generally
applies to market participants who communicate with one another to
pre-negotiate the terms of a trade away from a trading system or
platform, but then execute the trade on the trading system or
platform in a manner that appears competitive and subject to market
risk. Accordingly, the Commission intended the prohibition to
maintain the integrity of price competition and market risk that is
incident to trading in the market. See supra Section VI.A.2.--Sec.
37.203(a)--Pre-Arranged Trading Prohibition; Sec. 37.9--Time Delay
Requirement.
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A. Sec. 43.2--Definition--Block Trade; Sec. 37.203(a)--Elimination of
Block Trade Exception to Pre-Arranged Trading
During the part 37 implementation process, SEFs and market
participants informed the Commission that for swap transactions that
are intended to be cleared, requiring that such swaps to ``occur away''
from a SEF's trading system or platform creates an issue with carrying
out pre-execution credit screening.\897\ These market participants note
that, in many cases, clearing FCMs are unable to conduct pre-execution
credit screening for such block trades because they are unaware that a
block trade has occurred away from a SEF until after it has been
executed and reported to the SEF.\898\ Accordingly, SEFs were unable to
facilitate pre-execution credit checks for block trades.
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\897\ For the Commission's discussion of pre-execution credit
screening requirements, see supra Section XII.B.2.b.(3)--Sec. Sec.
37.702(b)(2)-(3)--Pre-Execution Credit Screening.
\898\ CFTC Letter No. 17-60, Re: Extension of No-Action Relief
for Swap Execution Facilities from Certain ``Block Trade''
Requirements in Commission Regulation 43.2 at 2 (Nov. 14, 2017)
(``NAL No. 17-60'').
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DMO acknowledged this operational challenge and accordingly has
granted ongoing no-action relief from the requirement that swap block
trades ``occur away'' from a SEF.\899\ Based on Commission staff no-
action relief, a SEF may allow market participants to execute swap
block trades that are intended to be cleared on a SEF's non-Order Book
trading system or platform.\900\ As a result, FCMs and SEFs have been
able to comply with their respective pre-execution credit screening
obligations.
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\899\ NAL No. 17-60; CFTC Letter No. 16-74, Re: Extension of No-
Action Relief for Swap Execution Facilities from Certain ``Block
Trade'' Requirements in Commission Regulation 43.2 (Oct. 7, 2016);
CFTC Letter No. 15-60, Re: Extension of No-Action Relief for Swap
Execution Facilities from Certain ``Block Trade'' Requirements in
Commission Regulation 43.2 (Nov. 2, 2015); CFTC Letter No. 14-118,
No-Action Relief for Swap Execution Facilities from Certain ``Block
Trade'' Requirements in Commission Regulation 43.2 (Sept. 19, 2014).
\900\ NAL No. 17-60 at 2-3.
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The Commission proposes to revise certain elements of the ``block
trade'' definition under Sec. 43.2. First, the Commission proposes to
eliminate the ``occurs away'' requirement for swap block trades.
Second, the Commission proposes to require that to the extent
counterparties seek to execute any swap that has a notional or
principal amount at or above the appropriate minimum block trade size
applicable to such swap on a SEF, they must do so on a SEF's trading
system or platform. For swaps listed by a SEF for trading that
participants intend to execute on the SEF and submit for clearing, the
Commission believes that the proposed revised definition would (i)
allow FCMs to conduct pre-execution credit screenings in accordance
with Sec. 1.73; and (ii) allow SEFs to facilitate those screenings in
accordance with the Commission's proposed requirement under Sec.
37.702(b).\901\ In addition, for swaps listed by a SEF that
participants intend to execute on the SEF, but do not intend to submit
for clearing, participants would no longer be permitted to submit an
already-executed block trade to the SEF pursuant to its rules; such
transactions would be required to be executed on the SEF.
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\901\ The Commission notes that proposed Sec. 37.702(b) applies
to SEFs that list (i) swaps that are subject to the clearing
requirement; and/or (ii) swaps that are not subject to the clearing
requirement, but for which the SEF facilitates processing and
routing to a DCO for clearing. See supra Section XII.B.3.--
Applicability of Sec. 37.702(b) to SEFs that Do Not Facilitate
Clearing.
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The Commission notes that this revised block trade definition is
consistent with the provisions of the Dodd-Frank Act. CEA section
2(a)(13), as amended by the Dodd-Frank Act, directs the Commission to
prescribe criteria for determining what constitutes a block trade for
the purpose of establishing appropriate post-trade reporting time
delays. The provision, however, does not set forth any pre-trade
requirements, such as a requirement that the transaction be executed
away from a SEF. Second, requiring block trades to be executed on a SEF
for those swaps listed by the SEF, rather than allowing them to be
executed away from the SEF, would also facilitate the statutory SEF
goal of promoting swaps trading on SEFs.\902\
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\902\ See 7 U.S.C. 7b-3(e).
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[[Page 62044]]
The revised definition also corresponds with other proposed changes
to the SEF regulatory framework. For example, the Commission believes
that allowing SEFs to use flexible means of execution for swap
transactions negates the need to allow swap block trade execution to
occur away from SEFs. Similarly, the Commission's proposed approach to
pre-execution communications should facilitate swap block trade
execution on SEFs; proposed Sec. 37.201(b) would generally prohibit
participants from conducting such communications away from the SEF,
except for communications regarding a listed swap that is not subject
to the trade execution requirement, among other exceptions.\903\
Accordingly, participants may pre-negotiate block trades with one
another for those swaps away from a SEF and submit them to the SEF for
execution. This approach would allow participants to comply with the
proposed definition, i.e., the swap must be executed on a SEF, but also
facilitate compliance with pre-execution credit screening requirements
if the swap is intended to be cleared.
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\903\ See supra Section VI.A.2.a.--Sec. 37.201(b)--Pre-
Execution Communications.
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To conform to the amended block trade definition, the Commission
also proposes to eliminate the block trade exception to the pre-
arranged trading prohibition under Sec. 37.203(a). Given that block
trades would no longer occur away from a SEF, but would be executed on
a SEF via flexible means of execution, the Commission expects that
market participants will have sufficient ability to continue to execute
such transactions through a SEF's trading system or platform.
Request for Comment
The Commission requests comments on all aspects of proposed Sec.
43.2. The Commission specifically requests comment on the following
questions:
(105) Should the Commission limit the type of execution methods
that may be utilized to permit block trades to receive a public
reporting delay as set forth in Commission regulation Sec. 43.5(d)? If
so, then which methods of execution for block trades should be
precluded from receiving a public reporting delay, and why? Would views
on this question change if the public dissemination delay for a block
trade was extended beyond fifteen minutes? If so, then please explain
why.
(106) Should the Commission allow all swap block trades on SEFs to
be negotiated through pre-execution communications and then submitted
to SEFs for execution? Please explain why or why not.
XXIII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act \904\ requires Federal agencies, in
promulgating regulations, to consider the impact of those regulations
on small businesses. The regulations adopted herein will directly
affect SEFs, DCMs, DCOs, SDs, MSPs and certain ECPs. The Commission has
previously established certain definitions of ``small entities'' to be
used by the Commission in evaluating the impact of its regulations on
small entities in accordance with the Regulatory Flexibility Act.\905\
The Commission has also previously determined that SEFs,\906\
DCMs,\907\ DCOs,\908\ SDs,\909\ MSPs \910\ and ECPs \911\ are not small
entities for the purpose of the Regulatory Flexibility Act.
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\904\ 5 U.S.C. 601 et seq.
\905\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982)(``1982 Policy Statement'').
\906\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476, 33548 (Jun. 4, 2013).
\907\ 1982 Policy Statement.
\908\ A New Regulatory Framework for Clearing Organizations, 66
FR 45604, 45609 (Aug. 29, 2001).
\909\ Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
\910\ Id.
\911\ See 66 FR 20740, 20743 (Apr. 25, 2001).
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Therefore, the Chairman, on behalf of the Commission, pursuant to 5
U.S.C. 605(b), hereby certifies that the proposed rules will not have a
significant economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq.
(``PRA'') imposes certain requirements on Federal agencies (including
the Commission) in connection with conducting or sponsoring any
``collection of information,'' \912\ as defined by the PRA. Among its
purposes, the PRA is intended to minimize the paperwork burden to the
private sector, to ensure that any collection of information by a
government agency is put to the greatest possible uses, and to minimize
duplicative information collections across the government.\913\
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\912\ For purposes of this PRA discussion, the terms
``information collection'' and ``collection of information'' have
the same meaning, and this section will use the terms
interchangeably.
\913\ 44 U.S.C. 3501.
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The PRA applies to all information, regardless of form or format,
whenever the government is obtaining, causing to be obtained, or
soliciting information, and includes required disclosure to third
parties or the public, of facts or opinions, when the information
collection calls for answers to identical questions posed to, or
identical reporting or recordkeeping requirements imposed on, ten or
more persons.\914\ The PRA requirements have been determined to include
not only mandatory, but also voluntary information collections, and
include both written and oral communications.\915\
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\914\ 44 U.S.C. 3502.
\915\ 5 CFR 1320.3(c)(1).
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The Commission's proposed amendments would result in a collection
of information within the meaning of the PRA, as discussed below. Under
the PRA, an agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number from the Office of Management and
Budget (``OMB''). The proposed rulemaking would amend parts 9, 36, 37,
38, 39, and 43 of the Commission's regulations to include new
information collections, eliminate certain existing information
collections, and modify existing information collections.\916\
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\916\ The proposed amendments would not substantially or
materially modify existing information collection burdens, or create
new information collection burdens, under parts 9, 39, and 43.
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OMB control number 3038-0074 currently covers, among other things,
all information collections arising in part 37 (other than the
information collections related to existing Sec. 37.10) and part
9.\917\ OMB control number
[[Page 62045]]
3038-0052 covers, among other things, information collections arising
in part 38 (other than the information collections related to Sec.
38.12).\918\ OMB control number 3038-0099 covers the information
collections related to the ``available to trade'' determination (``MAT
determination'') process under Sec. 37.10 and Sec. 38.12.
Accordingly, the proposed rulemaking would amend OMB control numbers
3038-0074 and 3038-0052; however, the Commission proposes to eliminate
OMB control number 3038-0099 along with the corresponding MAT
determination information collections under Sec. 37.10 and Sec.
38.12. Instead, the Commission proposes to transfer the corresponding
MAT determination information collections under Sec. 37.10 and Sec.
38.12 to part 36, and the related information collections related to
the MAT determination process for SEFs and DCMs will be incorporated
under OMB control numbers 3038-0074 and 3038-0052, respectively. The
Commission, therefore, is submitting this proposal to OMB for review in
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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\917\ The Commission notes that this OMB control number covers
all information collections in part 37, including Subpart A and the
SEF core principles, i.e., Subparts B through P, and the appendices
thereto, i.e., Appendix A (Form SEF), Appendix B (guidance and
acceptable practices), and proposed Appendix C (guidance to Core
Principle 3). This OMB control number also includes all information
collections related to part 9 to the extent applicable to SEFs. For
clarity, existing Sec. 37.10(a) is not covered under this OMB
control number, but rather is subject to a separate information
collection under OMB control number 3038-0099. The Commission
further notes that in the most recent request for an extension of
OMB control number 3038-0074, the Commission stated in the renewal
notice that OMB control number 3038-0074 ``covers all information
collections in part 37 of the Commission's regulations, including
Subpart A and the SEF core principles (i.e., Subparts B and C) . . .
. [other than] any information collections related to Sec. 37.10 .
. . .'' The Commission notes that the reference to ``Subparts B and
C'' should specify ``Subparts B through P'' instead. Agency
Information Collection Activities Under OMB Review, 81 FR 65630, n.1
(Sep. 23, 2016) (``2016 Part 37 PRA Renewal'').
\918\ The Commission notes that this OMB control number covers
all information collections in part 38 of the Commission's
regulations, including Subpart A and the DCM core principles, i.e.,
Subparts B through X. This OMB control number also includes all
information collections related to part 9 to the extent applicable
to DCMs. The Commission also notes for clarity that existing Sec.
38.12 is not covered under this OMB control number, but rather is
subject to a separate information collection with OMB control number
3038-0099.
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The collections of information under these proposed amendments are
necessary to implement certain provisions of the CEA, as amended by the
Dodd-Frank Act. Among other provisions in the CEA, CEA section 8a(5)
provides the Commission with authority to promulgate rules as
reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of the CEA.\919\
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\919\ The full authority provided under part 37 of the
Commission's regulations includes: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-
2, 7b-3, and 12a, as amended by Titles VII and VIII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act, Public Law
111-203, tit. VII-VIII, 124 Stat. 1376 (2010).
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If the proposed amendments are adopted, responses to the proposed
collections of information generally would be mandatory, although
certain collections of information could vary based upon a SEF's
discretion or level of business. For example, a SEF has the discretion
to establish the scope of its trading operations, e.g., determining
which swaps to list for trading, which may affect the various burden
hours discussed herein.
The Commission will protect proprietary information according to
the Freedom of Information Act and 17 CFR part 145, ``Commission
Records and Information.'' In addition, section 8(a)(1) of the CEA
strictly prohibits the Commission, unless specifically authorized by
the CEA, from making public ``data and information that would
separately disclose the business transactions or market positions of
any person and trade secrets or names of customers.'' The Commission is
also required to protect certain information contained in a government
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
As discussed in the preamble to the final rules for part 37 (``SEF
Core Principles Final Rule''), the methodology the Commission used to
formulate the proposed estimates reflect an average across all SEFs
(and in respect to proposed part 36, all SEFs and DCMs).\920\ By
definition, averages are meant to serve as only a reference point; the
Commission understands that due to both discretionary and mandatory
requirements, some SEFs may go above the estimated burden hours to
complete information collection requirements, while others may stay
below those estimates.\921\
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\920\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476, 33551 (Jun. 4, 2013).
\921\ Id.
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1. Information Provided by Reporting Entities/Persons
The following is a brief description of the information collections
for SEFs, and as applicable DCMs and other market participants, under
the proposed amendments to parts 36, 37 and 38.\922\ To the extent that
the Commission does not identify a specific provision, the Commission
does not believe that any associated change substantively or materially
modifies an existing information collection burden or creates a new
one.\923\
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\922\ As noted above, the Commission proposes to eliminate the
MAT determination process for DCMs under Sec. 38.12.
\923\ For the purposes of the PRA discussion herein, the
Commission will not discuss the proposed amendments to parts 9, 39,
and 43 because it has determined that they would not impose new
information collection burdens or substantively or materially modify
existing burdens therein. Further, the Commission will not discuss
any proposed amendments to parts 36, 37, and 38 unless the
Commission has determined that such changes would create, eliminate,
or substantively or materially modify existing information
collections or related burden hours.
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The Commission notes that some of the proposed amendments are
covered by other OMB control numbers. For example, some amendments
would require SEFs to promulgate new rules that are required to be
submitted to the Commission pursuant to part 40 of the Commission's
regulations.\924\ PRA burdens, if any, related to the submission by a
SEF to the Commission of new rules, policies and procedures, and
amendments have been accounted for in the previous information
collection burden estimate associated with part 40, which governs the
process by which SEFs must submit rules and amendments to the
Commission.\925\ Additionally, some of the hours associated with those
information collections would not be deemed to be ``burden hours'' if
they result from ``usual and customary'' business practices.\926\
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\924\ For example, proposed Sec. Sec. 37.201(a)(1)-(3) would
require a SEF to establish rules governing its operation that
specify (i) the protocols and procedures for trading and execution,
including entering, amending, cancelling, or executing orders for
each execution method; (ii) the manner or circumstances in which the
swap execution facility may exercise discretion in facilitating
trading and execution for each execution method; and (iii) the
sources and methodology for generating any market pricing
information provided to facilitate trading and execution for each
execution method.
\925\ Provisions Common to Registered Entities, 76 FR 44776,
44789 (July 27, 2011).
\926\ 5 CFR 1320.3(b)(2). For example, proposed Sec.
37.6(b)(2)(iii) would require a SEF to establish and enforce rules
to require the intermediary to transmit the confirmation or trade
evidence record to the respective counterparty ``as soon as
technologically practicable'' upon receipt of the confirmation or
trade evidence record from the SEF. The Commission notes that SEF
members and market participants acting in an intermediary capacity
and executing swaps on behalf of customers, as a matter of industry
practice, generally make such confirmations available to their
customers, i.e., the swap counterparties. Accordingly, this proposed
amendment reflects an existing ``usual and customary practice'' that
would create a new information collection but would not impose any
associated burden hours.
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a. Sec. 37.3(a)--Requirements for Registration
The Commission expects that as a result of the proposed application
of the SEF registration requirement under Sec. 37.3(a), additional
swaps broking entities will register as SEFs. For PRA purposes, the
Commission previously had revised the current number of registered SEFs
from 23 \927\ to the current 25 \928\ and had estimated approximately 4
new SEF applicants per year.\929\
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\927\ 2016 Part 37 PRA Renewal at 65631.
\928\ Agency Information Collection Activities: Notice of Intent
To Revise Collection Numbers 3038-0052 and 3038-0074, Core
Principles and Other Requirements for Designated Contract Markets,
and Core Principles and Other Requirements for Swap Execution
Facilities, 83 FR 1609, 1611 (Jan. 12, 2018).
\929\ 2016 Part 37 PRA Renewal at 65631.
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The Commission notes that based on data from the National Futures
Association (``NFA''), more than 300 interdealer brokers that are
registered
[[Page 62046]]
with the NFA as ``introducing brokers'' are also ``swap firms,'' i.e.,
interdealer brokers that are registered as introducing brokers and also
designated to deal with swap products. The Commission, however, does
not expect that proposed Sec. 37.3(a) will result in all swap
interdealer brokers registering as SEFs. The Commission understands
that some of these entities may (i) already be affiliated with current
SEFs and could operate as part of their respective affiliated SEFs
rather than registering as new, separate SEFs; (ii) merge, become
affiliated with, or otherwise be acquired by registered SEFs; or (iii)
adjust their business practices such that they would not be required to
register as a SEF. Additionally, some of these entities may be
currently registered as introducing broker swap firms, but are not
currently in the business of swaps trading and therefore do not trigger
the SEF registration requirement. Additionally, the Commission notes
that certain non-U.S. interdealer brokers may also be affiliated with
platforms that are currently exempt or may become exempt in the future
from Commission registration, and therefore, would not need to
separately register as SEFs.
The Commission initially estimates that up to 60 swaps broking
entities, including interdealer brokers, and one Single-Dealer
Aggregator Platform would register as SEFs as a result of the proposed
application of the SEF registration requirement under Sec.
37.3(a).\930\ Consequently, for the purposes of this PRA analysis, the
Commission estimates that the proposed application of Sec. 37.3(a)
will impose an initial, non-recurring information collection burden of
295 burden hours associated with the SEF registration process for these
60 entities.\931\ The Commission does not believe that the proposed
application of the SEF registration requirement in Sec. 37.3(a) would
impose new information collection burdens or substantively or
materially modify existing burdens for registered SEFs.
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\930\ The Commission estimates that approximately 40-60 swaps
broking entities, including interdealer brokers would be required to
register as SEFs as a result of the proposed application of the SEF
registration requirement in Sec. 37.3(a). Similarly, the Commission
is aware of one Single-Dealer Aggregator Platform, which is
affiliated with a SEF. For the purposes of this PRA, the Commission
estimates and assumes that 60 such swaps broker entities and the one
Single-Dealer Aggregator Platform of which it is aware would
register as SEFs. For further discussion, see infra Section
XXIII.C.3.c.--Costs (cost discussion related to the SEF registration
requirement).
\931\ As noted below, based on the proposed changes to the SEF
registration requirements described herein, the Commission is
reducing the estimated burden hours associated with the registration
process by 5 hours from 300 hours to 295 hours.
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In connection with the Commission's proposed clarification of the
registration requirement, the Commission would propose to delay the
application of the registration requirement with respect to (i) swaps
broking entities, including interdealer brokers for a six-month period;
and (ii) foreign swaps broking entities, including foreign interdealer
brokers that facilitate swaps trading for U.S. persons for two-year
period, provided that in each case the subject entity submits a request
to the Commission with certain information.\932\ As noted above, the
Commission expects in the aggregate that approximately 60 such
entities, including swaps broking entities and foreign swaps broking
entities, would be required to register as SEFs, and the Commission
estimates that all such relevant entities would request a delay.
Accordingly, the Commission estimates that the voluntary request to
delay the registration requirement will impose an initial, non-
recurring information collection burden of 1 burden hour associated
with the SEF registration process for each of these 60 entities. The
Commission does not believe that the clarification in proposed Sec.
37.3(a) would impose new information collection burdens or
substantively or materially modify existing burdens for registered
SEFs.
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\932\ The request would include the (i) entity's name as it
appears in the entity's charter; (ii) name and address of the
entity's ultimate parent company; (iii) any names under which the
entity does business; (iv) address of principal executive office;
(v) a contact person's name, address, phone number, and email
address; (vi) asset classes and swap products for which the entity
facilitates trading; and (vii) any registrations, authorizations, or
licenses held. Foreign broking entities additionally would need to
provide (viii) certification that it currently arranges or
negotiates swap transactions for U.S. persons; (ix) home country
regulator or regulators; and (x) any registrations, authorizations,
or licenses held in the entity's home country.
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b. Sec. 37.3(b)--Procedures for Registration
Proposed Sec. 37.3(b) would streamline Form SEF by consolidating,
amending, and eliminating several of the existing exhibits.\933\ The
Commission believes that these changes would establish a clearer and
more simplified application for SEF applicants that would still provide
the Commission with sufficient information needed to determine
compliance. The Commission believes that the proposed streamlined Form
SEF will reduce the initial, non-recurring burden hours associated with
the application process for SEF registration by approximately 5 burden
hours.
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\933\ For further discussion on the specific changes, see supra
Section IV.C.3.b.--Sec. 37.3(b)(1)--Application for Registration.
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c. Sec. 37.3(c)--Amendment to an Order of Registration
Proposed Sec. 37.3(c) would eliminate the requirement that a SEF
amend Form SEF when requesting an amended order of registration from
the Commission. Instead, a registered SEF would file a request with the
Commission for an amended order pursuant to proposed Sec. 37.3(c), but
would no longer be required to file updated exhibits to Form SEF,
although a SEF would be required to provide the Commission with any
additional information and documentation as the Commission deems
necessary.\934\ The Commission estimates that approximately 1 SEF per
year seeks to amend its registration order and that the proposed change
would save that SEF approximately 2 burden hours.
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\934\ The Commission notes that it proposes to eliminate the
existing language under Sec. 37.3(b) that specifies the use of part
40 to file application amendments subsequent to registration. The
Commission emphasizes that not all of the information from the Form
SEF exhibits need to be updated pursuant to part 40 subsequent to
registration--for example, certain part 37 provisions already
require SEFs to update their information on an ongoing basis. Under
Sec. 37.1306, a SEF is required to file financial reports,
including fiscal year end reports, which precludes the need to amend
new Exhibit G (existing Exhibit I) and file it through part 40. As
discussed above, the Commission clarifies that part 40 only applies
to information from application exhibits that constitute a ``rule,''
as defined under Sec. 40.1(i). The Commission generally interprets
the Sec. 40.1(i) rule definition broadly to encompass governance
documentation (proposed Exhibit C); fees (proposed Exhibit H);
rulebooks (proposed Exhibit J); compliance manuals (proposed Exhibit
K); participant agreements (proposed Exhibit L); SDR-related
agreements (proposed Exhibit M); clearing-related agreements
(proposed Exhibit N); other third-party agreements (proposed Exhibit
O); and information related to execution methods (proposed Exhibit
P). Therefore, registered SEFs have already been submitting changes
to these types of documentation pursuant to the part 40 rule filing
procedures.
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d. Sec. 37.5(c)--Provision of Information Relating to a Swap Execution
Facility
Proposed Sec. 37.5(c) would amend the existing notification
requirements related to transfers of equity interest in a SEF. Proposed
Sec. 37.5(c)(1) would require a SEF to file a notice with the
Commission regarding any transaction that results in the transfer of
direct or indirect ownership of fifty percent or more of the equity
interest of a SEF as opposed to only direct ownership transfers as
currently required.\935\ As part of that notification, a SEF may
[[Page 62047]]
incur burdens that are similar to those incurred when providing a
notice of a direct change, including providing details of the proposed
transaction and how the transaction would not adversely impact the
SEF's ability to comply with the SEF core principles and the
Commission's regulations, responding to any requests for supporting
documentation from the Commission, and updating any ongoing changes to
the transaction. Accordingly, the Commission estimates that
approximately 1 additional SEF per year would need to notify the
Commission as a result of an indirect equity transfer and that the
proposed amendment would impose a one-time, non-recurring information
collection of approximately 10 burden hours on such SEF.
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\935\ Transfer of ownership in an ``indirect'' manner may occur
through a transaction that involves the transfer of ownership of a
SEF's direct parent or an indirect parent, and therefore, implicates
effective change in ownership of the SEF's equity interest.
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e. Sec. 37.6(b)(1)--Legally Binding Documentation
Proposed Sec. Sec. 37.6(b)(1)(i)-(ii) would amend the existing
swap documentation requirements by establishing separate transaction
documentation requirements for cleared and uncleared swaps,
respectively. Under existing Sec. 37.6(b), a SEF is required to
provide each counterparty to a transaction with a written
``confirmation'' that contains all of the terms of a swap transaction
at the time of the swap's execution for both cleared and uncleared swap
transactions, including (i) ``economic terms'' specific to the
transaction and (ii) non-transaction specific ``relationship terms''
governing the relationship between the two counterparties.\936\ To
include all of the terms of a uncleared swap into a confirmation, a SEF
would comply with Sec. 37.6(b) by incorporating by reference the
relevant terms set forth in the previously-negotiated agreements and
documents, as long as the SEF had obtained these agreements prior to
execution.\937\
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\936\ As noted above, economic terms include, for example, swap
product, price, trade date, settlement date, and notional amount.
``Relationship terms'' generally govern all transactions between two
counterparties, e.g., default provisions, margin requirements, and
governing law. See supra Section IV.F.--Sec. 37.6--Enforceability.
\937\ SEF Core Principles Final Rule at 33491 n.195.
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Proposed Sec. 37.6(b)(1)(i), which would continue to apply the
existing confirmation requirement to cleared swap transactions, would
not alter the information collection burdens with respect to cleared
swaps. For uncleared swaps, however, proposed Sec. 37.6(b)(1)(ii)
would require a SEF to provide a ``trade evidence record'' that
memorializes the terms that are agreed upon by the counterparties on
the SEF. In contrast to the requirement for cleared swaps, proposed
Sec. 37.6(b)(1)(ii) would not require the trade evidence record to
include all the terms of the swap transaction, including relationship
terms contained in underlying documentation between the counterparties,
nor would the SEF need to obtain or maintain the underlying agreements
prior to the execution of the swap transaction.\938\ To the extent that
such terms either (i) are agreed upon between the counterparties in
underlying documentation established away from the SEF and continue to
govern the transaction post-execution or (ii) are not required to
establish legal certainty for a specific transaction, a SEF would not
be required to incorporate those terms into a trade evidence record.
The proposed approach would address the challenges that have prevented
SEFs from fully complying with Sec. 37.6(b) by reducing the
administrative burdens for SEFs, who under the proposal would not be
required to obtain, incorporate, or reference those previous
agreements; and for counterparties, who would not be required to submit
all of their relevant documentation with other potential counterparties
to the SEF.
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\938\ The Commission anticipates that the terms listed in a
trade evidence record would include, at a minimum, the transaction's
``economic terms,'' e.g., trade date, notional amount, settlement
date, and price.
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As a result, the Commission believes that the proposed amendments
would reduce a SEF's annual recurring information collection burden for
uncleared swap transactions. Accordingly, the Commission estimates that
proposed Sec. 37.6(b)(1)(ii) would reduce annual recurring information
collection burdens by about 375 hours per SEF.\939\
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\939\ The Commission previously estimated that the process to
obtain, review, incorporate, and maintain the previously-negotiated
agreements takes approximately 1.5 hour per SEF participant and that
on average, a SEF has about 375 participants. For purposes of this
PRA discussion herein, however, the Commission is revising its
estimate of the number of burden hours that the proposal would
eliminate and will assume that each such agreement takes
approximately 1.0 hours per SEF participant. Accordingly, 375
participants x 1.0 hour per participant = 375 estimated burden
hours. The Commission also notes that this estimate of 375 burden
hours includes the burden estimates in connection with Sec.
37.1001, which establishes a SEF's recordkeeping obligations.
Supporting Statement for New and Revised Information Collections,
Core Principles and Other Requirements for Swap Execution
Facilities, OMB Control Number 3038-0074, (Sept. 23, 2016), https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201609-3038-005.
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f. Sec. 37.203(d)--Automated Trade Surveillance System
Proposed Sec. 37.203(d) would eliminate the prescriptive automated
trade surveillance system capabilities requirements enumerated in
existing Sec. 37.203(d), except for the ability of a SEF to
reconstruct sequence of market activity, and would instead require that
a SEF's automated trade surveillance system be capable of detecting and
``reconstructing'' potential trade practice violations.\940\
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\940\ The Commission notes that this proposed change is
consistent with the proposed amendments to Sec. Sec. 37.205(b)(2)-
(3), as discussed below, that would similarly limit a SEF's
electronic transaction history database and electronic analysis
capability requirements. The Commission, however, emphasizes that a
SEF must continue to have the capability to load and process all
executed trades, including those resulting from orders entered by
voice or certain other electronic communications, such as instant
messaging and email.
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As a result, the proposed rule would provide each SEF with the
flexibility to determine what capabilities its automated trade
surveillance system must have, based on the nature of the SEF's trading
systems or platforms, to satisfy its core principle compliance
responsibilities. Although it is possible that SEFs use their
discretion to decrease the information collections and related burden
hours, SEFs would still be obligated to comply with the same underlying
core principle obligations with which they must currently comply. As a
result, the Commission estimates and assumes that SEFs would continue
to fulfill their information collection burdens in a manner similar to
the status quo. Accordingly, the Commission assumes that proposed Sec.
37.203(d) would not impose new information collection burdens or
substantively or materially affect SEFs' total burden hours.
g. Sec. 37.203(e)--Error Trade Policy
Proposed Sec. 37.203(e) would require SEFs to establish an error
trade policy that, among other things, would notify all market
participants of (i) any swap transaction that is under review; (ii) any
determination by the SEF that the swap transaction under review either
has been determined to be or not to be an error trade; and (iii) the
resolution of any error trade, including any trade term adjustment or
trade cancellation. To the extent that SEFs currently are not
explicitly required to provide market participants with notice of any
of these events, proposed Sec. 37.203(e) would impose a new
information collection burden on SEFs.\941\ The Commission
[[Page 62048]]
estimates that proposed Sec. 37.203(e) would increase a SEF's annual
recurring information collection burden by approximately 15 burden
hours, based on an estimate that a SEF on average would incur
approximately 15 error trade reviews per year.\942\ Because most SEFs
already have established and currently maintain the necessary personnel
and systems to provide such notices to its market participants, the
Commission believes that the proposed amendment would not require SEFs
to expend initial, non-recurring burden hours in order to comply.
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\941\ The Commission notes that existing Sec. 37.203(e)
provides SEFs with the authority to cancel or adjust prices for
error trades if necessary to mitigate market disruption; in
connection with this authority, existing Sec. 37.203(e) also
requires SEFs to make any such adjustments and cancellations
transparent to market participants. 17 CFR 37.203(e). To the extent
that proposed Sec. 37.203(e) requires SEFs to provide notice to
market participants for error trades in additional circumstances,
the proposed amendment imposes a new collection of information.
\942\ As noted above, proposed Sec. 37.203(e) would require a
SEF to provide market participants with a first notice upon the
initiation of a review of an alleged error trade, a second notice
upon any determination as to whether such swap transaction is or is
not an error trade, and a third notice upon the resolution of the
review, including any trade term adjustment or trade cancellation.
The Commission estimates that each notice requires about \1/3\
burden hours, for a total of 1 burden hour per error trade (\1/3\
burden hours x 3 notices = 1 burden hour per error trade for
notices). Further, the Commission estimates that each SEF on average
will have approximately 15 error trade reviews per year.
Accordingly, 1 burden hour x 15 error trade reviews per year = 15
burden hours per year. The Commission notes, however, that certain
error trades may be resolved more quickly than 1 hour or take longer
than 1 hour depending on the availability and coordination of the
counterparties and relevant SEF personnel.
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h. Sec. 37.205(a)--Audit Trail Required
Proposed Sec. 37.205(a) would make several changes to SEFs' audit
trail compliance obligations. First, the proposed amendment would
replace the requirement that SEFs must ``detect, investigate, and
prevent'' customer and market abuse with a requirement instead that
SEFs must be able to ``reconstruct all trading on its facility, detect
and investigate customer and market abuses, and take appropriate
disciplinary action.'' Second, the Commission proposes to move the
requirement that audit trail data shall be sufficient to reconstruct
all indications of interest, requests for quotes, orders and trades, to
the guidance to Core Principle 2 in Appendix B.\943\ Third, the
Commission proposes to eliminate the requirement that SEFs capture
post-execution allocation information in their audit trail data; in
lieu of requiring the audit trail track a customer order through
``fill, allocation, or other disposition,'' the Commission proposes to
require SEFs to capture the audit trail data only through execution on
the SEF since the Commission has learned from SEFs' representations
that SEFs are unable to routinely obtain post-allocation information as
required by Sec. Sec. 37.205(a) and (b)(2) from third parties, such as
DCOs and SDRs.
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\943\ The Commission proposes to add this guidance to paragraph
(a)(4) to Core Principle 2 in Appendix B. The Commission proposes to
eliminate the existing language in paragraph (a)(4). See infra
Section VII.E.2.--Sec. 37.206(b)--Disciplinary Program.
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To the extent that the Commission is providing SEFs with greater
discretion in fulfilling their information collection obligations with
respect to audit trail requirements under Sec. 37.205, the Commission
estimates and assumes that SEFs would continue to fulfill their
information collection burdens in a manner similar to the status quo.
Accordingly, the Commission assumes that proposed Sec. 37.205(a) would
not substantively or materially affect a SEF's total information
collection burden hours.\944\
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\944\ As the Commission discussed above, certain existing
requirements under Sec. 37.205(a) are either unfeasible or impose
greater information collection burdens than the Commission
originally had estimated, e.g., the requirement to collect post-
execution trade allocation information. Subsequently, Commission
staff provided no-action relief with respect to such obligations.
See, e.g., CFTC Letter No. 15-68, Re: No-Action Relief for Swap
Execution Facilities from Certain Audit Trail Requirements in
Commission Regulation 37.205 Related to Post-Execution Allocation
Information (Dec. 22, 2015) (subsequently extended in CFTC Letter
No. 17-54, Re: No-Action Relief for Swap Execution Facilities from
Certain Audit Trail Requirements in Commission Regulation 37.205
Related to Post-Execution Allocation Information (Oct. 31, 2017)).
Accordingly, the 2016 Part 37 PRA Renewal took into consideration in
its revised PRA burden hour estimates the unfeasibility with
complying with such requirements and the corresponding no-action
relief. As a result, the Commission's proposal to eliminate such
information collections under the proposal would not result in a net
change to a SEF's aggregate burden hours because the 2016 Part 37
PRA Renewal already considered such relief and non-compliance with
such requirements in its revised estimate. The Commission notes
that, otherwise, the burden hour estimate in the 2016 Part 37 PRA
Renewal would have been even greater.
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i. Sec. 37.205(b)--Elements of an Acceptable Audit Trail Program
Proposed Sec. 37.205(b) would narrow the scope of audit trail data
that must be captured in a transaction history database under existing
Sec. 37.205(b)(2) by eliminating the requirement that SEFs include in
their electronic transaction history database ``all indications of
interest, requests for quotes, and order and trades entered into'' a
SEF's trading system or platform. Instead, the SEFs would be required
to include only ``trades'' executed via voice or via entry into a SEF's
electronic trading system but must include all ``orders'' that are
entered into an electronic trading system. The Commission additionally
proposes to eliminate the remaining requirements of Sec. 37.205(b)(2)
detailing the information that must be included in transaction history
database. Consistent with the changes to Sec. 37.205(b)(2), the
Commission further proposes to amend Sec. 37.205(b)(3) to clarify that
a SEF's electronic analysis capability must enable the SEF to
reconstruct transactions, rather than ``indications of interest,
requests for quotes, orders, and trades.''
To the extent that the Commission is providing SEFs with greater
discretion in fulfilling their information collection obligations with
respect to audit trail requirements under Sec. 37.205, the Commission
estimates and assumes that SEFs would continue to fulfill their
information collection burdens in a manner similar to the status quo.
Accordingly, the Commission assumes that proposed Sec. 37.205(b) would
not substantively or materially affect a SEF's total information
collection burden hours.
j. Sec. 37.205(c)--Audit Trail Reconstruction
Proposed Sec. 37.205(c) would eliminate the existing requirements
for a SEF to establish an annual audit trail review and a related
enforcement program and instead require the SEF to ``establish a
program to verify its ability to comprehensively and accurately
reconstruct all trading on its facility. . . .'' The Commission
believes that this change will provide SEFs with discretion regarding
what records they must maintain in order to comply with their
information collection requirements, i.e., to determine what components
of their audit, if incomplete or inaccurate, could impair their ability
to conduct effective surveillance, and to determine and implement the
most effective means for enforcing compliance with their audit trail
and recordkeeping requirements.\945\ The Commission also proposes to
adopt guidance to Core Principle 2 in Appendix B specifying that an
effective audit trail reconstruction program should annually review an
adequate sample of executed and unexecuted orders and trades from each
execution
[[Page 62049]]
method offered to verify compliance with Sec. 37.205(c).\946\
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\945\ Notwithstanding these proposed changes, the Commission
notes that to comply with the general audit trail requirement under
proposed Sec. 37.205(a), a SEF must capture all audit trail data
necessary to reconstruct all trading on its facility, detect and
investigate customer and market abuses, and take disciplinary
action, the SEF must ensure that market participants are submitting
accurate and complete audit trail data.
\946\ The Commission proposes to add this guidance to paragraph
(a)(5) to Core Principle 2 in Appendix B. 17 CFR part 37 app. B. As
discussed below, the Commission proposes to eliminate the existing
language in paragraph (a)(5) to Core Principle 2 in Appendix B, see
supra Section VII.E.2.---Sec. 37.206(b)--Disciplinary Program.
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To the extent that the Commission is providing SEFs greater
discretion in fulfilling their information collection obligations with
respect to audit trail requirements under Sec. 37.205, the Commission
estimates and assumes that SEFs would continue to fulfill their
information collection burdens in a manner similar to the status quo.
Accordingly, the Commission will assume that proposed Sec. 37.205(c)
would not substantively or materially affect a SEF's total information
collection burden hours.
k. Sec. Sec. 37.206(b)-(d)--Disciplinary Program
The Commission proposes to eliminate the existing requirements
under (i) Sec. 37.206(c), which currently specify certain minimum
requirements for a SEF disciplinary hearing, including providing a
transcript of the hearing to a respondent under certain conditions; and
(ii) Sec. 37.206(d), which requires that a disciplinary panel render a
written decision promptly following a hearing, along with a detailed
list of information that the SEF must include in the decision. Proposed
Sec. 37.206(b) would generally require a SEF to establish a
disciplinary program to enforce its rules and provide the SEF with the
discretion to administer that program through compliance staff instead
of mandatory disciplinary panels. The Commission also proposes to add
guidance to Core Principle 2 in Appendix B to specify that a SEF's
rules governing the adjudication of a matter by the SEF's disciplinary
panel should be fair, equitable, and publicly available and that a
SEF's rules should require the disciplinary panel to promptly issue a
written decision following a hearing or the acceptance of a settlement
offer.\947\
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\947\ The Commission proposes to add this guidance as part of a
new paragraph (a)(7) to Core Principle 2 in Appendix B.
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To the extent that the Commission is providing SEFs greater
discretion in fulfilling their information collection requirements with
respect to carrying out disciplinary hearing and issuing hearing
decisions, the Commission estimates and assumes that SEFs would
continue to fulfill their information collection burdens in a manner
similar to the status quo. Accordingly, the Commission will assume that
proposed Sec. Sec. 37.206(b)-(d) would not substantively or materially
affect a SEF's total information collection burden hours.
l. Sec. 37.401--General Requirements for Monitoring of Trading and
Trade Processing
Proposed Sec. 37.401(b) would require that a SEF collect and
evaluate data on its market participants' trading activity outside of
the SEF ``as necessary'' rather than ``on an ongoing basis'' as
currently required.\948\ Similarly, proposed Sec. 37.401(c) would
require a SEF to monitor and evaluate general market data to detect and
prevent manipulative activity ``as necessary.'' \949\ The Commission
anticipates that this will reduce annual recurring information
collection burden hours by approximately 50 burden hours per SEF.
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\948\ The proposed amendment would renumber existing subsection
(a) to subsection (b).
\949\ The proposed amendment would renumber existing subsection
(b) to subsection (c).
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m. Sec. 37.1301(b)--General Requirements for Financial Resources
Proposed Sec. 37.1301(b) would permit SEFs that also operate as
DCOs to file a single financial report under Sec. 39.11 that covers
both the SEF and DCO. Because this proposed approach would streamline
and simplify the SEF financial reporting requirement process under
Sec. 37.1306, the Commission estimates that the proposed change would
decrease annual recurring information collection burden by 5 burden
hours. The Commission also estimates that 1 SEF will take advantage of
this approach per year.
n. Sec. 37.1306--Financial Reporting to the Commission
Proposed Sec. 37.1306 would make several changes that would affect
SEFs' information collection burden hours. First, proposed Sec.
37.1306(a) would require SEFs' quarterly financial statement to be
prepare in accordance with GAAP.\950\ Because GAAP-compliant financial
statements generally require additional effort compared to non-GAAP
compliance financial statements, the Commission estimates that the
proposed change would increase annual recurring information collection
burden hours by 10 burden hours and not impose an initial, non-
recurring burden.
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\950\ Alternatively, if a SEF is not domiciled in the United
States and is not otherwise required to prepare financial statements
in accordance with GAAP, then proposed Sec. 37.1306(a)(2)(ii) would
allow the SEF to submit financial statements prepared in accordance
with either International Financial Reporting Standards issued by
the International Accounting Standards Board, or a comparable
international standard that the Commission may otherwise accept in
its discretion.
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Second, proposed Sec. 37.1306(c), among other things, would
require a SEF to determine all of the costs that a SEF would incur to
wind down its operations and the amount of time for the projected wind-
down period, as well as explain the basis for its determinations. The
Commission estimates that proposed Sec. 37.1306(c) will impose an
initial, non-recurring information collection of 20 burden hours
associated with the SEF's obligation to provide a description of the
costs and timing of a projected wind-down scenario, along with the
basis for its determination. Additionally, the Commission estimates
that this information collection burden would impose 5 annual recurring
information collection burden hours after the initial year to update
this information.\951\
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\951\ The Commission notes that existing Sec. 37.1306(c)
requires a SEF to provide ``[s]ufficient documentation'' explaining
both the methodology it used to compute its financial resources
requirement as well as the basis for its determinations regarding
its liquidity requirements. In addition to the change discussed
above, proposed Sec. 37.1306(c) would clarify the type of
information that SEFs must include in the financial statements they
submit to the Commission, including (i) list all of its expenses,
without exclusion, and (ii) identification of all expenses that the
SEF excluded or pro-rated in its projected operating cost
calculations and explain the basis for excluding or pro-rating any
expenses. The Commission believes that these changes are neither an
addition nor modification to existing burden hours since the
Commission is merely clarifying the type of documentation that must
be provided to be deemed ``sufficient'' and are not intended to
increase burden hours or the information that the Commission
originally intended for SEFs to provide. Accordingly, other than as
discussed above, the Commission believes that the proposed amendment
to Sec. 37.1306(c) would not impose new information collection
burdens on SEFs or substantively or materially modify existing
burdens.
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o. Sec. 37.1401(g)--Program of Risk Analysis and Oversight Technology
Questionnaire
Proposed Sec. 37.1401(g) would require a SEF to annually submit an
up-to-date questionnaire that would be located in Appendix A to part 37
(``Questionnaire'') based on the existing Operational Capability
Technology Questionnaire located in Exhibit V to Form SEF in Appendix
A.\952\ A SEF
[[Page 62050]]
would only need to submit new changes to the Questionnaire and would
not need to resubmit any information that has not changed. An applicant
for SEF registration is required to file the Questionnaire pursuant to
Form SEF in order to demonstrate compliance with Core Principle 14 and
Sec. 37.1401.\953\ The majority of the updated Questionnaire would
remain unchanged, although the proposal would additionally include
enterprise technology risk assessments, board of director and committee
information, third-party service provider information, and
cybersecurity threat intelligence capabilities in order to keep up-to-
date with the rapidly changing field of system safeguards and
cybersecurity.
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\952\ The Commission notes that based on the proposed amendments
to Form SEF in Appendix A, Exhibit V would be re-designated as
Exhibit Q of Form SEF. The up-to-date questionnaire would be called
the ``Program of Risk Analysis and Oversight Technology
Questionnaire'' and would be located in Appendix A to part 37. To
the extent that still-current information and documents were
provided in the most recent update to the Questionnaire, a SEF
responding to a System Safeguards Examination document request would
be able to reference that fact, rather than resubmitting such
information and documents.
\953\ The current version of the Questionnaire requests
documents and information pertaining to the following nine areas of
an applicant's program of risk analysis and oversight, including:
(i) Organizational structure, system descriptions, facility
locations, and geographic distribution of staff and equipment,
including organizational charts and diagrams; (ii) enterprise risk
management program and governance, including information regarding
the Board of Directors, audits, and third-party providers; (iii)
information security, including storage of records, access controls,
and cybersecurity threat intelligence capabilities; (iv) business
continuity and disaster recovery plan and resources, including
testing and recovery time objectives; (v) capacity planning and
testing; (vi) system operations, including configuration management
and event management; (vii) systems development methodology,
including quality assurance; (viii) physical security and
environmental controls; and (ix) testing, including vulnerability,
penetration, and controls testing.
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The Commission believes that the aggregate burden hours imposed on
SEFs are mitigated for several reasons. First, an annually-updated
Questionnaire would limit the work required of SEFs in responding to a
System Safeguards Examination document requests to providing updated
information and documents for sections of Exhibit Q that have changed
since the last annual filing. Second, SEFs currently must provide
similar information under existing Sec. Sec. 37.1401(f)-(g).\954\
Third, much of the information comprising a SEF's annual compliance
report would be able to be used for the Questionnaire. Accordingly, the
Commission estimates that proposed Sec. 37.1401(g) would establish a
new collection of information with annual recurring burden hours of 8
burden hours per SEF.
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\954\ The Commission notes that proposed subsection (h)
(renumbered from existing subsection (g)) requires a SEF to provide
to the Commission system safeguards-related books and records,
including (1) current copies of its business continuity-disaster
recovery plans and other emergency procedures; (2) all assessments
of its operational risks or system safeguards-related controls; (3)
all reports concerning system safeguards testing and assessment
required by this chapter; and (4) all other books and records
requested by Commission staff in connection with Commission
oversight of system safeguards or maintenance of a current profile
of the SEF's automated systems. Moreover, Sec. 37.1401(f) requires
a SEF to provide Commission staff with timely advance notice of all
material planned changes to automated systems that may impact
reliability, security, or adequate scalable capacity of such systems
and planned changes to the SEF's program of risk analysis and
oversight.
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p. Sec. 37.1501(d)--Preparation of Annual Compliance Report
Proposed Sec. 37.1501(d) \955\ would make several changes that
would generally reduce burden hours for SEFs. First, under proposed
Sec. 37.1501(d) a SEF would no longer need to include in its annual
compliance report (``ACR'') either a review of all the Commission
regulations applicable to a SEF or identify the written policies and
procedures designed to ensure compliance with the Act and Commission
regulations. Instead, the Commission believes that requiring an ACR to
include a description and self-assessment of the effectiveness of the
SEF's written policies and procedures to ``reasonably ensure''
compliance with the Act and applicable Commission regulations is more
closely aligned with the corresponding provisions of Core Principle 15
and would still allow the Commission to properly assess the SEF's
compliance and self-regulatory programs. Accordingly, the Commission
estimates that proposed Sec. 37.1501(d) would reduce annual recurring
information collection burden hours by approximately 10 burden hours
per SEF.
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\955\ The proposed amendment would renumber existing subsection
(e) to subsection (d).
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Second, proposed Sec. 37.1501(d)(3) would maintain the current
requirement that an ACR describe the ``financial, managerial, and
operational resources'' set aside for compliance with the Act and
Commission regulations, but would eliminate the requirement that a SEF
specifically discuss its compliance staffing and structure; a catalogue
of investigations and disciplinary actions taken over the last year;
and a review of disciplinary committee and panel performance. The
Commission estimates that proposed Sec. 37.1501(d)(3) would reduce
annual recurring information collection burden hours by approximately 5
burden hours per SEF.
Third, to facilitate the Commission's ability to assess a SEF's
written policies and procedures regarding compliance matters, proposed
Sec. 37.1501(d)(4) would require a SEF to discuss only material
noncompliance matters and explain the corresponding actions taken to
resolve such matters.\956\ The Commission believes that requiring SEFs
to focus on describing material non-compliance matters, rather than
describing all compliance matters in similar depth, will streamline
this requirement and provide more useful information to the Commission.
Further, the Commission proposes to eliminate the enumerated mechanisms
for identifying non-compliance issues, which conforms to the ability of
a chief compliance officer (``CCO'') to establish procedures to address
non-compliance issues through ``any means,'' as described above.
Accordingly, the Commission estimates that this change would reduce
annual recurring information collection burden hours per SEF by 3
burden hours.
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\956\ The Commission proposes to renumber paragraph (e)(5) to
paragraph (d)(4) and adopt the amendments as described above and
other non-substantive amendments.
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Fourth, proposed Sec. 37.1501(d)(5) would limit a SEF CCO's
certification of an ACR's accuracy and completeness to ``all material
respects'' of the report. The Commission understands that CCOs have
been hesitant to certify that an entire ACR is accurate and complete
under the penalty of the law, without regard to whether a potential
inaccuracy or omission would be a material error or not. Accordingly,
since the Commission believes that the proposed change would entail
fewer burdens for a CCO to collect the necessary information to enable
the CCO to certify the ACR, the Commission estimates that this change
would reduce annual recurring information collection burden hours per
SEF/CCO by 10 burden hours.
q. Part 36--Trade Execution Requirement
Proposed part 36 would address the swap trade execution requirement
and would eliminate the MAT determination process under existing Sec.
37.10 and Sec. 38.12, as well as the associated compliance schedules
set forth under Sec. 37.11 and Sec. 38.11. Proposed Sec. 36.2 would
require SEFs and DCMs to each respectively file a standardized form
(``Form TER'') to the Commission that details the swaps that they list
for trading that are subject to the trade execution requirement, as
well as include such information on their respective websites. The
Commission estimates that filing these forms and providing the related
information on their website will create a new information collection
with an initial, non-recurring burden of approximately 5 burden hours
per SEF to complete and submit Form TER. Additionally, the Commission
estimates that this
[[Page 62051]]
requirement will impose approximately 5 annual recurring burden hours
per SEF related to updating, or confirming no changes need to be made
to, Form TER. As noted above, there are 25 SEFs currently registered
with the Commission, and the Commission expects up to another 60 SEFs
to register as a result of the Commission's proposed application of the
SEF registration requirement. Accordingly, the Commission estimates
that the information collection burdens related to Form SEF will impose
an aggregate of 425 initial, non-recurring burden hours across 85
entities and an aggregate of 425 annual recurring burden hours across
the same.\957\
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\957\ The current 25 registered SEFs + the 60 entities that the
Commission expects would register as a result of the Commission's
proposed application of the SEF registration requirement = 85 total
entities. Accordingly, 85 total entities x 5 hours per entity = 425
total hours for all SEF entities. The Commission notes that the
related burden hours for the current MAT determination process are
included in separate OMB control number 3038-0099, which estimates 5
annual recurring responses that average 16 burden hours per
response, for a total estimate of 80 annual recurring burden hours
across all SEFs and DCMs. The Commission proposes to eliminate OMB
control number 3038-0099 and transfer the relevant burden to OMB
control numbers 3038-0052 and 3038-0074. While the Commission
expects additional swap products and transactions would become
subject to the Commission's revised interpretation of the trade
execution requirement in CEA section 2(h)(8), the Commission also
expects that 60 additional entities would register as SEFs as a
result of the Commission's application of the SEF registration
requirement. See supra Section XXIII.B.1.a.--Sec. 37.3(a)--
Requirements for Registration. Accordingly, the Commission expects
that any additional burden hours associated with any increase in the
number of swap products traded on SEF or in swap transaction volume
would be covered by the additional burden hours associated with the
60 new entities that the Commission expects to register as SEFs.
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2. Information Collection Comments
The Commission invites the public to comment on any aspect of the
paperwork burdens discussed herein, particularly for those provisions
for which the Commission proposes to eliminate specific requirements
and instead provide SEFs with discretion in complying with their
information collection obligations. Copies of the supporting statements
for the collections of information from the Commission to OMB are
available by visiting RegInfo.gov. Pursuant to 44 U.S.C. 3506(c)(2)(B),
the Commission solicits comments in order to (i) evaluate whether the
proposed collections of information are necessary for the proper
performance of the functions of the Commission, including whether the
information will have practical utility; (ii) evaluate the accuracy of
the Commission's estimate of the burden of the proposed collections of
information; (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information proposed to be
collected; and (vi) minimize the burden of the proposed collections of
information on those who are to respond, including through the use of
appropriate automated collection techniques or other forms of
information technology.
Those desiring to submit comments on the proposed information
collection requirements should submit them directly to the Office of
Information and Regulatory Affairs, OMB, by fax at (202) 395-6566, or
by email at [email protected]. Please provide the Commission
with a copy of submitted comments so that all comments can be
summarized and addressed in the final rule preamble. Refer to the
Addresses section of this notice of proposed rulemaking for comment
submission instructions to the Commission.
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\958\ Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) factors further below. Prior to the section 15(a)
consideration for each set of rules, the Commission separately
discusses the costs, benefits, and potential alternatives to the
approach for the proposed regulations, organized in the following
manner:
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\958\ 7 U.S.C. 19(a).
SEF Registration
(1) Application of SEF Registration Requirement
(2) SEF Registration Process and Related Forms
Market Structure and Trade Execution
(1) Elimination of Minimum Trading Functionality and Execution
Method Requirements
(2) Trade Execution Requirement and Elimination of MAT Process
(3) Pre-Execution Communications and Block Trades
(4) Impartial Access
Compliance and SRO Responsibilities
(1) SEF Trading Specialists
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
(ii) Audit Trail and Surveillance Program
(iii) Compliance and Disciplinary Programs
(iv) Regulatory Service Provider
(3) Error Trade Policy
(4) Chief Compliance Officer
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
(ii) Confirmation and Trade Evidence Record
(iii) Information-Sharing
(6) System Safeguards
Design and Monitoring of Swaps
(1) Swaps Not Readily Susceptible to Manipulation
(2) Monitoring of Trading and Trade Processing
Financial Integrity of Transactions
Financial Resources
The Commission recognizes that the proposed rules may impose costs,
but currently lacks the requisite data and information to reasonably
estimate them. This lack of data and information is attributable in
part to the discretion that a SEF would have under the proposed rules
to achieve compliance by adopting different measures. Accordingly, the
Commission cannot predict the approach that each SEF would adopt to
achieve such compliance. Additionally, the initial and recurring
compliance costs for any particular SEF or market participant would
depend on the size, existing infrastructure, level of swap activity,
and practices and cost structure of the relevant entity. Costs or
benefits may be impacted, for example, if certain entities seek to
avoid the regulations attendant to SEFs by reducing their swap
activities. In situations where the Commission is unable to quantify
the costs and benefits, the Commission identifies and considers the
costs and benefits of the applicable proposed rules in qualitative
terms.
The Commission notes that this consideration is based on its
understanding that the swaps market functions internationally with (i)
transactions that involve U.S. firms occurring across different
international jurisdictions; (ii) some entities organized outside the
U.S. that are prospective Commission registrants; and (iii) some
entities typically operating both within and outside the U.S. who
follow substantially similar business practices wherever located. Where
the Commission does not specifically refer to matters of location, the
cost-benefit discussion below refers to the effects of the proposed
rules on all subject swaps
[[Page 62052]]
activity, whether based on their actual occurrence in the U.S. or on
their connection with, or effect on, U.S. commerce pursuant to CEA
section 2(i).\959\
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\959\ Pursuant to CEA section 2(i), activities outside of the
U.S. are not subject to the swap provisions of the CEA, including
any rules prescribed or regulations promulgated thereof, unless
those activities either have a direct and significant connection
with activities in, or effect on, commerce of the United States; or
contravene any rule or regulation established to prevent evasion of
a Dodd-Frank Act-enacted provision of the CEA. 7 U.S.C. 2(i).
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The Commission generally requests comment on all aspects of its
cost-benefit considerations, including the identification and
assessment of any costs and benefits not discussed therein; the
potential costs and benefits of the alternatives that the Commission
discussed in this release; data and any other information to assist or
otherwise inform the Commission's ability to quantify or qualitatively
describe the costs and benefits of the proposed rules; and
substantiating data, statistics, and any other information to support
positions posited by commenters with respect to the Commission's
discussion. Commenters may also suggest other alternatives to the
proposed approach where the commenters believe that they would be
appropriate under the CEA and would provide a more appropriate cost-
benefit profile.
2. Baseline
The primary focus of the proposed rules is to amend requirements
set forth for swap execution facilities under part 37 of the
Commission's regulations; \960\ the process for a SEF or DCM to make a
swap ``available to trade'' under parts 37 and 38, respectively; \961\
and related regulations under parts 39 and 43. Hence, the Commission
believes that the baseline for the consideration of costs and benefits
is the existing regulations set forth in part 37; Sec. 37.10 and Sec.
38.12; Sec. 39.12(b)(7); and Sec. 43.2. For this reason, the
Commission is considering the changes to costs and benefits, as
compared to the baseline, resulting from the proposed regulations
discussed herein. The Commission notes that some of the proposed rules
would codify existing, time-limited no-action relief and other guidance
issued by Commission staff that market participants and SEFs may have
relied upon to alter their compliance practices with respect to certain
existing rules. To the extent that market participants have relied upon
such relief or staff guidance, the magnitude of the actual costs and
benefits of the proposed rules may not be as significant. The
Commission's cost-benefit discussion will note instances where the
Commission believes that market participants or SEFs have operated
under relevant no-action relief or staff guidance.
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\960\ The Commission adopted the part 37 regulations in 2013.
Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476 (Jun. 4, 2013) (``SEF Core Principles Final
Rule'').
\961\ The Commission adopted the regulation establishing the
process for a SEF or DCM to make a swap ``available to trade'' in
2013. Process for a Designated Contract Market or Swap Execution
Facility To Make a Swap Available to Trade, Swap Transaction
Compliance and Implementation Schedule, and Trade Execution
Requirement Under the Commodity Exchange Act, 78 FR 33606 (Jun. 4,
2013) (``MAT Final Rule'').
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3. SEF Registration
a. Overview
(1) Application of SEF Registration Requirement
The Commission proposes to apply the SEF registration requirements
in CEA section 5h(a)(1) and Sec. 37.3(a)(1) to both (i) swaps broking
entities, including interdealer brokers, that facilitate multiple-to-
multiple swaps trading away from SEFs; and (ii) Single-Dealer
Aggregator Platforms that aggregate single-dealer pages. Accordingly,
these entities would be required to either register as a SEF or become
a part of an existing SEF. Other alternatives, however, include
adjusting their activity to avoid the SEF registration requirement; or
in the case of foreign swaps broking entities, which includes foreign
interdealer brokers that currently facilitate trading, i.e.,
negotiation or arrangement, of swaps transactions for U.S. persons
(``Eligible Foreign Swaps Broking Entities''), working with the
appropriate regulator within their country of domicile to seek an
exemption from registration pursuant to CEA section 5h(g).\962\
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\962\ Pursuant to CEA section 5h(g), the Commission may exempt
facilities from SEF registration if the facility is subject to
comparable, comprehensive supervision and regulation on a
consolidated basis by the appropriate governmental authorities in
the home country of the facility. 7 U.S.C. 7b-3(g).
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The Commission is also proposing to delay the compliance date of
any final rule that applies the SEF registration requirement. For
foreign swaps broking entities, the Commission proposes to delay the
compliance date for a period of two years. This proposed delay would
provide more time for the Commission to further develop its cross-
border regulatory regime, including clarifying the cross-border
jurisdictional reach of the SEF registration requirement under CEA
section 2(i). For U.S. swaps broking entities, including interdealer
brokers, the Commission proposes to delay the compliance date for a
period of six months in order to provide such entities time to obtain
SEF registration.
(2) SEF Registration Process and Related Forms
The Commission proposes several clarifying and streamlining
amendments to Form SEF. Some of the proposed amendments would amend or
eliminate several of the information requirements set forth in the
existing exhibits. For example, the Commission is proposing to
consolidate certain exhibits regarding governance (existing Exhibits C
and G) and personnel (existing Exhibits E and F), as well as eliminate
an exhibit regarding the financial resources of any affiliates
(existing Exhibit J). The Commission is also proposing to clarify
certain information requirements not explicitly enumerated in the
existing requirements, but which have been incorporated in practice as
part of the existing SEF application review process. For example, SEF
applicants would need to provide additional information in Form SEF
about, among other things, the asset classes the SEF applicant intends
to list and submit for clearing (new Exhibit N). The Commission is also
proposing to eliminate the requirement to use Form SEF to request an
amended order of registration; under the proposed rules, a registered
SEF would be able to file a request with the Commission for an amended
order of registration.
Finally, the Commission proposes to revise Sec. 37.4 to exclude
product submissions from the SEF registration process. Section 37.4
currently permits a SEF applicant to submit the terms and conditions of
swaps that it intends to list for trading as part of its application
for registration. Section 37.4 also requires the Commission to consider
such swaps for approval at the time that the Commission issues a SEF's
registration order or, for a dormant SEF, reinstatement of
registration. As proposed, a SEF applicant would have to obtain
registration prior to submitting product terms and conditions or
related amendments under Sec. 40.2 or Sec. 40.3, which govern the
submission of new product terms and conditions or related amendments by
registered entities.
b. Benefits
(1) Application of SEF Registration Requirement
The Commission believes that ensuring that all entities operating
trading systems or platforms that facilitate swaps trading between
multiple market participants are subject
[[Page 62053]]
to the SEF registration requirement would impart substantial benefits
on the swaps market (emphasis added). Ensuring that ``multiple-to-
multiple'' swaps trading activity occurs on a registered SEF should
concentrate the liquidity formation on SEFs and provide oversight
benefits and efficiencies that enhance market integrity. The proposed
application of the SEF registration requirement should help to ensure
that the entire swaps trading process, including pre-trade and post-
trade protocols, occurs on a SEF in most cases; combined with the
proposed interpretation of the trade execution requirement discussed
below, which would require additional swaps to be executed on a SEF,
the proposed application of the registration requirement should bring a
material amount of swaps trading activity under SEF oversight. The
transition of greater trading to a SEF should improve market oversight
by allowing a SEF to monitor a broader swath of the swaps market, which
would result in an enhancement of the Commission's own oversight
capabilities.
Further, increased swaps trading on a SEF also should benefit
market participants, including, among other things, protections to
mitigate abusive trading or other market disruptions via a facility's
audit trail, trade surveillance, market monitoring, recordkeeping, and
anti-fraud and market manipulation rules. Additionally, the use of SEF
mechanisms would help to enhance post-trade efficiencies and facilitate
compliance with related Commission requirements, including pre-trade
credit screening and the submission of transactions for clearing and
reporting. Among other things, the Commission believes that access to
such services could benefit certain market participants more than
others, in particular those who have not previously established access
to such services.
(2) SEF Registration Process and Related Forms
The proposed amendments to Form SEF may benefit potential SEF
applicants, including those swaps broking entities and Single-Dealer
Aggregator Platforms that the Commission anticipates would elect to
register as SEFs, by making a more efficient and potentially less
burdensome SEF registration process. The Commission anticipates that
certain changes to Form SEF would reduce duplicative information
requirements, while also continuing to ensure that it receives
sufficient information to determine whether the applicant is in
compliance with the core principles and Commission regulations. The
additional proposed information requirements include information that
Commission staff has been requesting in practice as part of the SEF
registration process after applicants submit Form SEF. Thus, requiring
this information on Form SEF should increase the efficiency of the SEF
registration process by reducing the number of follow-up questions and
requests. The Commission also anticipates that these proposed
requirements will reduce the amount of time that the Commission needs
to review a completed application.
The Commission also proposes conforming amendments to Form SEF that
are consistent with the proposed regulations. The proposed amendments
prompting the revision or elimination of certain existing information
requirements relate to, among other things, proposed amendments to
existing execution method and financial resource requirements, as
discussed below. The proposal to eliminate the temporary registration
provisions that have expired should have no direct impact on costs or
benefits. Additionally, the Commission proposes to exclude product
submissions from the SEF application process. The Commission believes
that separating these two processes would likely promote efficiency for
both Commission staff and SEF applicants. Otherwise, the review of a
SEF applicant's registration application could be unnecessarily delayed
or stayed because Commission staff may require additional consideration
or analysis of the novelty or complexity of the proposed product.
c. Costs
(1) Application of SEF Registration Requirement
Any swaps broking entity or Single-Dealer Aggregator Platform that
elects to register as a SEF would incur the costs of registering,
owning, and operating a SEF. The Commission previously discussed the
costs of registering and operating a SEF in the SEF Core Principles
Final Rule; \963\ these costs and benefits are further modified by the
proposed amendments described in the preamble above and cost-benefit
considerations discussed further below.
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\963\ SEF Core Principles Final Rule at 33567.
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These entities are likely to incur initial setup costs to upgrade
or create their existing systems or platforms to comply with the SEF
core principles and Commission regulations applicable to SEFs,
including the SEF registration requirement. The Commission recognizes
that the additional ongoing marginal and fixed costs of maintaining a
SEF could be significant for some of these entities. For example, some
of these entities would have to educate their employees on SEF
compliance practices; hire additional employees such as a CCO; and
develop additional functions such as audit trail, trade surveillance,
recordkeeping, and market monitoring.
To avoid or mitigate some of these costs, some swaps broking
entities may become a part of a SEF with whom they are affiliated,
thereby leveraging existing resources; nevertheless, they would likely
still incur one-time costs and some ongoing costs. The Commission also
notes that many swaps broking entities are currently registered with
the Commission as introducing brokers (``IBs''); as such, they already
follow certain similar regulatory requirements, including those related
to oversight and recordkeeping. Therefore, the SEF registration costs
to these entities would likely be lower since they already adhere to
similar regulatory obligations. A Single-Dealer Aggregator Platform
also would need to register as or join a SEF, thereby likely incurring
similar costs.\964\ Similarly, the Commission believes that the cost
for an unaffiliated Single-Dealer Aggregator Platform to become a SEF
or join a SEF would be greater than the cost for a Single-Dealer
Aggregator Platform already affiliated with a SEF.
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\964\ The Commission is aware of one Single-Dealer Aggregator
Platform that is currently affiliated with a SEF.
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The Commission estimates that there are approximately 40-60 swaps
broking entities, including interdealer brokers, that would need to
either register as a SEF or join a SEF as a result of the Commission's
proposed application of the SEF registration requirement.\965\ For some
of these entities, the cost to become a SEF or affiliate with a SEF may
compel them to cease operating trading systems or platforms that
facilitate multiple-to-multiple swaps trading between market
participants. To mitigate these registration costs, the Commission is
proposing a six-month delay to the compliance date for applicable U.S.
swaps broking entities. This proposed delay would provide additional
time for U.S. swaps broking entities to become registered as SEFs,
thereby increasing the opportunity for
[[Page 62054]]
them to continue operating without interruption.
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\965\ These estimates are based on introducing broker
information made available from the National Futures Association
(``NFA''). The NFA information indicates that there more than 300
registered IBs currently designated as a ``swap firm'' that broker
swap products.
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Smaller swaps broking entities or smaller Single-Dealer Aggregator
Platforms may be more likely than larger entities or platforms to
abstain from SEF activities to avoid the SEF registration requirement.
Smaller entities or platforms are less likely to have existing
technology and procedures or available resources to comply with new SEF
requirements; therefore, their initial costs of compliance with those
requirements may be larger or have a proportionally greater effect on
smaller entities. Market participants may also bear some costs if some
entities abstain from SEF activities. For example, market participants
who have utilized these entities to trade swaps would no longer be able
to do so for swaps that must be traded on a SEF or swaps that they
would otherwise want to execute on a SEF. Therefore, these participants
would incur costs that could include search and transition costs to
identify and onboard to new SEFs. In transitioning to a new platform,
those market participants may incur less favorable financial terms or
have access to reduced services.
The Commission estimates that approximately 10-20 of the swaps
broking entities that would potentially need to either register as a
SEF or join a SEF are located outside of the U.S. or otherwise have
operations outside of the U.S. (``Eligible Foreign Swaps Broking
Entities''). To mitigate these registration costs, the Commission is
proposing a two-year delay to the compliance date for Eligible Foreign
Swaps Broking Entities. The proposed delay is likely sufficient for
these entities either to register as SEFs in an orderly manner or to
become subject to comparable and comprehensive supervision from their
home regulators, and thus become eligible for an exemption to the SEF
registration requirement pursuant to CEA section 5h(g). This proposed
delay would also allow these entities more time to avoid operational
disruptions, which should mitigate costs for these entities and limit
disturbances in the swaps markets, while the Commission addresses the
application of CEA section 2(i).
The delayed compliance date for Eligible Foreign Swaps Broking
Entities would also delay the prospective benefits discussed above for
those swaps trading on these foreign entities. However, the Commission
does not anticipate that this delay would draw trading volume away from
domestic SEFs. The Commission understands that market participants
generally use Eligible Foreign Swaps Broking Entities to trade swaps
outside of standard business hours in the U.S. and/or to access
liquidity in other non-U.S. markets. The proposed six-month
implementation window for U.S. swaps broking entities would also delay
the benefits discussed above, but the amount of time needed for an
entity to obtain SEF registration renders the compliance with the
registration requirement by the compliance date of any final rule
impractical.
Additionally, some customers of swaps broking entities and Single-
Dealer Aggregator Platforms may incur the costs of ``onboarding'' with
a SEF, to the extent that these market participants are not currently
customers of a SEF. The Commission's proposal to expand the trade
execution requirement to include all swaps subject to the clearing
requirement that are listed on a SEF would prevent market participants
from trading these swaps off-SEF in most instances. Accordingly, those
market participants who wish to continue to trade these swaps would
have to onboard to a SEF. The Commission estimates that up to 807
market participants in the interest rate swaps (``IRS'') market trade
cleared swaps exclusively off-SEF and thus may need to onboard to a
SEF.\966\ While the IRS market is the largest market by both trading
volume and by notional amount outstanding \967\ among all swap asset
classes, additional market participants trading cleared swaps in the
credit asset class may also need to onboard to a SEF.\968\ Market
participants that must onboard to a SEF would incur costs to integrate
their system with a SEF's interface as well as to train personnel to
comply with a SEF's rulebook. For some market participants, this may
require programming new ways to view, receive, and export information.
Onboarding would also subject these market participants and their
trading to the SEF's jurisdiction, which market participants may view
as another disadvantage. As a result of the costs related to onboarding
and trading on SEFs, certain market participants may reduce their use
of swaps.\969\
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\966\ To estimate the number of market participants in the IRS
market that would choose to onboard with a SEF, the Commission first
analyzed IRS trading during January 2018 and identified market
participants who traded cleared IRS but did not trade an IRS on a
SEF during that month. Then, the Commission compared the list of
legal entity identifiers (``LEIs'') associated with those market
participants to the LEIs of market participants who transacted on a
SEF within the 2017 calendar year and identified the LEIs that have
never transacted on a SEF during the sample period analyzed. The
Commission identified 807 unique LEIs who traded a cleared IRS in
January 2018 but did not trade an IRS on a SEF in 2017 or in January
2018. The Commission notes that these 807 LEIs made up 21 percent of
total IRS notional traded in January 2018 and accounted for 38
percent of the trades.
\967\ According to the International Swaps and Derivatives
Association (``ISDA'') SwapsInfo, the notional volume of trading in
IRS in 2017 was about $192 trillion, as compared to about $7
trillion for credit. ISDA, ISDA SwapsInfo Weekly Analysis: Week
Ending December 22, 2017, https://analysis.swapsinfo.org/2017/12/ird-and-cds-weekly-trading-volume-week-ending-december-22-2017/ (``2017
ISDA SwapsInfo Weekly Analysis''). According to the Bank of
International Settlement statistics on the global OTC derivatives
market, IRS constitute 69 percent of the total OTC derivatives
market, by notional. Bank of International Settlement, https://stats.bis.org/statx/srs/table/d5.1.
\968\ The Commission has not estimated the number of additional
market participants in the credit asset class (who do not also trade
IRS) that may onboard to a SEF as a result of the proposal.
\969\ Similar to the point made above regarding entities
potentially refraining from SEF activities, any perceived
disadvantages of transacting on SEFs may cause some market
participants to alter their risk management processes to avoid or
reduce their transactions on SEFs. If these market participants were
to use more costly or less effective risk management strategies in
place of swaps, this could increase the cost or reduce the
effectiveness of risk management in general.
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To the extent that a market participant's swaps are already
executed on a SEF after being arranged by a swaps broking entity,
however, the Commission does not anticipate that the market participant
would incur significant additional internal costs by using the SEF for
the entire trading process. Some SEFs may charge higher fees for these
trades due to the additional oversight the Commission contemplates that
the SEF would provide.
(2) SEF Registration Process and Related Forms
The Commission proposes to reduce some information requirements as
part of the proposed Form SEF, but would require additional information
in other areas. As a result, the Commission believes that some proposed
changes to Form SEF would reduce costs while others would increase
costs. However, the Commission believes that the cost of preparing Form
SEF, as proposed to be amended, is likely to be comparable to the cost
of preparing the existing Form SEF. Since the additional information
required by Form SEF generally consists of information that the
Commission has been requesting as part of the registration process, SEF
applicants already likely incur the costs associated with providing
that information. Additionally, the Commission proposes to remove the
product submission process from the SEF application process. SEF
applicants may incur additional administrative costs associated with
completing the product submission apart from a SEF
[[Page 62055]]
application.\970\ However, the Commission believes these additional
costs will mostly be related to the format and manner of submission, as
the content of a product submission would materially remain the same.
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\970\ The Commission notes that this change--and the concomitant
benefits and costs--also would affect dormant SEFs, which like SEF
applicants currently may include proposed products as part of their
process to obtain reinstatement of their registration from dormancy.
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d. Section 15(a) Factors \971\
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\971\ The discussion here and in the other section 15(a)
discussions below cover the proposed amendments that the Commission
has identified as being relevant to the areas set out in section
15(a) of the CEA: (i) Protection of market participants and the
public; (ii) efficiency, competitiveness, and financial integrity of
futures markets; (iii) price discovery; (iv) sound risk management
practices; and (v) other public interest considerations. For
proposed amendments that are not specifically addressed within the
respective CEA section 15(a) factor discussion, the Commission has
not identified any effects.
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(1) Protection of Market Participants and the Public
The Commission believes that the proposed application of the
statutory SEF registration requirement to certain entities not
currently registered as SEFs should protect market participants and the
public by helping to ensure that entities that meet the SEF definition
provide the protections associated with SEF core principles and the
Commission's regulations. As noted above, these protections include
audit trail, trade surveillance, market monitoring, recordkeeping, and
anti-fraud and market manipulation rules. The proposed amendments to
the SEF registration process should maintain the protection of market
participants and the public by continuing to help ensure that SEF
applicants provide the Commission with the information it needs to
determine whether the SEF applicant will be able to comply with the SEF
core principles and Commission regulations.
(2) Efficiency, Competitiveness, and Financial Integrity of Markets
The Commission believes that the proposed application of the
statutory SEF registration requirement to certain entities not
currently registered should enhance the competitiveness and financial
integrity of markets since these registered SEFs would be subject to
relevant SEF core principles, including, among others, Core Principles
2, 4, and 15. The Commission also believes that the proposal would
subject entities providing similar services to comparable regulations,
thus increasing the competitiveness of SEFs. The greater use of SEF
functions, such as pre-trade credit screening, submission to DCOs for
clearing, and reporting to SDRs should also enhance efficiencies in the
swaps market. Proposed Form SEF should continue to provide a means for
SEF applicants to demonstrate compliance with core principles related
to financial integrity, including Core Principle 13 regarding SEF
financial resources.
(3) Price Discovery
The Commission believes that the application of the statutory SEF
registration requirement to certain entities not registered as SEFs may
further price discovery in swaps, given that more swap transactions
would be traded on SEFs and more market participants would be
participating on SEFs. This increased trading may enhance the liquidity
of the swaps market on SEFs. The Commission believes that, generally,
market participants would have access to better price discovery in more
liquid markets.
(4) Sound Risk Management Practices
The Commission believes that the proposed application of the
statutory SEF registration requirement to certain entities not
currently registered as SEFs may further sound risk management
practices by helping to ensure that swaps trading occurs subject to the
rules of the SEF and receive the protections associated with the SEF
core principles and Commission regulations.
(5) Other Public Interest Considerations
The Commission believes that the proposal that entities that meet
the SEF definition must register as SEFs should further the public
interest consideration of promoting trading of swaps on SEFs as stated
in CEA section 5h(e).
Request for Comment
The Commission requests comment on all aspects of the consideration
of the costs and benefits of the provisions related to SEF
registration. The Commission estimates that there would be 40 to 60
newly-registered SEFs. For those newly-registered SEFs, and with the
understanding that costs will vary depending on the entity, what would
be the average cost for a newly-registered SEF to comply with the
Commission's proposed new SEF regime? If possible, please provide
itemized costs per requirement. What would be the on-going costs to
comply with that regime?
The Commission believes that many swaps broking entities, including
interdealer brokers, are currently affiliates of a registered SEF. As a
result, the cost of integrating a swaps broking entity's non-registered
SEF into its current SEF registration regime will be significantly less
than those of newly-registered SEFs, i.e., those entities that do not
have a registered SEF as an affiliate. Is the Commission's assumption
correct? If not, then why not? What would be the cost of integrating
and updating an entity's compliance program to reflect the proposed
rule's new and amended requirements? What would be the on-going costs
to comply?
4. Market Structure and Trade Execution
a. Overview
(1) Elimination of Minimum Trading Functionality and Execution Method
Requirements
Based on its increased understanding of swaps trading dynamics and
the increased scope of swaps that would become subject to the trade
execution requirement, the Commission proposes to eliminate the
prescribed execution methods under Sec. 37.9 for swaps subject to the
trade execution requirement. In addition, the Commission proposes to
eliminate the minimum trading functionality and Order Book provisions
under Sec. Sec. 37.3(a)(2)-(3). As a result, for any swap that it
lists, a SEF would be able to offer any execution method that is
consistent with the SEF definition in CEA section 1a(50) and the
general rules related to trading and execution consistent with the SEF
core principles and proposed part 37 rules. In particular, a SEF would
be allowed to offer flexible methods of execution for any swap that it
lists for trading, regardless of whether or not the swap is subject to
the trade execution requirement.
In order to effect Core Principle 2, the existing rules under Sec.
37.201 would be replaced with new general, disclosure-based trading and
execution rules that would apply to any execution method offered by a
SEF. Proposed Sec. 37.201(a) would require a SEF to specify (i) the
protocols and procedures for trading and execution; (ii) the extent to
which the SEF may use its ``discretion'' in facilitating trading and
execution; and (iii) the sources and methodology for generating any
market pricing information.
(2) Trade Execution Requirement and Elimination of MAT Process
The Commission proposes to eliminate the ``Made Available to
Trade'' (``MAT'') process and proposes to interpret the trade execution
requirement in CEA section 2(h)(8) to require swaps to be executed on a
SEF or DCM if a swap is both subject to the
[[Page 62056]]
clearing requirement in section 2(h)(1) of the Act and listed for
trading on a SEF or DCM. The current rule, by contrast, creates a
process for a swap to be categorized as ``MAT'' under Sec. 37.10 and
Sec. 38.12 that is largely driven by a registered SEF or DCM.
The Commission further proposes to use its authority pursuant to
CEA section 4(c) \972\ to exempt four different types of swap
transactions from the trade execution requirement. Specifically, the
Commission proposes that counterparties be exempted from the trade
execution requirement for (i) swap transactions involving swaps that
are listed for trading only by an Exempt SEF (as opposed to a
registered SEF or DCM); (ii) swap transactions that are subject to and
meet the requirements of the clearing exception under 2(h)(7) of the
Act or the clearing exceptions or exemptions under part 50 of the
Commission's regulations; (iii) swap transactions that are executed as
a component of a package transaction that includes a component that is
a new issuance bond; and (iv) swap transactions between ``eligible
affiliate counterparties'' (``inter-affiliate counterparties'') that
elect to clear such transactions, notwithstanding their ability to
elect the clearing exemption under Sec. 50.52.
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\972\ CEA section 4(c) empowers the Commission, if certain
conditions are met and subject to certain limitations, to ``promote
responsible economic or financial innovation and fair competition''
by exempting any transaction or class of transactions, including
swaps, from the provisions of the CEA. 7 U.S.C. 6(c).
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To facilitate compliance with the proposed interpretation of the
trade execution requirement, the Commission proposes a compliance
schedule, based on participant type, for the additional swaps that
would become subject to the trade execution requirement. Under the
proposal, entities would fall into categories based on their swaps
trading experience and resources: Category 1 entities would have a 90-
day compliance timeframe; Category 2 entities would have 180 days, and
all other relevant entities would have 270 days to allow them to
onboard onto a SEF, a DCM, or an Exempt SEF and to comply with the
trade execution requirement. The Commission also is proposing to
establish a centralized registry on its website to identify those SEFs
and DCMs that list swaps subject to the trade execution requirement and
the particular swaps listed on each entity. To establish the registry,
the Commission is proposing to require SEFs and DCMs to file a
standardized Form TER, concurrently with any Sec. 40.2 or Sec. 40.3
product filing, that would detail the swaps that they list for trading
that are subject to the clearing requirement. In turn, Form TER would
provide a streamlined process to allow the Commission to provide market
participants with a public registry of the SEFs and DCMs that list
particular swaps for trading. Finally, the Commission is also proposing
that DCMs and SEFs be required to publicly post their Form TER on their
respective websites.
(3) Pre-Execution Communications and Block Trades
For swaps subject to the trade execution requirement, proposed
Sec. 37.201(b) would require a SEF to prohibit its market participants
from engaging in pre-execution communications away from its facility,
including negotiating or arranging the terms and conditions of a swap
prior to its execution on the SEF via the SEF's methods of execution.
In conjunction with prohibiting pre-execution communications and pre-
arranged trading under Sec. 37.203, the Commission is eliminating the
fifteen-second time delay requirement under Sec. 37.9(b). Under
proposed Sec. 37.203, SEFs must prohibit pre-arranged trading for
trading systems or platforms such as Order Books, where pre-arranged
trading would be considered to be an abusive trading practice. This
prohibition, however, would be subject to certain proposed exceptions.
First, swap transactions that are not subject to the trade execution
requirement would be excluded from the proposed prohibition. Second,
package transactions that also include components that are not subject
to the trade execution requirement would also be excluded from that
proposed prohibition.
The Commission also proposes to revise the definition of ``block
trade'' in existing Sec. 43.2 to eliminate the ``occurs away''
requirement for swap block trades on SEFs. Pursuant to the revised
definition, counterparties that seek to execute swaps at or above the
block trade size on a SEF must do so on a SEF's trading system or
platform, rather than away from the SEF pursuant to its rules as
currently required. For swaps subject to the trade execution
requirement, counterparties would not be able to conduct pre-execution
communications to negotiate or arrange a block trade away from the
SEF.\973\ Commission staff has provided time-limited no-action relief
from the ``occurs away'' requirement of the block trade definition
under Sec. 43.2, and the Commission understands that some market
participants have elected to execute their block trades on-SEF pursuant
to that relief.\974\
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\973\ The Commission notes that market participants may pre-
negotiate or pre-arrange block trades for swaps that are not subject
to the trade execution requirement subject to an exception to the
proposed prohibition on pre-execution communications under proposed
Sec. 37.201(b).
\974\ CFTC Letter No. 17-60, Re: Extension of No-Action Relief
for Swap Execution Facilities from Certain ``Block Trade''
Requirements in Commission Regulation 43.2 (Nov. 14, 2017).
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(4) Impartial Access
Proposed Sec. 37.202 would modify the impartial access
requirements to allow a SEF to devise its participation criteria based
on its own trading operations and market. Specifically, a SEF would be
required to establish rules that set forth impartial access criteria
for accessing its markets, market services, and execution methods; such
impartial access criteria must be transparent, fair, and non-
discriminatory and applied to all similarly situated market
participants. Based on this approach, the Commission would not require
a SEF to maintain impartial access in a manner that promotes an ``all-
to-all'' trading environment. Rather, a SEF would be allowed to serve
different types of market participants or have different access
criteria for different execution methods in order to facilitate trading
for a desired market.
In addition to amending the impartial access requirement, the
Commission also proposes several other related amendments. Under
proposed Sec. 37.202(a)(1), a SEF would no longer be required to
provide impartial access to ISVs. Further, under proposed Sec.
37.202(a)(2), a SEF would be allowed to establish fee structures in a
fair and non-discriminatory manner. This revision would eliminate the
existing requirement under Sec. 37.202(a)(3), which requires a SEF to
set ``comparable fees'' for ``comparable access.''
b. Benefits
(1) Elimination of Minimum Trading Functionality and Execution Method
Requirements
The Commission believes that eliminating the minimum trading
functionality requirement would provide several benefits. Based on its
experience, the Commission has observed that market participants have
generally not used Order Books for swaps trading on SEFs despite their
availability for all SEF-listed swaps.\975\
[[Page 62057]]
The Commission recognizes that market participants view Order Books as
unsuitable for trading in a large segment of the swaps market and
believes that eliminating this requirement would reduce costs by
enabling SEFs to discontinue their use as a method of execution or
limit their availability, based on their own discretion, to swaps that
are liquid enough to support such trading.\976\ Moreover, new SEFs
would be able to register without setting up an Order Book, which
should significantly reduce the cost of establishing a SEF.
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\975\ A recent research study finds that for index CDS, a
minimal amount of trading activity on the two highest-volume SEFs
occurs via an order book. Lynn Riggs, Esen Onur, David Reiffen &
Haoxiang Zhu, Mechanism Selection and Trade Formation on Swap
Execution Facilities: Evidence from Index CDS 10 (2017), https://www.cftc.gov/idc/groups/public/@economicanalysis/documents/file/oce_mechanism_selection.pdf (``2017 Riggs Study'').
\976\ The Commission notes that additional factors, such as the
use of name give-up and the lack of certain trading features, may
have also contributed to the limited use of Order Books.
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The Commission also believes that eliminating the required methods
of execution for swaps subject to the trade execution requirement and
instead allowing flexible means of execution on SEFs together with
expanding the scope of swaps subject to the trade execution
requirement, may further the statutory goal of promoting the trading of
swaps on SEFs more effectively than the current SEF framework. As a
result of their bespoke or customized structure, the Commission
recognizes that swaps that currently are not MAT, but that would become
subject to the trade execution requirement under the Commission's
proposal, may be less liquid than current MAT swaps, and therefore, may
be less suited for execution via an Order Book or a request-for-quote
system that sends a quote to no less than three unaffiliated market
participants and operates in conjunction with an Order Book (``RFQ
System'').
Under the proposed approach, market participants would be allowed
to utilize execution methods that best suit their trading needs and the
swap being traded.\977\ These needs may include the desire to minimize
potential information leakage and front-running risks and/or the need
to account for market conditions for those swaps at a given time.\978\
Allowing market participants to choose the appropriate method of
execution for their trading needs may increase market efficiency and
lower transaction costs since market participants are expected to seek
out the most efficient and cost-effective method of execution to carry
out their swaps trading needs and to select the appropriate level of
pre-trade transparency for their transactions.\979\ For example, a
market participant whose primary goal is obtaining best execution in
the market can choose the execution method that provides the
appropriate degree of pre-trade transparency, based on the swap's
characteristics and the trader's execution options and their individual
trading needs, including submitting a RFQ to more than three liquidity
providers. A market participant that perceives benefits from
maintaining a relationship with a particular liquidity provider (such a
relationship may extend beyond the swap market) can choose an execution
method that facilitates that goal.\980\
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\977\ For example, Michael Barclay, Terrence Hendershott and
Kenneth Kotz studied mechanism choice for U.S. Treasury securities
and have found that Treasury securities move from primarily
electronic trading to primarily voice trading when there is an
exogenous decline in trading volume. Michael Barclay, Terrence
Hendershott, Terrence & Kenneth Kotz, Automation versus
intermediation: Evidence from Treasuries going off the run, 61 J.
Fin. 2395-14 (2006).
\978\ The 2017 Riggs Study finds that in the index CDS market
customers exercise discretion over transacting via RFQ versus
streaming quotes depending on the size of their trades or the
urgency of their trading needs. The study also shows that customers
can choose to send RFQs to more than the minimum required number of
three participants when their trade size is smaller and again when
their transactions are more urgent. 2017 Riggs Study at 10.
\979\ Terrence Hendershott and Ananth Madhavan looked at trading
in corporate bonds where customers can trade bonds either through
voice solicitation of dealer quotes or through an electronic
exchange that initiates an RFQ. Broadly speaking, Hendershott and
Madhavan find that bonds that have characteristics associated with
more frequent trading are more likely to be traded through the RFQ
process, while trading tends to move to a voice mechanism when bonds
go off-the-run and liquidity falls. Comparing the costs between
execution methods, they found that electronic trades are associated
with lower trading costs for small trades, but that voice
solicitation is cheaper for larger trades. Terrence Hendershott &
Ananth Madhavan Click or call? Auction versus search in the over-
the-counter market, 70 J. Fin. 419-47 (2015).
\980\ The 2017 Riggs Study finds that in the index CDS market,
customers are more likely to seek quotes via the RFQ process from
dealers affiliated with their clearing members, as well as from
dealers who make up a larger fraction of the customer's past trading
volume. 2017 Riggs Study at 27.
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SEFs would have broader latitude to innovate and develop new and
different methods of execution tailored to their markets. Accordingly,
the proposed flexibility would enable SEFs to provide their market
participants with additional choices for executing swaps subject to the
trade execution requirement beyond the Order Book or RFQ System. Such
methods could be more efficient for a broader range of swaps and
various market liquidity conditions, which may allow SEFs to
effectively promote appropriate counterparty and swap-specific levels
of pre-trade price transparency.\981\ This potential innovation of
efficient, transparent, and cost-effective trading means would
facilitate natural market evolution via SEFs, which may ultimately
lower transaction costs and increase trading efficiency.
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\981\ For example, Darrell Duffie and Haoxiang Zhu suggest that
work-ups can sometimes be a more efficient means of transacting than
a limit order book. See Darrell Duffie & Haoxiang Zhu, Size
Discovery, 30 Rev. Fin. Stud. 1095-1150 (2017).
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This approach may also increase SEF competition as SEFs seek to
differentiate from one another based on execution methods that they
offer. The Commission believes that such increased competition may lead
to reduced costs and increased transparency for market participants.
The Commission further believes that flexible means of execution may
provide opportunities for new entrants in the SEF market. New entrants
would be able to utilize unique or novel execution methods that are not
currently offered by incumbent SEFs. The Commission believes that new
entrants would help increase competition in the market, which may lead
to reduced transaction costs.
The Commission anticipates that SEFs with active Order Books would
continue to offer them, such that customers who wish to transact on
Order Books would continue to be able to do so. The Commission also
notes that swap transactions on SEFs will continue to be subject to the
part 43 real-time reporting requirements, so market participants would
continue to benefit from the post-trade transparency associated with
access to information about the most recent transaction price.
While the Commission is proposing to allow SEFs to utilize flexible
methods of execution, the Commission is concurrently proposing under
Sec. 37.201(a) to require that SEFs implement various trading and
execution-related rules, which would require SEFs to disclose in their
rulebook the protocols and procedures of the execution methods they
offer, including any discretion the SEF may have in facilitating
trading and execution, e.g., in regards to price formation or bid/offer
matching. The Commission believes that these rules should provide
market participants a requisite level of transparency by requiring SEFs
to disclose information regarding their execution methods, trading
systems, and operations. By requiring such disclosure, the Commission
believes that SEFs would provide market participants with a consistent
level of information so that they are better able to make fully
informed decisions when selecting a SEF or particular execution method.
[[Page 62058]]
The Commission believes that promoting such transparency also helps
promote market efficiency and integrity.
(2) Trade Execution Requirement and Elimination of MAT Process
The Commission believes that expanding the scope of swaps that must
be traded and executed on SEFs or DCMs would directly promote more SEF
trading, which is one of the Dodd-Frank Act's statutory goals. As noted
above, data analyzed by Commission staff indicates that the percentage
of IRS trading volume that is subject to the trade execution
requirement declined from approximately 10 to 12 percent of total
reported IRS volume in 2015 to approximately 7 to 9 percent of total
reported IRS volume in 2017 and the first half of 2018.\982\ According
to an ISDA analysis, the share of total reported IRS volumes that
occurred on SEFs since 2015 has ranged between approximately 55 to 57
percent of total reported IRS volumes.\983\
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\982\ Commission staff conducted an analysis of publicly
available data accessed via Clarus Financial Technology
(``Clarus''). In a separate analysis, ISDA found that only 5 percent
of trading volume in IRS during 2015 and the first three quarters of
2016 consisted of IRS subject to the trade execution requirement.
ISDA, ISDA Research Note: Trends in IRD Clearing and SEF Trading 1,
3, 11 (Dec. 2016), https://www.isda.org/a/xVDDE/trends-in-ird-clearing-and-sef-trading1.pdf (``2016 ISDA Research Note'').
\983\ See, e.g., ISDA, ISDA SwapsInfo Weekly Analysis: Week
Ending October 19, 2018, https://analysis.swapsinfo.org/2018/10/interest-rate-and-credit-derivatives-weekly-trading-volume-week-ending-october-19-2018/ (``2018 ISDA SwapsInfo Weekly Analysis'');
ISDA, ISDA SwapsInfo Weekly Analysis: Week Ending December 22, 2017,
https://analysis.swapsinfo.org/2017/12/ird-and-cds-weekly-trading-volume-week-ending-december-22-2017/ (``2017 ISDA SwapsInfo Weekly
Analysis''); ISDA, ISDA SwapsInfo Weekly Analysis: Week Ending
December 24, 2015, https://analysis.swapsinfo.org/2015/12/ird-and-cds-weekly-analysis-week-ending-december-24-2015/ (``2015 ISDA
SwapsInfo Weekly Analysis'').
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A recent ISDA analysis also shows that more than 85 percent of IRS
trading volume is subject to the clearing requirement.\984\ The
Commission believes that much, but not all, of that trading volume
consists of swaps that are listed for trading on a SEF. With respect to
credit default swaps (``CDS''), ISDA's analysis has shown that 71 to 79
percent of trading volume in index CDS has occurred on SEFs since
2015,\985\ while just over 89 percent of CDS trading volume is subject
to the clearing requirement.\986\ Since only a portion of IRS and CDS
trading that is also subject to the clearing requirement has occurred
on SEFs, the Commission believes that additional IRS and CDS trading
may transition to SEFs as a result of the proposed expansion of the
trade execution requirement to cover all swaps that are subject to the
clearing requirement and listed for trading on a SEF or DCM.
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\984\ ISDA, ISDA Research Note: Actual Cleared Volumes vs.
Mandated Cleared Volumes: Analyzing the US Derivatives Market 3
(July 2018), https://www.isda.org/a/6yYEE/Actual-Cleared-Volumes-vs-Mandated-Cleared-Volumes.pdf (``2018 ISDA Research Note'').
\985\ See, e.g., 2018 ISDA SwapsInfo Weekly Analysis; 2017 ISDA
SwapsInfo Weekly Analysis; 2015 ISDA SwapsInfo Weekly Analysis.
These market share estimates are based on total SEF volume in the
asset class divided by total volume in the asset class. In both
cases, the volume is expressed in notional amount and includes both
cleared and uncleared swaps. Since ISDA uses part 43 data that
contains capped notional amounts pursuant to Sec. 43.4(h), while
the actual notional amounts are not capped, the Commission notes
that these estimates likely overstate SEF market share.
\986\ 2018 ISDA Research Note at 15-16.
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The Commission believes that the expanded trade execution
requirement would ensure that more swaps trading occurs on SEFs. In
turn, increased swaps trading on SEFs would help foster and concentrate
liquidity and price discovery on SEFs. This may help increase market
efficiency and competition between market participants, which would
further decrease transaction costs. Further, the Commission believes
that a broad trade execution requirement, in conjunction with the
proposed prohibition on pre-execution communications, would ensure that
swaps trading occurs on SEFs, which may further amplify the preceding
benefits.
Bringing more swaps trading on to SEFs, including the entire
liquidity formation process, would allow these swap trades to directly
benefit from SEF oversight (including audit trail, trade surveillance,
market monitoring, recordkeeping, and anti-fraud and market
manipulation rules) and services that enhance market integrity
(including pre-trade credit checks, straight through processing, and
reporting to SDRs). Additionally, the Commission expects liquidity
pools on SEFs to improve for various products that would become subject
to the expanded trade execution requirement as a result of an increase
in the number of market participants. This may further improve
liquidity, and an increase in the number of products traded on SEFs,
which would allow market participants to have direct access to more
price observations for these products compared to the current SEF
framework. With an increase in the amount of transactions on SEFs, the
Commission also believes, that since SEFs would have more market data,
they may be better equipped to fulfill their Core Principle 4 duties,
as discussed further below. As such, the Commission believes that with
direct access to more trades, a SEF may be better situated to prevent
manipulation, price distortion, or disruptions to the functioning of an
orderly market, which is likely to benefit all market participants.
In conjunction with the Commission's proposed interpretation of the
trade execution requirement, the Commission is proposing to exempt
certain transactions from this requirement. The proposed exemptions in
CEA section 4(c) cover (i) swap transactions involving swaps that are
listed for trading only by an Exempt SEF; (ii) swap transactions that
are subject to and meet the requirements of the clearing exception in
CEA section 2(h)(7) or the clearing exceptions or exemptions under part
50 of the Commission's regulations; (iii) swap transactions that are
executed as a component of a package transaction that includes a
component that is a new issuance bond; \987\ and (iv) swap transactions
between inter-affiliate counterparties that elect to clear such
transactions, notwithstanding their ability to elect the clearing
exemption under Sec. 50.52. The Commission believes that exempting
these swap transactions that would otherwise be subject to the trade
execution requirement would be beneficial for the swaps markets. These
exemptions would appropriately calibrate the trade execution
requirement to appropriate market participants and swap transactions,
which can reduce the cost of trading.
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\987\ The Commission understands that a bond issued and sold in
the primary market that may constitute part of a package transaction
is a ``security,'' as defined in section 2(a)(1) of the Securities
Act of 1933 or section 3(a)(10) of the Securities Exchange Act of
1934. To the extent that counterparties may be facilitating package
transactions that involve a security, or any component agreement,
contract, or transaction over which the Commission does not have
exclusive jurisdiction, the Commission does not opine on whether
such activity complies with other applicable law and regulations.
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The Commission is proposing to exempt swaps that are listed only by
an Exempt SEF from triggering the trade execution requirement. Since it
may be burdensome for a U.S. person to identify and onboard with an
Exempt SEF that is the only platform listing a swap that is subject to
the expanded trade execution requirement, the Commission believes that
exempting these swaps from the trade execution requirement until they
are listed by a registered SEF or a DCM would reduce such burdens.
The Commission is also proposing to exempt from the expanded trade
execution requirement those transactions that are excepted or exempted
from the clearing
[[Page 62059]]
requirement. The Commission believes that swap transactions exempted
from the clearing requirement may benefit from the proposed exemption
by providing counterparties with flexibility regarding where they can
trade or execute such swaps, which the Commission believes may help
counterparties reduce transaction costs that they would otherwise incur
from mandatory trading or execution on a SEF.
Furthermore, the Commission is proposing to exempt ``package
transactions'' that involve swap and new issuance bond components. In
light of the involvement of the bond issuer and the underwriter in
arranging and executing a package transaction in conjunction with a new
issuance bond and the unique negotiation and fit-for-purpose nature of
these package transactions, the Commission understands that it remains
difficult or impossible to trade these package transactions on a SEF.
Market participants currently may rely on Commission staff's temporary
no-action relief to trade MAT swaps that involve new issuance bonds
away from a SEF.\988\ The proposed rule would ensure that package
transactions involving new issuance bonds can be traded off-SEF on an
ongoing basis.
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\988\ See CFTC Letter No. 17-55, Re: Extension of No-Action
Relief from Sections 2(h)(8) and 5(d)(9) of the Commodity Exchange
Act and from Commission Regulations 37.3(a)(2) and 37.9 for Swaps
Executed as Part of Certain Package Transactions (Oct. 31, 2017)
(``NAL No. 17-55'').
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Finally, the Commission proposes to exempt from the trade execution
requirement any swap transaction between inter-affiliate counterparties
that elect to clear such transactions, notwithstanding their ability to
elect the clearing exemption under Sec. 50.52. Under the current
rules, inter-affiliate transactions are only exempt from the trade
execution requirement if the inter-affiliate counterparties elect not
to clear the transaction. However, despite these transactions not being
intended to be price-forming or arm's length and therefore not suitable
for trading on SEFs, inter-affiliate counterparties that elect to clear
their inter-affiliate transactions are subject to the trade execution
requirement. This proposal instead would treat cleared and uncleared
inter-affiliate swap transactions the same with respect to the trade
execution requirement. The Commission believes that this approach would
be beneficial because inter-affiliate swap transactions do not change
the ultimate ownership and control of swap positions (or result in
netting) and permitting them to be executed internally (provided that
they qualify for the clearing exemption under existing Sec. 50.52) may
reduce costs relative to requiring that they be executed on SEF.
Finally, the Commission believes that this exemption may help ensure
that inter-affiliate counterparties are not discouraged from clearing
their inter-affiliate swap transactions in order to avoid having to
trade them on SEFs subject to the trade execution requirement, which
may have systemic risk benefits.\989\
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\989\ The Commission notes that the Division of Market Oversight
had previously provided no-action relief that mirrors this proposal
so these benefits may have already been realized. See CFTC Letter
No. 17-67, Re: Extension of No-Action Relief from Commodity Exchange
Act Section 2(h)(8) for Swaps Executed Between Certain Affiliated
Entities that Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Dec. 14, 2017) (``NAL No. 17-67'').
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The proposed trade execution requirement compliance schedule is
intended to recognize that different categories of counterparties have
different abilities and resources for achieving compliance with the
trade execution requirement. As such, a phased compliance schedule
should benefit counterparties by providing them with more time to adapt
to the expanded trade execution requirement.
Proposed Form TER, which would provide for a uniform submission by
SEFs and DCMs of information on swaps subject to the clearing
requirement that are listed by such SEFs and DCMs, is intended to
provide the Commission with the information needed to create a trade
execution registry. This registry, in combination with the proposal
requiring that DCMs and SEFs publicly post their Form TER on their
websites, should benefit market participants and the public by
facilitating determinations of whether a swap is subject to the trade
execution requirement.
(3) Pre-Execution Communications and Block Trades
The Commission proposes to prohibit pre-execution communications
for transactions subject to the trade execution requirement. The
Commission believes that this prohibition would ensure that for swaps
subject to the trade execution requirement, the trading of such swaps
actually occurs within the confines of the SEF, which the Commission
believes, in conjunction with the proposed interpretation of the trade
execution requirement, would help foster and concentrate liquidity and
price discovery which may help increase market efficiency and decrease
transaction costs, as discussed above. Further, the Commission believes
that with trading occurring within the SEF, market participants would
receive the protections associated with SEF trading, as discussed
above. With an expanded scope of swaps subject to the trade execution
requirement, the Commission is concerned that allowing a
disproportionate amount of SEF transactions to be pre-arranged or pre-
negotiated away from the facility under the pretense of trading
flexibility would undercut the impact of the expansion of the
requirement. Without a limitation on pre-execution communications that
occur away from the SEF, the SEF's role in facilitating swaps trading
would be diminished, undermining the statutory goals of promoting
greater swaps trading on SEFs and pre-trade price transparency.
The Commission does not intend to impose this prohibition on swap
transactions not subject to the trade execution requirement and certain
package transactions. These exceptions would allow those participants
who wish to voluntarily execute such trades on a SEF to do so without
having to alter their current trading practices. These exceptions are
intended to recognize the practical realities of executing these types
of swaps, which are often highly customized, on SEFs.
The Commission also proposes to amend the block trade definition to
require that counterparties that seek to execute swaps that are above
the block trade size on a SEF must do so on a SEF's trading system or
platform and not away from the SEF pursuant to its rules. Requiring
market participants to execute swap block trades on a SEF should help
SEFs facilitate the pre-execution screening by futures commission
merchants (``FCM'') of transactions against risk-based limits in an
efficient manner through SEF-based mechanisms. Further, the proposed
amendments regarding block trades on SEFs would promote the statutory
goal in CEA section 5h(e) of promoting swaps trading on SEFs. The
Commission notes that many market participants currently rely on no-
action relief under which some block trades currently trade on-SEFs,
and that this benefit has largely already been realized for these
swaps.\990\
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\990\ See CFTC Letter No. 17-60, Re: Extension of No-Action
Relief for Swap Execution Facilities from Certain ``Block Trade''
Requirements in Commission Regulation 43.2 at 2 (Nov. 14, 2017)
(``NAL No. 17-60'').
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(4) Impartial Access
Proposed Sec. 37.202 would allow SEFs greater discretion to
establish certain
[[Page 62060]]
types of trading markets for certain types of participants through the
use of access criteria, including fees. The Commission recognizes that
many SEFs believe they are limited in the types of trading markets and
services that they can develop and maintain because the current
impartial access rule can be applied to promote an ``all-to-all''
trading environment, which is neither required under Core Principle 2
nor is consistent with swaps market structure. The Commission
recognizes that some SEFs would like to target specific sectors of the
swaps market and tailor their trading systems or platforms, as well as
swap products, for trading among certain types of market participants.
The Commission believes that affirmatively allowing SEFs the ability to
target and design their SEFs to cater to certain market participants
should result in an overall increase in swap market liquidity.
The proposed clarification to the impartial access requirement
should allow SEFs to adapt to existing trading practices in the swaps
market, which feature different types of access-related practices. For
example, the Commission recognizes that some entities in the dealer-to-
dealer market, e.g., interdealer broker operations, operate based on
fee structures that account for a host of business considerations,
including discounts based on past or current trading volume
attributable to the market participant, market maker participation, or
pricing arrangements related to services provided by a SEF-affiliated
entity involving other non-swap products. The Commission's proposed
approach to fee requirements under Sec. 37.202(a)(2) would allow these
types of entities, which would be subject to the SEF registration
requirement under the Commission's clarification of Sec. 37.3(a), to
continue to facilitate certain trading markets and maintain existing
pools of liquidity. Maintaining certain types of markets, such as the
dealer-to-dealer market, should be beneficial to all market
participants, including participants in the dealer-to-client market. In
particular, the availability of liquidity and certain pricing to a
dealer's clients in the dealer-to-client market may be dependent upon
the ability of dealers to operate in a dealer-to-dealer market, where
it is easier to offload risk. The Commission expects that continuing to
apply the existing approach--``comparable fees'' for ``comparable
services''--to the dealer-to-dealer environment may diminish the
economic benefits of, and therefore impede, SEFs from developing
additional services to facilitate trading.
The Commission notes that the benefits from this proposed change
may already be realized to some degree as de facto dealer-to-dealer
SEFs already exist under the current rule, and it is difficult to
predict what innovative services, if any, SEFs may offer in the future.
However, the proposed rule would explicitly allow SEFs to provide
tailored services, as long as they meet the requirement that their
access rules are transparent, fair, and non-discriminatory.
c. Costs
(1) Elimination of Minimum Trading Functionality and Execution Method
Requirements
The Commission proposes to eliminate the minimum trading
functionality requirement that SEFs offer an Order Book for all swap
transactions. The Commission notes that some market participants may
not perceive a significant cost from the lack of availability of an
Order Book because the Order Books on many SEFs exhibit little or no
trading activity and contain few or no bids and offers, despite SEFs
maintaining them over the past few years. This suggests that market
participants are not currently using the available Order Books and may
therefore not perceive a cost if the Order Books are eliminated.\991\
As noted above, the Commission anticipates that SEFs with active Order
Books would continue to offer them; however, the Commission also
believes that these existing Order Books, as a result of greater
flexibility in execution methods, may see a negative impact to
liquidity, which may be offset by an increase in liquidity on SEFs that
offer other means of execution. Market participants may incur costs to
integrate their systems with the new trading methodologies offered by
SEFs. For some market participants, this may require programming new
ways to interact with SEFs. Expanding the requirement to use SEFs for
swap transactions would also increase the extent of SEFs' jurisdiction
over market participants' trading, which market participants may view
as a disadvantage or an increased cost. If market participants react to
this by using other means of risk management in place of the swaps that
are required to be traded on SEF, then their risk management processes
may be more disadvantageous or costlier.
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\991\ To the extent that requiring SEFs to offer Order Books
facilitates their eventual use, the proposed elimination of the
minimum trading functionality under Sec. 37.3 creates a potential
decrease in future pre-trade price transparency. If SEFs decide to
stop offering Order Books pursuant to this proposal, some swaps
markets may not be able to move onto an Order Book even if there is
future interest from some market participants. This cost would be
mitigated to the extent that SEFs can always reinstate their order
books in response to customer demand or offer other execution
methods that provide similar pre-trade price transparency benefits.
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As noted above, the Commission anticipates that competitive
pressures may drive SEFs to offer flexible execution methods, which may
impose additional costs on SEFs. The Commission believes that these
additional costs may be mitigated, as SEFs would have the option, under
the proposal, of continuing their existing execution practices.
The Commission recognizes that the overall amount of pre-trade
price transparency in swap transactions currently subject to the trade
execution requirement may decline if the Order Book and RFQ-to-3
requirement under existing Sec. 37.9 are eliminated. This potential
reduction in pre-trade price transparency could reduce the liquidity of
certain swaps trading on SEFs and increase the overall trading costs.
The Commission believes that this increased cost may be most severe for
smaller customers that trade infrequently, and therefore may not be
aware of current swaps pricing without pre-trade price transparency.
The purpose of the Sec. 37.9 requirement that transactions in
swaps subject to the trade execution requirement be executed using an
Order Book or an RFQ System is to ensure that all activity in these
swaps benefit from a baseline amount of pre-trade price transparency,
i.e., knowledge of multiple bids and offers that may be available.
While the proposal may result in a reduction of the benefits from the
existing system, this cost may be mitigated because every SEF still has
the option of offering an Order Book and continuing to offer market
participants the ability to submit RFQs to multiple liquidity providers
on the SEF. Accordingly, the Commission anticipates that market
participants would not need to forgo the pre-trade transparency
associated with these means of execution. Further, the Commission notes
that to the extent that SEFs and other market participants respond to
the proposed approach by offering flexible execution methods, market
participants should benefit by having the opportunity to choose an
execution method with a more appropriate level of pre-trade
transparency for their transactions and their swaps trading needs.
[[Page 62061]]
According to a Commission staff research paper \992\ that analyzed
SEF trading in index CDS \993\ subject to the trade execution
requirement, approximately 45 percent of the RFQs were sent to three
liquidity providers and the remaining 55 percent were sent to four or
more. The mean number of RFQ recipients was 4.12.\994\ The Commission
anticipates that all or most of the market participants making RFQs to
four or more liquidity providers would continue to send RFQs to
multiple participants, even absent a rule requiring them to do so. Some
percentage of those market participants currently sending RFQs to
exactly three liquidity providers would probably send requests to only
one or two liquidity providers if they were allowed to, but the
Commission is unable to estimate what percentage of market participants
would choose to send RFQs to fewer liquidity providers. As noted, those
market participants sending RFQs to only one liquidity provider would
be forgoing pre-trade transparency, but would be doing so voluntarily.
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\992\ 2017 Riggs Study at 11.
\993\ The Commission has not performed a similar analysis for
IRS.
\994\ The Commission understands that one of the two SEFs
analyzed currently limits the number of liquidity providers
receiving a single RFQ-to-five participants.
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The Commission notes that the cost of a potential decline in pre-
trade price transparency may be offset by the possible benefits from
greater liquidity by permitting SEFs to offer other execution methods
in episodically liquid markets. Additional execution methods like
auction systems, to the extent SEFs decide to offer them, and other
potential execution methods may be offered in response to the proposal
and could be used to facilitate pre-trade price transparency at lower
costs, particularly if SEFs also offer indicative quotes or indicative
market clearing prices to participants.\995\
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\995\ The Commission is aware of existing periodic auction
mechanisms that aim to aggregate the buy and sell interests for a
given swap and to clear the market by displaying the market mid-
price to the market participants and allowing them to transact on
that price.
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Proposed Sec. 37.201(a), which would require SEFs to disclose in
their rulebook the protocols and procedures of execution methods they
offer, including any discretion in facilitating trading and execution
would impose administrative costs on SEFs. The Commission believes that
those costs are similar to those imposed by existing Sec. 37.201(a),
which establishes similar disclosure requirements, but would be more
tailored to existing SEF execution methods.
(2) Trade Execution Requirement and Elimination of MAT Process
The proposed elimination of Sec. 37.10 and Sec. 38.12 and the
proposed interpretation of the trade execution requirement as codified
under Sec. 36.1(a) would likely require some market participants to
onboard to a SEF or DCM, if they have not already done so, in order to
continue trading swaps. The costs for a market participant to onboard,
along with the time various market participants would have to join a
SEF or DCM under the compliance schedule, and trade on a SEF, discussed
above, are also relevant.
To the extent more swaps are traded on SEFs or DCMs as a result of
the proposed interpretation of the trade execution requirement as set
out under Sec. 36.1(a), SEFs and DCMs may incur additional costs, as
part of their normal course of business, to update their systems to
accommodate the increased number of products listed. Because this would
be an expansion built on top of existing systems, the Commission does
not expect the costs associated with this expansion to be substantial.
Additionally, the Commission believes that the proposed exemptions for
certain swaps from the trade execution requirement would not impose new
costs on market participants or on SEFs.
The Commission expects there to be some cost to SEFs and DCMs
related to the proposed Form TER requirement, where they would have to
submit the specific relevant economic terms of the swaps they list for
trading to the Commission (and posted on the website) in a timely
manner. These costs are discussed in relation to the Commission's
analysis above of information collection burdens under the PRA that are
affected by the proposed rules.
(3) Pre-Execution Communications and Block Trades
Under the proposal, pre-execution communications for swaps subject
to the trade execution requirement would have to occur within the
confines of a SEF and could not occur outside of the SEF's facilities.
In practice, this would mean that pre-execution communications between
dealers and their customers could not occur through non-SEF telephones,
email systems, instant messaging systems, or other means of
communication outside of the SEF. SEFs would incur costs if they choose
to set up telephone conference lines, proprietary instant messaging or
email systems, or any other system within the SEF to facilitate pre-
execution communications within the confines of the SEF.
SEFs could potentially use existing technology to facilitate pre-
execution communications on SEF, thus mitigating some potential costs.
The proposal could also impose costs on dealers and their customers
since they commonly communicate via telephone or other systems today
and may have to change their communication or trading practices to
comply with the proposed rule. The costs for market participants would
be mitigated to the extent that SEFs elect to incur the costs of
providing telephone or other systems for their market participants to
use for pre-execution communications, but costs may then increase
correspondingly for SEFs.
The proposed amendment to the block trade definition to require
that counterparties that seek to execute swaps that are above the block
trade size on a SEF must do so on a SEF's trading system or platform
would cause these transactions to incur the costs of trading on a SEF
as discussed above. To the extent market participants react to these
costs by reducing their use of block trades, they may be disadvantaged,
incur additional costs, or hinder the effectiveness of their risk
management program.
(4) Impartial Access
The proposed changes to the impartial access requirement, which
would not require an ``all-to-all'' market as envisioned by the current
rules, may inhibit the ability of certain market participants to access
certain trading markets and liquidity pools. Under the proposed
changes, SEFs may be able to offer markets that feature levels of
liquidity and competitive pricing that only a limited category of
participants could access. For example, SEFs that desire to serve the
dealer-to-dealer segment of the market may have access criteria that
certain participants cannot meet, thus preventing those participants
from onboarding and from providing bids and offers, which could be
disadvantageous to those participants and otherwise reduce access to
favorable prices and impede price competition. Although the proposed
changes to impartial access would require a SEF to allow those who seek
and are able to meet set criteria to participate on its trading system
or platform, this approach may still permit SEFs to impose barriers to
access.
Additionally, allowing different trading markets to operate and
accommodate a limited set of market participants for similar or the
same swaps may impose costs through
[[Page 62062]]
information asymmetries. For example, a SEF that serves a dealer-to-
dealer segment and a SEF that services a dealer-to-client segment may
feature different pricing for certain standardized IRS. Participants in
the dealer-to-client market, who do not have access to the pricing and
volume information of these dealer-to-dealer SEFs, may not have
beneficial pricing information available on the latter that would
otherwise help to inform their trading. This may increase costs for
those market participants with information disadvantages.
The Commission notes, however, that the current SEF market
structure and participation have generally continued to develop along
these traditional market segments, absent the proposed access criteria.
Therefore, the Commission anticipates that costs to market participants
may not change much from the current situation.
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
The Commission anticipates that the proposed interpretation of the
trade execution requirement, which may result in an expanded scope of
swaps being required to trade on SEFs, coupled with the proposed ban on
pre-execution communications for swaps subject to the trade execution
requirement away from the facility, would help improve the protection
of market participants and the public by allowing SEFs to more
effectively surveil their markets and prevent manipulation and
disruption to the functioning of an orderly swaps market. The proposed
rules are expected to facilitate more transactions on SEFs, ensure that
such transactions are executed entirely on SEFs, and facilitate more
market participants trading on SEFs, effectively allowing SEFs to have
direct access to more data and have direct visibility to a larger
portion of the market.
The Commission anticipates that the proposed exemptions for certain
swaps from the trade execution requirement should not materially affect
the protection of market participants and the public. The proposed
exemptions are intended to allow a limited number of swap transactions
otherwise subject to the trade execution requirement to occur off-SEF
where there is good reason to do so. These include transactions that
involve end-users who are eligible for the end-user exception to both
the clearing requirement and the trade execution requirement,
transactions that are currently exempt under Part 50 from the clearing
requirement, and transactions that cannot readily be executed on a
registered SEF, even in light of the proposed rules allowing
flexibility of execution methods.
The Commission believes that the proposed flexible execution
methods should promote protection of market participants and the public
by facilitating the trading of swaps on SEFs, including those swaps
newly subject to the trade execution requirement. The Commission also
believes that the proposed amendment to the block trade definition
should help protect market participants and the public by moving block
trades to SEFs with the associated protections described above. The
proposal to prohibit pre-execution communications for transactions
subject to the trade execution requirement away from the facility
should help to ensure that the entire process of trading and executing
a transaction would occur on SEF. Swaps traded on SEFs receive the
protections associated with the SEF core principles and Commission
regulations, including, among other things, monitoring of trading and
prohibitions against manipulation and other abusive trading practices.
The Commission believes that proposed Sec. 37.201(a), which would
require SEFs to disclose in their rulebook the protocols and procedures
of execution methods they offer, including any discretion in
facilitating trading and execution, should help protect market
participants and the public by ensuring that they are informed about
how these various execution methods operate.
The elimination of the mandatory Order Book and RFQ System
execution methods for Required Transactions may reduce the benefits
associated with pre-trade price transparency. In the absence of pre-
trade price transparency, a counterparty may not obtain swaps at
current market prices. However, the Commission believes that the
approach taken in the proposed rule should promote pre-trade price
transparency in the swaps market by allowing execution methods that
maximize participation and concentrate liquidity during times of
episodic liquidity.
(2) Efficiency, Competitiveness, and Financial Integrity of Markets
The Commission anticipates that the proposed interpretation of the
trade execution requirement, which may result in an expanded scope of
swaps being required to trade on SEFs, should improve the efficiency
and competitiveness of the swaps markets. Although SEFs and market
participants may incur costs in trading an expanded scope of swaps on
SEFs, the Commission expects that markets would become more efficient
as a whole, since an increase in the number of market participants
trading on SEFs should allow liquidity demanders to more efficiently
locate liquidity providers and trade with them. These efficiency gains
may be attenuated, however, if the costs of SEF trading are higher than
expected or if market participants respond to the expanded trading
requirement by reducing their use of swaps that are required to be
traded on SEF.
The Commission believes competitiveness can also improve through
more market participants trading on SEFs that offer a variety of
trading mechanisms, some of which can be designed to improve
competitiveness and liquidity formation in the market. To the extent
these market participants did not have access to such trading
mechanisms, they should benefit from increased competition and
liquidity formation. Improvements in competiveness would be attenuated,
however, if the increase in trading on SEFs is less than anticipated.
The Commission anticipates that the proposed exemptions from the
trade execution requirement, as discussed above, may maintain the
current efficiency of those trades and thus maintain the financial
integrity of the counterparties. The Commission believes that the
proposed exemptions are narrowly tailored and thus, should not
materially affect the competitiveness of the swap markets.
The Commission believes that the proposed rules allowing flexible
execution methods should enhance the efficiency and financial integrity
of markets by providing an opportunity for SEFs to offer more execution
methods that may be more efficient and cost-effective for their
customers than those currently offered. The proposal to prohibit pre-
execution communications for transactions subject to the trade
execution requirement away from the facility should enhance the
financial integrity of markets by helping to ensure that such
communications receive the protections to financial integrity
associated with SEF core principles, including Core Principle 7. Under
the proposal, market participants should continue to have access to
pre-trade price transparency, which should continue to promote
competitive bid-ask spreads, e.g., by submitting RFQs to multiple
liquidity providers or by using additional execution methods that
should be just as good at promoting pre-
[[Page 62063]]
trade price transparency as order books and RFQ systems.\996\
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\996\ As noted above, however, to the extent that the Order Book
and other methods of execution mandated by the current rule promote
pre-trade price transparency, the proposed elimination of this
mandate may impair competition if it reduces market participants'
ability to observe pre-trade prices, and thereby lose insight into
competitive conditions in the market.
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Additionally, the Commission's proposal to create and publish the
trade execution requirement registry on its website should benefit
market participants and increase efficiency by reducing uncertainty
about whether a swap is required to be traded on a certain platform.
Similarly, the Commission's proposal that a SEF publicly post its Form
TER on its website also reinforces the efficiency benefit for market
participants, albeit at the expense incurred by DCMs and SEFs related
to Form TER filings, as discussed above.
The Commission believes that the proposed changes to impartial
access may enhance the efficiency, competitiveness, and financial
integrity of markets by allowing SEFs to develop trading platforms and
fee structures that better reflect the underlying features of the
products traded on the SEF and customer needs. This can facilitate
competition between liquidity providers, leading to better pricing for
all traders that participate in the relevant segment of the market. The
proposed revision to the impartial access rule might impair competition
by preventing some traders from providing or accessing liquidity on
some SEFs or having access to the most up-to-date pricing information.
Impaired access to liquidity or pricing information may result in some
market participants transacting in swaps at uncompetitive terms.
(3) Price Discovery
The Commission believes that in general market participants should
have access to better price discovery in more liquid markets under the
proposed rule, because it should result in a higher number of products
being traded on SEFs by an increased number of market participants.
With increased transactions on SEFs, through an increase in number of
products as well as in market participants, SEFs would offer more price
points on the same or comparable products and potentially more bids and
offers. This increased trading on SEFs may also offset any impairment
to price discovery resulting from a loss in pre-trade price
transparency from the elimination of the mandate to offer specified
trading methods. The Commission expects all of these improvements to
culminate in better and faster price discovery for market participants,
although improvements in price discovery may be attenuated if the
increase in trading on SEFs is less than anticipated.
While, as a general matter, the Commission believes that price
discovery in swaps subject to the trade execution requirement should
occur on SEFs, the Commission nevertheless believes that the proposed
exemptions from the trade execution requirement should not materially
impact price discovery in the U.S. swaps markets. Many of the
transactions eligible for the exemptions, such as inter-affiliate
trades, are not price-forming or involve end-users, while other
eligible transactions in swaps that are only listed by Exempt SEFs
cannot readily be traded on a registered SEF.
The Commission believes that the proposal to prohibit pre-execution
communications for transactions subject to the trade execution
requirement away from the facility should further price discovery on
SEFs by helping to ensure that all negotiations related to price
discovery occur on SEFs. The proposed amendment to the block trade
definition would also tend to encourage more price discovery on SEFs.
The proposed flexible execution methods would provide SEFs an
opportunity to develop innovative execution methods that could enhance
the price discovery process.
To the extent that the revised impartial access rules lead to a
less competitive market, the market also may suffer from reduced price
discovery.
(4) Sound Risk Management Practices
The Commission believes the proposed expansion of the trade
execution requirement may further sound risk management practices by
requiring that a larger set of swap transactions are negotiated,
arranged, and executed in a manner that is subject to the rules of a
SEF and that those trades receive the protections associated with SEF
core principles and Commission regulations.
The Commission anticipates that the proposed exemptions from the
trade execution requirement should not significantly impair the
furtherance of sound risk management practices because firms using the
exemptions should continue to be able to move swap positions between
affiliates and take advantage of the statutory end-user exception from
the clearing requirement. Exempting certain transactions that cannot
readily be executed on a SEF, such as package transactions involving
new issuance bonds and transactions in swaps that are only listed by
Exempt SEFs, should allow entities using these swaps to continue their
sound risk management practices.
The Commission believes that the proposed rules enabling flexible
execution methods and requiring that pre-execution communications for
transactions subject to the trade execution requirement occur on-SEF
may further sound risk management practices by requiring that these
trades are negotiated, arranged, and executed on a SEF and that these
trades receive the protections associated with SEF core principles and
Commission regulations. Similarly, the Commission believes that the
proposed rules enabling flexible execution methods should promote
trading on SEFs and increase the number of transactions receiving these
protections, thereby facilitating greater choice by market participants
in execution methods that better suit their risk management needs,
including allowing market participants to reduce potential information
leakage and front-running risks. These improvements may be attenuated
if the increase in trading on SEFs is less than anticipated. The
proposed amendment to the block trade definition may further sound risk
management practices by requiring block trades to occur on SEFs, while
still allowing reporting delays pursuant to Part 43, which may give
liquidity providers time to hedge such block trades before they are
reported.
(5) Other Public Interest Considerations
The Commission believes the proposed interpretation of the trade
execution requirement and the proposed flexibility in execution methods
would further the public interest consideration of promoting trading on
SEFs as stated in CEA section 5h(e), while also continuing to provide
market participants with access to the pre-trade price transparency
offered by certain SEF execution methods. While the Commission is
proposing to eliminate the minimum trading functionality requirement
that SEFs offer an Order Book or other prescribed trading methods for
all swap transactions, the Commission anticipates that market
participants would still be able to realize pre-trade price
transparency by sending RFQs to multiple market participants or using
other multiple-to-multiple execution methods offered by SEFs that seek
to encourage transparency and concentrate liquidity formation.
The Commission believes that the proposal to prohibit pre-execution
[[Page 62064]]
communications for transactions subject to the trade execution
requirement away from the facility and the proposed amendment to the
block trade definition should also further the public interest
consideration of promoting trading on SEFs by moving additional trading
activity to SEFs.
Request for Comment
The Commission requests comment on all aspects of the consideration
of the costs and benefits of the provisions related to market structure
and trade execution.
5. Compliance and SRO Responsibilities
a. Overview
(1) SEF Trading Specialists
The Commission is proposing to adopt regulations under Sec.
37.201(c) that would categorize certain persons employed by a SEF as a
``SEF trading specialist.'' The Commission proposes to define a SEF
trading specialist as any natural person who, acting as an employee (or
in a similar capacity) of a SEF, facilitates the trading or execution
of swaps transactions (other than in a ministerial or clerical
capacity), or who is responsible for direct supervision of such
persons. The Commission proposes to require a SEF to ensure that its
SEF trading specialists are not subject to a statutory disqualification
under sections 8a(2) or 8a(3) of the Act, have met certain proficiency
requirements, and undergo ethics training on a periodic basis. Proposed
Sec. 37.201(c) also would require a SEF to establish standards of
conduct for its SEF trading specialists, and to diligently supervise
their activities.
Proposed Sec. 37.201(c)(2) would prohibit a SEF from permitting a
person who is subject to a statutory disqualification under section
8a(2) or 8a(3) of the Act to serve as a SEF trading specialist if the
SEF knows, or in the exercise of reasonable care should know, of the
statutory disqualification. There are certain exceptions for persons
who have retained registration in other categories despite the
disqualification.\997\
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\997\ Specifically, the Commission proposes an exception to the
prohibition under Sec. 37.201(c)(2) for any person listed as a
principal or registered with the Commission as an associated person
of a futures commission merchant, retail foreign exchange dealer,
introducing broker, commodity pool operator, commodity trading
advisor, or leverage transaction merchant, or any person registered
as a floor broker or floor trader, notwithstanding that such person
is subject to a disqualification from registration under sections
8a(2) or 8a(3) of the Act. The Commission is proposing an additional
exception to the requirement under Sec. 37.201(c)(2) for any person
otherwise subject to a disqualification from registration for whom a
registered futures association (``RFA''), provides a notice stating
that if the person applied for registration with the Commission as
an associated person, the registered futures association would not
deny the application on the basis of the statutory disqualification.
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Proposed Sec. 37.201(c)(3) would require a SEF to establish and
enforce standards and procedures, including taking and passing an
examination \998\ to ensure that its SEF trading specialists have the
proficiency and knowledge necessary to fulfill their responsibilities
to the SEF as SEF trading specialists; and comply with applicable
provisions of the Act, Commission regulations, and the rules of the
SEF.
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\998\ Such an examination would be developed and administered by
an RFA.
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Proposed Sec. 37.201(c)(4) would require a SEF to establish and
enforce policies and procedures to ensure that its SEF trading
specialists receive ethics training on a periodic basis.
Proposed Sec. 37.201(c)(5) would require a SEF to establish and
enforce policies and procedures that require its SEF trading
specialists, in dealing with market participants and fulfilling their
responsibilities to the SEF, to satisfy standards of conduct as
established by the SEF.
Finally, proposed Sec. 37.201(c)(6) would require a SEF to
diligently supervise the activities of its SEF trading specialists in
facilitating trading on the SEF.
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
Proposed Sec. 37.2(b) would define ``market participant.'' Part 37
specifies that a SEF's jurisdiction applies to various market
participants who may be involved in trading or executing swaps on its
facility; to date, SEFs have been relying on preamble language
describing a ``market participant'' provided in the SEF Core Principles
Final Rule to determine the scope of jurisdiction. By clarifying and
codifying the market participant definition in the part 37, the
Commission would maintain the existing recordkeeping responsibilities
of traders that meet the proposed definition, as well as the
jurisdiction SEFs have with respect to those traders. For example,
under Sec. 37.404(b), a SEF is required to adopt rules that require
its market participants to keep records of their trading, including
records of their activity in any index or instrument used as a
reference price, the underlying commodity, and related derivatives
markets. In addition, a SEF is required to have means to obtain that
information.
The key change to the proposed definition of market participant
from the existing approach under part 37 is the exclusion of clients of
asset managers or other similar situations. As noted above, ``market
participants'' are subject to certain recordkeeping requirements, and
under this definition, such clients would not be subject to these
recordkeeping requirements.
(ii) Audit Trail and Surveillance Program
The Commission proposes a number of changes to the existing rules
regarding SEF audit trail and surveillance programs. First, the
Commission proposes amending the audit trail requirements by moving
certain Sec. 37.205(a) requirements to guidance to Core Principle 2 in
Appendix B. This guidance would state that audit trail data should be
sufficient to reconstruct all indications of interest, requests for
quotes, orders, and trades. The Commission also proposes to remove the
requirement to capture post-trade allocation information. Second, the
Commission proposes to eliminate the prescriptive requirements that
specify the nature and content of the original source documents under
Sec. 37.205(b)(1). Third, the Commission would replace Sec.
37.205(c)'s audit trail enforcement requirement with an audit trail
reconstruction requirement, which would be focused on verifying a SEF's
ability to reconstruct audit trail data rather than enforcing audit
trail requirements on market participants. Fourth, the Commission
proposes amending Sec. 37.203(d), Sec. 37.205(b)(2), and Sec.
37.205(b)(3) to relieve a SEF's obligation to conduct automated
surveillance on orders that are not entered into an electronic trading
system or platform, e.g., orders entered by voice or certain other
electronic communications, such as instant messaging and email.\999\
Fifth, the Commission proposes amending Sec. 37.203(d) to eliminate
the enumerated capabilities that every automated surveillance system
must have and to instead require that the automated surveillance system
be able to detect and reconstruct potential trade practice violations.
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\999\ Sections 37.203(d), 37.205(b)(2), and 37.205(b)(3) require
a SEF that offers any form of voice trading functionality, as a
condition to its registration, to establish a voice audit trail
surveillance program to ensure that it can reconstruct a sample of
voice trades and review such trades for possible trading violations.
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(iii) Compliance and Disciplinary Programs
The Commission proposes several amendments to the rules that
address a SEF's compliance program. First, the
[[Page 62065]]
Commission proposes to amend Sec. 37.203(f)(1) to state that SEFs must
establish and maintain procedures requiring compliance staff to conduct
investigations, including the commencement of an investigation upon the
receipt of a request from Commission staff or upon the discovery or
receipt of information by the SEF that indicates the existence of a
reasonable basis for finding that a violation may have occurred or will
occur.\1000\ Second, the Commission proposes eliminating existing Sec.
37.203(f)(2)'s 12-month requirement for completing investigations and
providing SEFs the ability instead to complete investigations in a
timely manner taking into account the facts and circumstances of the
investigation.\1001\
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\1000\ The Commission proposes adding language in the guidance
to Core Principle 2 in Appendix B stating that compliance staff
should submit all investigation reports to the CCO or other
compliance department staff responsible for reviewing such reports
and determining next steps in the process, and that the CCO or other
responsible staff should have reasonable discretion to decide
whether to take any action, such as presenting the investigation
report to a disciplinary panel for disciplinary action. 17 CFR part
37 app. B.
\1001\ For purposes of Sec. 37.203(f)(2), the Commission
proposes to provide SEFs with reasonable discretion to determine the
timely manner in which to complete investigations pursuant to the
guidance to Core Principle 2 in Appendix B. 17 CFR part 37 app. B.
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Third, the Commission proposes several amendments to the rules that
address a SEF's disciplinary program. Proposed Sec. 37.206(b) requires
that a SEF administer its disciplinary program through one or more
disciplinary panels, as currently allowed, or through its compliance
staff. The Commission also proposes to simplify a SEF's disciplinary
procedures by eliminating the following requirements: (1) Existing
Sec. 37.206(c), which sets forth minimum requirements for a hearing,
and (2) existing Sec. 37.206(d)'s requirement that a disciplinary
panel render a written decision promptly following a hearing, along
with detailed items required to be included in the decision, and
replacing it with guidance for proposed Sec. 37.206(b) to specify that
a SEF's rules should require the disciplinary panel to promptly issue a
written decision following a hearing or the acceptance of a settlement
offer. Consistent with the changes to Sec. 37.206(b), the Commission
proposes to eliminate paragraphs (a)(11)-(12) from the guidance to Core
Principle 2 in Appendix B addressing Sec. 37.206(b), which provides
specific guidelines for a SEF's ability to provide rights of appeal to
respondents and issue a final decision.
Additionally, proposed Sec. 37.206(c) would establish certain
requirements for warning letters that already apply to sanctions, and
would allow more than one warning letter within a rolling 12-month
period for entities, as well as for individuals for rule violations
related to minor recordkeeping or reporting infractions. As a
streamlining and conforming change, the Commission also proposes to
eliminate the existing warning letter requirement from Sec.
37.203(f)(5), and combine this requirement into proposed Sec.
37.206(c).
(iv) Regulatory Service Provider
The Commission proposes several amendments to the rules that
address a SEF's use of regulatory service providers. Proposed Sec.
37.204(a) expands the scope of entities that may provide regulatory
services to include any non-registered entity approved by the
Commission. The Commission also proposes to combine and amend existing
Sec. Sec. 37.204(b)-(c), resulting in several changes to the
supervision requirements of a regulatory services provider (``RSP'').
First, proposed Sec. 37.204(b) eliminates the requirement that the SEF
hold regular meetings and conduct periodic reviews of the provider and
instead allows SEFs to determine the necessary processes for
supervising their RSP. Second, under proposed Sec. 37.204(b) a SEF may
allow its RSP to make substantive decisions, provided that, at a
minimum, the SEF is involved in such decisions. Third, the Commission
proposes to eliminate the requirement under Sec. 37.204(c) that a SEF
document where its actions differ from the RSP's recommendations,
deferring instead to the SEF and its RSP to mutually agree on the
method it will use to document substantive decisions.
(3) Error Trade Policy
Proposed Sec. 37.203(e) would require that SEFs establish and
maintain rules and procedures that facilitate the resolution of error
trades in a fair, transparent, consistent, and timely manner as opposed
to the requirement in existing Sec. 37.203(e) that SEFs have the
authority to adjust trade prices or cancel trades in certain
situations. The definition of ``error trade'' under Sec. 37.203(e)
would include any swap transaction executed on a SEF that contains an
error in any term of the swap transaction, including price, size, or
direction. However, this definition would not include a swap that is
rejected from clearing for credit reasons, and a SEF's error policy
would not apply.\1002\ At a minimum, such error policy would have to
provide the SEF with the authority to adjust an error trade's terms or
cancel the error trade, and specify the rules and procedures for market
participants to notify the SEF of an error trade, including any time
limits for notification. The proposed rule would also impose the new
requirement that a SEF notify all of its market participants, as soon
as practicable of (i) any swap transaction that is under review
pursuant to the SEF's error trade rules and procedures; (ii) a
determination that the trade under review is or is not an error trade;
and (iii) the resolution of any error trade, including any trade term
adjustment or cancellation.
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\1002\ Consistent with proposed Sec. 37.702(b)(1), a SEF would
deem any swap that is rejected from clearing for credit reasons as
void ab initio.
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(4) Chief Compliance Officer
The Commission proposes several amendments to the chief compliance
officer (``CCO'') regulations. First, the Commission proposes to allow
the senior officer \1003\ of a SEF to have the same oversight
responsibilities with respect to the CCO as the SEF's board of
directors. Specifically, the Commission proposes to (i) amend existing
Sec. 37.1501(b)(1)(i) to allow a CCO to consult with either the board
of directors or senior officer of the SEF as the CCO develops the SEF's
policies and procedures; (ii) amend existing Sec. 37.1501(c)(1)(iii)
\1004\ to allow a CCO to meet with either the senior officer of the SEF
or the board of directors on an annual basis; (iii) amend existing
Sec. 37.1501(c)(1)(iv) \1005\ to allow the CCO to provide self-
regulatory program information to the SEF's senior officer or to the
board of directors; and (iv) eliminate the restriction under existing
Sec. 37.1501(c)(3) that removal of the CCO requires approval of a
majority of the board of directors or a senior officer if the SEF does
not have a board of directors, and instead permit the board of
directors or the senior officer to remove the CCO under Sec.
37.1501(b)(3)(i).
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\1003\ As discussed below, the Commission proposes to define
``senior officer'' to mean the chief executive officer or other
equivalent officer of the swap execution facility.
\1004\ This requirement is in proposed Sec. 37.1501(b).
\1005\ This requirement is in proposed Sec. 37.1501(b)(6).
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Second, the Commission proposes to consolidate and amend existing
Sec. Sec. 37.1501(d)(5)-(6) \1006\ to allow a CCO to identify
noncompliance matters through ``any means,'' in addition to the
currently prescribed detection methods,
[[Page 62066]]
and to clarify that the procedures followed to address noncompliance
issues must be ``reasonably designed'' by the CCO to handle, respond,
remediate, retest, and resolve noncompliance issues identified by the
CCO. The Commission also proposes to amend the CCO's duty to resolve
conflicts of interest under existing Sec. 37.1501(d)(2).\1007\ The
Commission proposes to refine the scope of the CCO's duty to address
``reasonable steps'' to resolve ``material'' conflicts of interest that
may arise.
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\1006\ This requirement is in proposed Sec. 37.1501(c)(5).
\1007\ This requirement is in proposed Sec. 37.1501(c)(2).
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Third, the Commission is proposing certain amendments to the annual
compliance report (``ACR'') regulations in existing Sec.
37.1501(e),\1008\ that would eliminate duplicative or unnecessary
information requirements and streamline existing requirements. The
Commission proposes to eliminate existing Sec. 37.1501(e)(2)(i), which
requires an ACR to include a review of all of the Commission
regulations applicable to a SEF and identify the written policies and
procedures designed to ensure compliance with the Act and Commission
regulations and eliminate certain specific content required under
existing Sec. 37.1501(e)(4).\1009\ The Commission also proposes to
amend existing Sec. 37.1501(e)(5) \1010\ to require a SEF to only
discuss material noncompliance matters and explain the corresponding
actions taken to resolve such matters, rather than describing all
compliance matters. The Commission proposes to amend existing Sec.
37.1501(e)(6) \1011\ to limit a SEF CCO's certification of an ACR's
accuracy and completeness to ``all material respects'' of the report.
The Commission also proposes to streamline and reorganize the remaining
ACR content requirements, including consolidating the CCO's required
description of the SEF's policies and procedures under existing Sec.
37.1501(e)(1) \1012\ with the CCO's required assessment of the
effectiveness of these policies and procedures under existing Sec.
37.1501(e)(2)(ii) and also consolidating the CCO's required narrative
of any material changes made during the prior year with the CCO's
required narrative of any forthcoming recommended changes and areas of
improvement to the compliance program as required under existing Sec.
37.1501(e)(3) and existing Sec. 37.1501(e)(2)(iii),\1013\
respectively.
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\1008\ This requirement is in proposed Sec. 37.1501(d).
\1009\ This requirement is in proposed Sec. 37.1501(d)(3). The
proposed eliminated provisions currently require a discussion of the
SEF's compliance staffing and structure, a catalogue of
investigations and disciplinary actions taken over the last year,
and a review of disciplinary committee and panel performance.
\1010\ This requirement is in proposed Sec. 37.1501(d)(4).
\1011\ This requirement is in proposed Sec. 37.1501(d)(5).
\1012\ This requirement is in proposed Sec. 37.1501(d)(1).
\1013\ This requirement is in proposed Sec. 37.1501(d)(2).
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Fourth, the Commission proposes several amendments to simplify the
ACR submission procedures. The Commission proposes to amend existing
Sec. 37.1501(f)(2) \1014\ to provide SEFs with an additional 30 days
to file the ACR with the Commission, but no later than 90 calendar days
after a SEF's fiscal year end. Additionally, the Commission proposes to
eliminate the ``substantial and undue hardship'' standard required for
filing ACR extensions and replace it with a ``reasonable and valid''
standard currently set forth in existing Sec. 37.1501(f)(4).\1015\ The
Commission also proposes to clarify existing Sec. 37.1501(f)(3) \1016\
to provide that, as required for initial compliance reports, the CCO
must submit an amended ACR to the SEF's board of directors or, in the
absence of a board of directors, to the senior officer of the SEF, for
review prior to submitting the amended ACR to the Commission.
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\1014\ This requirement is in proposed Sec. 37.1501(e)(2).
\1015\ This requirement is in proposed Sec. 37.1501(e)(4).
\1016\ This requirement is in proposed Sec. 37.1501(e)(3).
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In addition to these substantive changes, the Commission proposes a
number of conforming, clarifying, and streamlining changes that would
not impose new costs or result in new benefits and are not discussed in
the cost and benefit sections below. The Commission proposes to
eliminate the CCO's obligations to the regulatory oversight committee
(``ROC''), including existing Sec. 37.1501(c)(1)(iii), which requires
a quarterly meeting with the ROC, and existing Sec. 37.1501(c)(1)(iv),
which requires the CCO to provide self-regulatory program information
to the ROC. The proposal would not impact SEFs as there is no
requirement that a SEF have a ROC.
Additionally, the Commission proposes to consolidate existing
Sec. Sec. 37.1501(b)-(c) into proposed Sec. 37.1501(b). The
Commission proposes to eliminate existing Sec. 37.1501(b)(1), which
requires a SEF to designate a CCO, and existing Sec. 37.1501(c)(2),
which requires the CCO to report directly to the board of directors or
the senior officer of the SEF, as these requirements are already
contained under Sec. 37.1500.
The Commission proposes to eliminate the requirement under existing
Sec. 37.1501(f)(1) that a SEF must document the submission of the ACR
to the SEF's board of directors or senior officer in board minutes or
some other similar written record. This requirement is already covered
in the general recordkeeping requirements in proposed Sec. 37.1501(f),
which is existing Sec. 37.1501(g).
The Commission proposes a non-substantive amendment to Sec.
37.1501(a)(2) to define a ``senior officer'' as ``the chief executive
officer or other equivalent officer of the swap execution facility.''
\1017\ In addition, proposed Sec. 37.1501(f), currently set forth
under Sec. 37.1501(g), would require a SEF to keep records in a manner
consistent with the recordkeeping requirements under Sec. Sec.
37.1000-1001.
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\1017\ In the SEF Core Principles Final Rule, the Commission
noted that it would not adopt a definition of ``senior officer,''
but noted that the statutory term would only include the most senior
executive officer of the legal entity registered as a SEF. See SEF
Core Principles Final Rule at 33544.
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Finally, the Commission proposes a new acceptable practice to Core
Principle 15 in Appendix B that would provide a non-exclusive list of
factors that a SEF may consider when evaluating an individual's
qualifications to be a CCO.\1018\ The proposal would provide a safe
harbor and not impose new obligations.
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\1018\ 17 CFR part 37 app. B.
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(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
The Commission is proposing to amend the existing notification
requirements related to transfers of equity interest in a SEF. Proposed
Sec. 37.5(c)(1) would require a SEF to file a notice with the
Commission regarding any transaction that results in the transfer of
direct or indirect ownership of fifty percent or more of the equity
interest of a SEF as opposed to only direct ownership transfers as
currently required. Transfer of ownership in an ``indirect'' manner may
occur through a transaction that involves the transfer of ownership of
a SEF's direct parent or an indirect parent, and therefore, implicates
effective change in ownership of the SEF's equity interest.
(ii) Confirmation and Trade Evidence Record
The Commission is proposing several amendments to the existing
confirmation requirement under
[[Page 62067]]
Sec. 37.6(b).\1019\ First, the Commission proposes Sec.
37.6(b)(1)(ii)(B) to allow a SEF to issue a ``trade evidence record''
for uncleared swap transactions that are executed on its facility. As
defined under proposed Sec. 37.6(b)(1)(ii)(B), a trade evidence record
means a legally binding written documentation that memorializes the
terms of a swap transaction agreed upon by the counterparties and
legally supersedes any conflicting term in any previous agreement that
relates to the swap transaction between the counterparties. The trade
evidence record, at a minimum, would be required to include the
necessary terms to serve as a legally binding record of the transaction
that supersedes any conflicting term in any previous agreements, but is
not required to contain all of the terms, in particular relationship
terms contained in underlying documentation between the counterparties.
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\1019\ The Commission notes that the confirmation requirements
in proposed Sec. 37.6(b)(1)(i)(A) are not changing.
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Second, the Commission proposes Sec. 37.6(b)(2)(i) to require a
SEF to provide counterparties with a confirmation document or trade
evidence record ``as soon as technologically practicable'' after the
execution of the transaction on the SEF.
Third, the Commission proposes Sec. 37.6(b)(2)(iii) to allow a SEF
to issue a confirmation document or trade evidence record to the
intermediary trading on behalf of a counterparty, provided that the SEF
establish and enforce rules to require transmission of the document or
record to the counterparty as soon as technologically practicable.
(iii) Information-Sharing
The Commission proposes to amend Sec. 37.504 to generally allow a
SEF to share information with third-parties as necessary to fulfill its
self-regulatory and reporting responsibilities by eliminating the
specifically enumerated list of entities with whom a SEF must share
information.
(6) System Safeguards
The Commission proposes to move the requirement in existing Sec.
37.205(b)(4) that a SEF must protect audit trail data from unauthorized
alteration and accidental erasure or other loss to proposed Sec.
37.1401(c). The Commission proposes a new Sec. 37.1401(g) to require
SEFs to annually prepare and submit an up-to-date Exhibit Q (existing
Exhibit V) \1020\ to Form SEF (``Technology Questionnaire'') for
Commission staff.
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\1020\ The Commission proposes to renumber existing Exhibit V to
Form SEF as proposed Exhibit Q to Form SEF. 17 CFR part 37 app. A.
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b. Benefits
(1) SEF Trading Specialists
The Commission expects that SEF trading specialists would exercise
a level of discretion and judgment in facilitating trading that is
informed by their knowledge and understanding of the market and the
products traded on it, and their communications with market
participants. The role of SEF trading specialists and their use of
discretion will likely increase under the Commission's proposed
approach to allow SEFs to offer flexible execution methods and to
expand the trade execution requirement. The dual and integral role that
SEF trading specialists play in exercising that discretion--interacting
with market participants, while facilitating fair, orderly, and
efficient trading and overall market integrity--calls for a regulatory
approach that aims to maintain market integrity and provide appropriate
protections for market participants.
The Commission believes that establishing a new category of SEF
personnel, ``SEF trading specialists,'' and requiring SEFs to subject
SEF trading specialists to fitness requirements, proficiency testing,
standards of conduct for SEF trading, and ethics training, and to
diligently supervise them, would enhance proficiency and
professionalism among SEF trading specialists, and would promote market
integrity and confidence of market participants. The Commission also
believes that these requirements would increase protection of market
participants and the public by promoting fair dealing. Furthermore,
diligent supervision of SEF trading specialists would increase
compliance with legal and regulatory requirements and SEF rules.
Proposed Sec. 37.201(c)(2)(i) would enhance protections for market
participants by seeking to ensure that SEFs do not employ persons
subject to a statutory disqualification as a SEF trading specialist,
subject to the proposed exception as discussed below. Sections 8a(2) or
8a(3) of the Act set forth numerous bases upon which the Commission may
refuse to register a person, including, without limitation, felony
convictions, commodities or securities law violations, and bars or
other adverse actions taken by financial regulators. The Commission
believes that by restricting SEFs from permitting such persons from
intermediating and facilitating SEF trading (except in a clerical or
ministerial capacity), market participants and the public would be
better protected from abusive and fraudulent trading practices.
Moreover, given the role SEF trading specialists play in facilitating
orderly and fair trading, the Commission believes that proposed Sec.
37.201(c)(2)(i) would enhance market integrity and fairness, and the
confidence of SEF market participants.
Proposed Sec. 37.201(c)(2)(ii)(A) would allow SEFs to employ as a
SEF trading specialist a person the National Futures Association
(``NFA'') has permitted to be listed as a principal or to register with
the Commission based on the NFA's determination that the incident
giving rise to the person's statutory disqualification is
insufficiently serious, recent, or otherwise relevant to evaluating the
person's fitness. Similarly, proposed Sec. 37.201(c)(2)(ii)(B) would
allow a SEF to employ as a SEF trading specialist a person subject to a
statutory disqualification who provides a written notice from an RFA
stating that if the person were to apply for registration as an
associated person, the RFA would not deny the application on the basis
of the statutory disqualification.
Proposed Sec. 37.201(c)(2)(ii) would benefit SEFs and their
prospective SEF trading specialists by allowing SEFs to employ a person
as a SEF trading specialist where the incident giving rise to the
person's statutory disqualification is insufficiently serious, recent,
or otherwise relevant to evaluating the person's fitness for
registration with the Commission. The Commission believes that, where
an RFA provides a notice that such circumstances are present, the
benefits of the prohibition under Sec. 37.201(c)(2)(i)--in particular
the protection of market participants and the public and enhancing
market integrity--are not implicated, and thus a SEF should be
permitted to employ such persons as a SEF trading specialist.
Given the level of discretion SEF trading specialists exercise, the
Commission believes that proposed Sec. 37.201(c)(3)(i) would benefit
market participants and the public by helping to ensure that SEF
trading specialists have the requisite proficiency and knowledge to
fulfill their responsibilities and to comply with the Act, Commission
regulations, and SEF rules. The proficiency examination requirement
under Sec. 37.201(c)(3)(ii) would further ensure that all SEF trading
specialists maintain a baseline level of proficiency. This would
increase protection of market participants and better ensure that
trading on SEFs is conducted in a fair, orderly, and efficient manner.
The
[[Page 62068]]
Commission expects the proposed requirements to enhance the confidence
of market participants and the public in the integrity and fairness of
SEF markets.
Proposed Sec. Sec. 37.201(c)(4)-(6) would respectively require a
SEF to ensure that SEF trading specialists receive ethics training on a
periodic basis, subject SEF trading specialists to standards of conduct
in dealing with market participants and fulfilling their
responsibilities, and diligently supervise the activities of its SEF
trading specialists.
Overall, these proposed rules would promote public and market
participants' confidence in the trading of swaps on SEFs and may bring
additional volumes of trading and liquidity to SEFs.
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
The primary benefit of the rule change is an anticipated reduction
in recordkeeping costs for clients of asset managers and SEFs.
(ii) Audit Trail and Surveillance Program
Many of the proposed changes to the audit trail and surveillance
requirements described above are expected to result in savings in terms
of compliance staff and resources for most SEFs. For example, SEFs that
offer voice trading are currently required to conduct regular voice
audit trail surveillance in lieu of the electronic analysis capability
requirements of Sec. 37.205(b)(3). These SEFs dedicate compliance
staff and resources to establishing and conducting the voice audit
trail surveillance programs, including contracting with the NFA for the
performance of the reviews. However, under the proposed changes to
Sec. 37.203(d), Sec. 37.205(b)(2), and Sec. 37.205(b)(3), these SEFs
would no longer be required to conduct regular automated surveillance
on indications of interest, requests for quotes, and orders that are
not entered into a SEF's electronic trading system or platform.
Therefore, new SEFs would not incur the cost to implement this
requirement and all SEFs would not incur the ongoing cost to maintain a
regular voice audit trail surveillance program.
Additionally, eliminating Sec. 37.205(c)'s requirement to enforce
audit trail requirements through annual reviews should result in cost
savings to all SEFs, as they would no longer need resources, either
internal compliance staff or the NFA, to perform audit trail reviews.
However, the Commission proposes to replace these requirements with
a requirement to perform audit trail reconstructions, which is expected
to reduce some of the cost savings as described above.\1021\ The
proposed changes to the audit trail rules under Sec. 37.205(a) are
intended to address the current challenges SEFs face with respect to
obtaining post-trade allocation information and conducting surveillance
on orders that are not entered into an electronic trading system or
platform. Similarly, proposed Sec. 37.203(d) would no longer require
SEF automated surveillance systems to have certain capabilities that
they cannot perform.
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\1021\ The Commission also notes that some of the new costs
associated with the reconstruction program requirement in proposed
Sec. 37.205(c) are offset by to the statutory mandate in Core
Principle 4 that already requires a SEF to have methods for
conducting comprehensive and accurate trade reconstructions.
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(iii) Compliance and Disciplinary Programs
SEF compliance programs should benefit from the proposed changes
related to conducting investigations. For example, changes proposed to
Sec. 37.203(f) seek to simplify the procedures for SEFs to conduct
investigations and prepare investigation reports. Specifically,
eliminating the 12-month requirement for completing investigations
under Sec. 37.203(f)(2), and replacing it instead with a general
statement that permits SEFs to complete investigations ``in a timely
manner taking into account the facts and circumstances of the
investigation'' would provide SEFs with greater discretion to manage
their workload, and allow them to prioritize their other compliance
responsibilities as needed. SEFs also may benefit from the additional
clarity and flexibility provided in language related to investigation
reports in the guidance to Core Principle 2 in Appendix B. The language
states that compliance staff should submit all investigation reports to
the CCO or other compliance department staff responsible for reviewing
such reports and determining next steps in the process, and that the
CCO or other responsible staff should have reasonable discretion to
decide whether to take any action, such as presenting the investigation
report to a disciplinary panel for disciplinary action.
SEFs may realize additional cost savings under the proposed changes
to the disciplinary rules under Sec. 37.206. Proposed Sec. 37.206(b)
would allow a SEF to administer its disciplinary program through not
only one or more disciplinary panels as currently allowed, but also
through its compliance staff. This proposed rule would provide SEFs
with more flexibility to adopt a cost effective disciplinary structure
that better suits their markets and market participants, while still
effectuating the requirements and protections of Core Principle 2. The
Commission anticipates that SEFs that choose to administer their
disciplinary programs through their compliance staff would incur the
greatest cost savings. These SEFs would not incur the cost associated
with establishing or maintaining disciplinary panels.
Additionally, to the extent that a SEF chooses to administer its
disciplinary programs through compliance staff, the SEF may no longer
incur certain costs associated with conducting hearings or appeals,
such as preparing materials and presentations for hearings before the
disciplinary panel, or the time spent by SEF employees preparing
written disciplinary decisions. A SEF also may benefit from increased
efficiencies that they can leverage from compliance staff's knowledge
about the SEF and its trading practices to adjudicate matters more
quickly than under the traditional disciplinary structure.
(iv) Regulatory Service Provider
A SEF may realize cost savings from the proposed changes under
Sec. 37.204. Expanding the scope of entities that may provide
regulatory services under proposed Sec. 37.204(a) to include any non-
registered entity approved by the Commission may result in an increase
in competition among RSPs, and reduce the overall cost of securing an
RSP. Under the proposed changes to Sec. 37.204(b), a SEF and its RSP
may also mutually agree on the method it will use to document
substantive decisions, rather than documenting every instance where the
SEF's actions differ from the RSP's recommendations, which may reduce
the administrative costs associated with documentation created and
maintained by a SEF and its RSP. Providing SEFs with the option under
proposed Sec. 37.204(b) to allow their RSPs to make substantive
decisions, should better enable an RSP to promptly intervene and take
action, as it deems necessary. Finally, eliminating the requirement
under Sec. 37.204(c) that a SEF document where its actions differ from
the RSP's recommendations, deferring instead to the SEF and its RSP to
mutually agree on the method it will use to document substantive
decisions, may encourage better communication among SEFs and its RSP.
[[Page 62069]]
(3) Error Trade Policy
The Commission believes that the proposed changes to the error
trade rule would reduce the costs and risks associated with error
trades and promote swaps market integrity and efficiency. When
counterparties execute a trade that is an error trade, the
counterparties bear the costs and risks from being bound to terms to
which they did not intend to assent. The proposed rule that requires
error trades be resolved in a fair, transparent, and consistent manner
would increase confidence that error trades would be corrected and that
published swap data is an accurate indication of market supply and
demand.
The proposed requirement that error trades be resolved in a timely
manner would reduce the costs associated with error trades, including
associated hedging costs. A counterparty may hedge an executed trade:
(i) Before it learns that the trade may be erroneous, (ii) after it
learns the trade may be erroneous, but before the SEF has determined
whether the trade is an error trade, (iii) after an error has been
identified but before it has been resolved, or (iv) after the SEF has
resolved the error. The potential cost of each case likely depends on
how quickly the SEF resolves the error because the longer a SEF takes
to do so, then the greater the chance the market price of the trade and
related hedge trade will move. For example, if a trader on a SEF enters
into a hedge trade and the SEF determines that the initial trade is
different from what the trader believed, then the trader may have to
execute a new trade that hedges the correct trade and unwind the
initial hedge trade. Doing so will be costly if the market has moved
and the price of entering into the new hedge and unwinding the old
hedge has increased. Similarly, a trader that waits to execute a hedge
trade until after the SEF has resolved the error will likely face
higher costs the longer the SEF takes to resolve the error. The
proposed timeliness requirement should result in faster error
resolution and lower the risk of costly market moves.
The proposed requirement that SEFs notify market participants that
a swap transaction is under review pursuant to error trade rules and
procedures, the determination that the trade under review is or is not
an error trade, and the resolution of any error trade review should
make markets more efficient. An error trade misinforms market
participants when its price is different than the price would be if the
trade had been executed non-erroneously. The notification requirement
should allow market participants to make better informed decisions
regarding supply and demand.
(4) Chief Compliance Officer
As discussed in the preamble, the Commission believes that some of
the regulations implementing Core Principle 15 may be unnecessarily
burdensome and inefficient. The proposed regulations are intended to
address these issues.
The proposal to give the senior officer the same authority as the
board of directors to oversee the CCO would provide SEFs with greater
opportunity to structure the management and oversight of the CCO based
on the SEF's particular corporate structure, size, and complexity. This
could increase efficiency and reduce costs. Additionally, the quality
of oversight of the CCO could improve if the senior officer is better
positioned than the board of directors to provide day-to-day oversight
of the CCO.
The proposal to permit the CCO to use any means to identify
noncompliance issues is less prescriptive and should also increase
efficiencies. The proposed amendment to Sec. 37.1501(d) to refine the
scope of the required information in a SEF's ACR should make the ACR
process more efficient and reduce costs. For example, the proposed
removal of Sec. 37.1501(e)(2)(i) and certain specific content set
forth under Sec. 37.1501(e)(4) should reduce the amount of time that a
CCO and his or her staff must spend preparing the ACR. Proposed Sec.
37.1501(d)(4), which would require that SEFs focus on describing
material non-compliance matters, rather than describing all compliance
matters, should streamline the ACR requirement and provide more useful
information to the Commission. Additionally, the proposed clarification
under Sec. 37.1501(e)(3) that the CCO must submit an amended ACR to
the SEF's board of directors or, in the absence of a board of
directors, the senior officer of the SEF, should reduce the need for
extensive follow-up discussions.
Finally, the proposal to allow SEFs more time to submit their ACRs
should reduce the time and resource burden on the CCO and compliance
department. This additional time should allow SEFs to fully complete
their ACRs and meet their other end-of-year reporting obligations, such
as the fourth quarter financial report. However, the Commission
understands that those SEFs that already may rely on Commission staff
no-action relief for an extra 30 days to complete the ACR may have
availed themselves of the benefits associated with the extended
reporting deadline.
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
The Commission notes that an indirect transfer of a SEF's equity
interest raises similar concerns as a direct transfer, notification of
which is currently required under the existing requirement. Therefore,
the Commission believes that proposed Sec. 37.5(c)(1) would benefit
market participants because the Commission would have the ability to
more broadly identify and assess situations where an indirect equity
interest transfer of a SEF could potentially impact its operational
ability to comply with the SEF core principles and the Commission's
regulations.
(ii) Confirmation and Trade Evidence Record
The Commission believes that the proposed ``trade evidence record''
approach in proposed Sec. 37.6(b) should benefit both SEFs and market
participants by decreasing the administrative costs to execute an
uncleared swap on a SEF. Not only would a SEF not be required to expend
time and resources to gather and maintain all of the underlying
relationship documentation between all possible counterparties on its
facility, but market participants would also not be required to expend
time and resources in gathering and submitting this information to the
SEF, including any amendments or updates to that documentation.
Consistent with the bilateral nature of the underlying relationship
documentation and current market practice outside of SEFs,
counterparties to the transaction would be better able to devise their
own confirmation documents by supplementing the information provided in
the trade evidence record with additional terms that they have
previously negotiated. Therefore, SEFs and counterparties should
benefit from a documentation requirement that better reflects the
nature of uncleared swap transactions. Moreover, the Commission
believes this trade evidence record may encourage more uncleared swaps
trading on SEFs where these trades can benefit from SEF oversight, and
ultimately would increase the financial integrity of the swaps market.
The Commission notes that to the extent that SEFs and market
participants have relied on the existing no-action relief provided by
Commission staff to avoid these costs by incorporating those terms by
reference in a confirmation
[[Page 62070]]
document, they have been availing themselves of the benefits from these
reduced costs.
SEFs should also benefit from the proposed requirement that they
transmit the confirmation document or the trade evidence record ``as
soon as technologically'' practicable after execution of the
transaction rather than at the same time as execution. In particular,
this approach should provide an opportunity for a SEF to develop
protocols for transmitting this documentation in a manner that is
adaptive to the type of execution method that is utilized to execute a
transaction. Given the flexible methods of execution that the
Commission proposes to allow for all swaps, this practical approach to
transmitting documentation should not impede the development of trading
systems or platforms. For example, a SEF that offers non-automated
execution methods would not be required to ensure that post-trade
processing protocols simultaneously transmit the confirmation or trade
evidence record at the time of execution.
Further, SEFs and market participants should benefit from allowing
an intermediary to receive a confirmation document or trade evidence
record on behalf of the counterparties to the transaction. This
approach should be more consistent with current market practice, such
that intermediaries maintain the connectivity in trading on the SEF.
Given that intermediaries are connected with and participating on the
SEFs, but are acting on behalf of the counterparties, a SEF is able to
transmit the documentation related to a swap transaction to the
intermediary, who would then transmit that information to the ultimate
counterparties.
(iii) Information-Sharing
The Commission believes that the proposed amendment to information-
sharing requirements would benefit SEFs by providing a better
opportunity to utilize third-party entities to fulfill their self-
regulatory and reporting responsibilities at a lower cost. The proposed
rule should increase the number of RSPs and likely increase the
competition between these providers, which should both lower costs and
improve the level of services offered. The Commission anticipates that
this benefit would be greater for smaller SEFs that otherwise would
have difficulty operating economically due to the high fixed costs of
some services.
(6) System Safeguards
The Commission has identified several potential benefits from the
proposed changes to the system safeguards requirements. First, the
proposed annual Technology Questionnaire filing requirement (in
proposed Exhibit Q) should help the Commission maintain a current
profile of the SEF's automated systems and be consistent with the
provisions of existing Sec. 37.1401(g)(4),\1022\ which allows the
Commission to request the results from a SEF's mandatory tests of its
automated systems and business continuity-disaster recovery
capabilities. The Commission believes that the proposed rule would
reduce the need for additional information and document requests
related to that existing requirement.\1023\
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\1022\ Existing Sec. 37.1401(g) generally requires a SEF to
provide all other books and records requested by Commission staff in
connection with Commission oversight of system safeguards pursuant
to the Act or Commission regulations, or in connection with
Commission maintenance of a current profile of the SEF's automated
systems. 17 CFR 37.1401(g).
\1023\ The current profile of a SEF's automated systems is also
supported by the provision of timely advance notice of all material
planned changes to automated systems that may impact the
reliability, security, or adequate scalable capacity of such
systems, and of planned changes to the SEF's program of risk
analysis and oversight, as required by Sec. 37.1401(f)(1)-(2). 17
CFR 37.1401(f)(1)-(2).
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Second, the Commission believes an annually-updated Technology
Questionnaire could expedite Systems Safeguards Examinations (``SSE'').
For example, it could reduce a SEF's overall compliance-related burdens
for SSEs by (i) reducing a SEF's effort to respond to SSE document
requests by instead allowing a SEF to provide updated information and
documents for sections of Exhibit Q that have changed since the last
annual filing; and (ii) allowing SEFs to respond to an SSE document
request by referencing Exhibit Q information and documents to the
extent that they are still current, rather than resubmitting such
information and documents. The Commission also notes that an annual
update to Exhibit Q, which would be required concurrently with
submission of the CCO annual compliance report, could provide
information and documents potentially useful in preparing that annual
report.
c. Costs
(1) SEF Trading Specialists
The Commission expects that SEFs and/or SEF trading specialists
would incur additional costs to satisfy the fitness requirement in
proposed Sec. 37.201(c)(2). The Commission expects that SEFs would vet
prospective SEF trading specialists to ensure that they are not subject
to a statutory disqualification. Such vetting may include the
completion by a prospective SEF trading specialist of a questionnaire
regarding employment and criminal history. Additionally, SEFs may
conduct criminal background checks through third-party service
providers to ensure that SEF trading specialists are not subject to a
statutory disqualification.
The costs of ensuring compliance with proposed Sec.
37.201(c)(2)(i) may be mitigated where a SEF trading specialist is
separately registered with the Commission in some other capacity (e.g.,
as an associated person), in which case a SEF may reasonably rely on
the person's registration status as evidence that the person is not
subject to a statutory disqualification or that the person falls within
the exception set forth in proposed Sec. 37.201(c)(2)(ii)(A). In cases
where a SEF relies on the exception in proposed Sec.
37.201(c)(2)(ii)(B), the SEF (or the SEF trading specialist) would bear
an additional cost of obtaining the required notice from an RFA.
The expected costs associated with the proficiency requirement in
proposed Sec. 37.201(c)(3)(i) would include the cost to a SEF of
determining if a SEF trading specialist is sufficiently proficient
(which can be accomplished by passing the examination, once it is
available) and, if necessary, providing training to ensure that a SEF
trading specialist possesses the requisite proficiency. In some cases,
the cost of determining proficiency may be minimal; for example where
the SEF trading specialist has an employment history that reflects the
requisite knowledge and experience.
The expected costs associated with the proficiency examination
requirement in proposed Sec. 37.201(c)(3)(ii) would include a fee
imposed by the RFA. This fee would likely be designed to, at a minimum,
offset the costs of developing and administering the examination.
Additional costs may include study, training, or other examination
preparation, borne by a SEF trading specialist or by a SEF on behalf of
the SEF trading specialist. As discussed above, once an examination for
swaps proficiency is made available, compliance by a SEF with the
examination requirement in proposed Sec. 37.201(c)(3)(ii) would
constitute compliance with the general proficiency requirement in
proposed Sec. 37.201(c)(3)(i). Thus, the cost associated with
complying with proposed Sec. 37.201(c)(3)(i) would be mitigated once
an RFA-administered examination is made available.
As discussed in the proposed amendments to the guidance to Core
[[Page 62071]]
Principle 2 in Appendix B, each SEF would have broad discretion in
developing and implementing its ethics training program under proposed
Sec. 37.201(c)(4). Given this discretion, the costs to SEFs to comply
with the ethics training requirement may vary widely from SEF to SEF.
Furthermore, the training needs of a SEF may vary according to the
size, number of SEF trading specialists, and the level of their
expertise and responsibilities within a SEF.
While the Commission believes that the requirements in proposed
Sec. Sec. 37.201(c)(5)-(6) would impose additional costs on SEFs, the
Commission anticipates that the costs would vary from SEF to SEF. A SEF
may utilize its existing compliance staff or may opt to add compliance
staff in order to enforce its standards of conduct for SEF trading
specialists and to meet the SEF's obligation to diligently supervise
SEF trading specialists. Additional costs associated with these
proposed requirements may include the costs of developing standards of
conduct and policies and procedures designed to ensure that SEF trading
specialists are diligently supervised.
(2) Rule Compliance and Enforcement
(i) Definition of ``Market Participant''
By effectively moving clients of asset managers out of the category
of market participant, the proposal potentially reduces SEFs' ability
to monitor the positions of these clients, although SEFs would still be
able to monitor the trading of the asset managers.\1024\ Hence, the
cost of the proposed change may be a reduction in the ability of SEFs
to detect abusive practices to the extent that clients of asset
managers are able to engage in such practices. However, these swap
users, who typically give up their trading discretion, appear to be the
least likely to engage in manipulative practices. For example, when a
client gives complete trading discretion to an asset manager, the
specifics of the asset manager's trading typically occurs without
particular knowledge of the client--that is, they do not know the
investment, whether any swap traded is occurring on a SEF, or even the
identity of the SEF. Importantly, the asset managers who conduct
trading on the SEF for the client remain subject to the SEF's record
retention and other requirements. Hence, to the extent that an asset
manager for a client is engaging in abusive trading practices on a SEF,
a SEF's ability to investigate and prevent those practices should not
be diminished.
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\1024\ The proposed definition of ``market participant''
includes any person who accesses a SEF through direct access
provided by a SEF; through access or functionality provided by a
third-party; or through directing an intermediary, such as an asset
manager, that accesses a swap execution facility on behalf of such
person to trade on its behalf. A person who does not access a SEF in
any of these ways, such as a client who does not direct the asset
manager to trade on its behalf, would not be a market participant
under the proposed definition. See proposed Sec. 37.2(b).
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(ii) Audit Trail and Surveillance Program
Without conducting automated surveillance on orders entered by
voice or certain other electronic communications, such as instant
messaging and email, SEFs may have a reduced ability to identify
potential misconduct involving voice orders. However, the Commission
recognizes that since SEFs currently do not have a cost-effective
solution for performing such automated surveillance, the proposed rules
do not provide lesser protections to market participants and the
public. Regarding the requirement to capture post-trade allocation
information, the Commission understands that SEFs currently cannot
capture this information. As a result of capturing less audit trail
data under the proposal, there may be possible costs in the form of
reduced protections to market participants and the public. However, the
Commission does not believe that the proposed rule is likely to
meaningfully reduce protections to market participants and the public
as compared to the current rules.
The Commission proposes to replace the audit trail enforcement
requirement with the requirement to perform audit trail
reconstructions.\1025\ Since SEFs are currently required to reconstruct
a sample of orders and trades under the voice audit trail surveillance
program, the Commission does not anticipate that any SEFs subject to
this program will incur any additional costs associated with performing
audit trail reconstructions under proposed Sec. 37.205(c). For SEFs
that electronically capture audit trail data and do not have a voice
component, the incremental cost of reconstructing trades should not be
material, as their automated trade surveillance systems should already
be capable of such reconstructions under Sec. 37.203(d).
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\1025\ The Commission also notes that some of the new costs
associated with the reconstruction program requirement under
proposed Sec. 37.205(c) are offset by the statutory mandate in Core
Principle 4 that currently requires a SEF to have methods for
conducting comprehensive and accurate trade reconstructions.
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(iii) Compliance and Disciplinary Programs
The Commission is mindful that the proposed elimination of the 12-
month requirement for completing investigations under Sec.
37.203(f)(2) could lead to delays in completing disciplinary actions.
However, the Commission notes that SEFs remain responsible for
completing investigations in a ``timely manner taking into account the
facts and circumstances of the investigation.'' In addition, while many
SEFs are likely to benefit from the proposed changes described above
related to the disciplinary process, there may be accompanying costs.
For example, a SEF's compliance staff may incur additional costs taking
on the added responsibilities previously performed by a disciplinary
panel.
The proposed changes to Sec. 37.206 also permit SEFs to establish
a disciplinary process that may provide respondents fewer procedural
protections than are required under the current rules. However, the
Commission notes that the guidance to Core Principle 2 in Appendix B
states that a SEF's rules relating to disciplinary panel procedures
should be fair, equitable, and publicly available. Competition and
customer demand should ensure that SEFs maintain suitable disciplinary
programs with sufficient protections.
(iv) Regulatory Service Provider
New RSPs may incur start-up costs associated with developing an
automated trade surveillance system and establishing and maintaining
sufficient compliance staff. However, the Commission would expect these
costs to decrease once the RSP has established its program and as it
gains experience providing regulatory services. RSPs may realize
further reductions in these costs as they gain economies of scale by
offering their services to multiple SEFs.
Eliminating the requirement that a SEF hold regular meetings and
conduct periodic reviews of its RSP may lead to varying degrees of
communication between a SEF and its RSP, but the Commission believes
that most SEFs would seek to maintain regular communication with their
RSPs, given that SEFs remain ultimately responsible for the performance
of any regulatory services received, for compliance with their
obligations under the Act and Commission regulations, and for the RSPs'
performance on their behalf.
(3) Error Trade Policy
The Commission anticipates that SEFs would incur costs to establish
and
[[Page 62072]]
maintain rules and procedures that facilitate the resolution of error
trades. As noted in the preamble, the proposed rule is intended to
reflect error trade policies that generally exist among SEFs so many
SEFs should have policies that are at least partially compliant with
the proposed rule and would not have to incur the full costs discussed
below. The Commission understands that SEFs implemented these policies
as an appropriate means to address error trades or to satisfy a
condition set forth in no-action relief provided by Commission staff.
Proposed Sec. 37.203(e)(2) would require that some SEFs incur the
costs associated with establishing and maintaining rules and procedures
that facilitate resolution of purported errors in a fair, transparent,
consistent, and timely manner. Existing Sec. 37.203(e) requires only
that a SEF have the authority to resolve errors when necessary to
mitigate certain market disrupting events. SEFs that do not currently
have error trade policies, or whose policies are not compliant with
proposed Sec. 37.203(e)(2), would incur one-time costs to develop a
compliant policy and ongoing costs to implement such policy.
To comply with the proposed Sec. 37.203(e)(3) requirement that
SEFs notify market participants of (i) any swap transaction that is
under review pursuant to the SEF's error trade rules and procedures;
(ii) a determination that the trade under review is or is not an error
trade; and (iii) the resolution of any error trade, including any trade
term adjustment or cancellation, some SEFs would have to incur costs to
establish a means of communicating such information to market
participants. The Commission believes that many SEFs would send
notifications electronically to their market participants. All SEFs
have the ability to communicate electronically with market
participants. However, some SEFs may not be able to send electronic
notifications ``as soon as practicable'' and could have to obtain and
implement software to do so. SEFs would also incur costs each time a
notification is sent. The Commission believes that the ongoing cost
would be minimal if the notification was sent electronically using a
partially automated software system. However, some SEFs may send
notifications to their market participants by other means.
The Commission does not believe the proposed error trade policy is
likely to increase the risk that counterparties act carelessly and make
more errors. As noted above, market participants may incur significant
costs when they enter into error trades if they need to unwind hedge
trades and execute new hedge trades. The Commission believes that these
costs encourage market participants to implement best practices to
avoid errors. The Commission also does not believe that the error trade
policy is likely to increase the risk that counterparties attempt to
use error trades to manipulate the market by entering into off-market
transactions and then cancelling the trades after the market has moved.
Since Sec. 37.203(e) already requires that SEFs correct error trades,
the proposed rule should not improve a market manipulation scheme's
chances of success.
(4) Chief Compliance Officer
The proposed change to Sec. 37.1501(b) to authorize the senior
officer to oversee the CCO, could impair the independence of the CCO,
and as a result the CCO's oversight of the SEF. However, the Commission
believes that this risk is mitigated by the Commission's review of
annual ACRs and examination programs.
The proposed amendments would eliminate requirements that the CCO
identify noncompliance matters using only certain specified detection
methods, design procedures that detect and resolve all possible
noncompliance issues, and eliminate all potential conflicts of
interest. These requirements would be replaced by more flexible
standards, which could potentially allow for some impairment of a CCO's
oversight of the SEF in some circumstances. However, the Commission
believes that the resulting costs (in the form of potential adverse
consequences) would not be material because the proposed changes would
now focus on material aspects of the compliance program, e.g., material
breaches and material conflicts of interest. The Commission believes
that the proposal acknowledges that the focus should be placed on
material compliance issues rather than all compliance issues.
The proposed change to Sec. 37.1501(e) to reduce the information
required in an ACR could make it more difficult for the Commission to
assess a SEF's compliance and self-regulatory programs. However, the
Commission does not anticipate that these changes would materially
impact the Commission's assessment as it already receives or has access
to such information from other sources. For example, the Commission
approves a SEF's compliance staffing and structure as part of the SEF's
registration or rule submission, and annual updates provide minimal
additional information, at best. In addition, SEFs report finalized
disciplinary actions to the NFA,\1026\ and the Commission could access
this information through its oversight of the NFA.
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\1026\ See Sec. 9.11 (stating that whenever an exchange
decision pursuant to which a disciplinary action or access denial
action is to be imposed has become final, the exchange must, within
thirty days thereafter, provide written notice of such action to the
person against whom the action was taken and notice to the National
Futures Association). 17 CFR 9.11.
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Finally, the proposal to give SEFs more time to submit their ACRs
could delay the Commission in recognizing and addressing a SEF
compliance issue. However, the Commission anticipates that such risk is
mitigated to the extent that SEFs provide ACRs on the timeline set
forth in the proposed rules. The Commission's experience with these
SEFs has not indicated that this delayed reporting has adversely
impacted its ability to recognize and address compliance issues in a
timely manner.
(5) Recordkeeping, Reporting, and Information-Sharing
(i) Equity Interest Transfer
The proposed additional requirement to notify the Commission of an
indirect change in ownership would increase costs to a SEF, who would
be required to provide notice in these instances. As part of that
notification, a SEF may incur costs that are similar to those incurred
when providing a notice of a direct change, including providing details
of the proposed transaction and how the transaction would not adversely
impact its ability to comply with the SEF core principles and the
Commission's regulation, responding to any requests for supporting
documentation from the Commission, and updating any ongoing changes to
the transaction.\1027\
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\1027\ The Commission previously identified the types of
information that a SEF should provide as part of its notification,
including (i) relevant agreement(s); (ii) associated changes to
relevant corporate documents; (iii) a chart outlining any new
ownership or corporate or organization structure, if available; and
(iv) a brief description of the purpose and any impact of the equity
interest transfer. SEF Core Principles Final Rule at 33490.
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(ii) Confirmation and Trade Evidence Record
With respect to uncleared swaps, the proposed ``trade evidence
record'' approach in proposed Sec. 37.6(b) could reduce the financial
integrity of transactions on SEFs compared to the current rule. There
could be a greater risk of misunderstanding between the counterparties
if they do not provide all the terms of a transaction at the time of
execution. Even when parties reference agreements, confusion could
arise from
[[Page 62073]]
issues such as multiple versions of the agreement with the same
labeling or missing sections. However, the Commission does not expect
that this risk will materially reduce the integrity of the swaps
market. The Commission notes that these agreements are usually
relationship terms between counterparties that govern all trading in
uncleared swaps and do not concern the terms of specific transactions.
The Commission expects that, since it should generally be less
extensive, the change should result in no increased costs.
The Commission also notes that to the extent that a SEF elects to
not issue a confirmation document that includes or incorporates all of
the terms of an uncleared swap transaction (including the trade
evidence record), the counterparties to the swap may be subject to
other Commission regulations that impose those burdens, and therefore,
increased costs. For example, where one of the counterparties to an
uncleared swap transaction is a swap dealer or major swap participant,
Sec. 23.501 requires that the swap dealer or major swap participant
issue a confirmation for the transaction as soon as technologically
practicable.\1028\ The Commission, however, believes that such costs
are likely to be mitigated by the reduced cost burdens Sec. 37.6(b)
otherwise currently imposes upon counterparties to an uncleared swap.
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\1028\ 17 CFR 23.501(a).
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(iii) Information-Sharing
The Commission recognizes that permitting SEFs to share information
with any third party to fulfill its self-regulatory obligations under
proposed Sec. 37.504 may increase the risk that the SEF's market
participant information is misappropriated. These third party entities
are not necessarily registered with the Commission and may lack the
document security and compliance knowledge, to adequately protect
market participant information. However, the Commission notes that a
SEF would remain responsible for maintaining the security of this
information, and would oversee their service providers to ensure
compliance, to the extent feasible. Furthermore, the Commission intends
to continue to review SEFs' operations to ensure ongoing compliance
(including the compliance of third-party service providers).
(6) System Safeguards
SEFs are currently required to file a Technology Questionnaire
under existing Exhibit V to Form SEF for registration as a SEF. SEFs
are likely to incur additional costs associated with annually updating
this Questionnaire in proposed Exhibit Q under proposed Sec.
37.1401(g). The Commission believes, however, that this cost may be
minimal, as the Technology Questionnaire pertains to the SEF's
operations and is information that a SEF should know for purposes of
its compliance with Core Principle 14 and the Commission regulations.
Further, the Commission believes that maintaining an annually updated
Exhibit Q would limit SSE document requests and the effort required to
respond to these requests and ad-hoc Commission system safeguards-
related requests under proposed Sec. 37.1401(h).
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
The Commission believes that the proposed amendments to the
existing SEF requirements related to compliance and self-regulatory
responsibilities are likely to increase professionalism in the swaps
market, further promote an orderly trading environment and market
integrity, and better enable the Commission to protect market
participants and the public.
First, several of the requirements should help the Commission to
determine whether a SEF's operations are compliant with the Act and the
Commission's regulations. For example, requiring a SEF to additionally
provide notice of any transaction resulting in the transfer of indirect
ownership of fifty percent or more of the SEF's equity interest under
Sec. 37.5(c)(1) would broaden the Commission's ability to review
changes in ownership that may affect the SEF's operations. Accordingly,
the Commission should be better able to assess whether such changes
would adversely impact the SEF's operations or its ability to comply
with the core principles or Commission's regulations, which are
intended in part to protect market participants.
The Commission's proposed amendments to the ACR requirements under
proposed Sec. 37.1501(d) should also better enable the Commission to
assess the effectiveness of a SEF's compliance or self-regulatory
programs. The proposed amendments, among other things, would remove
some of the existing content requirements that are duplicative and
unnecessary, but require the ACR to include a description and self-
assessment of the SEF's written policies. Removing information
requirements, e.g., requirements to review all Commission regulations
applicable to a SEF and to identify the written policies and procedures
enacted to foster compliance, may reduce the amount of information
available to the Commission in an ACR to assess a SEF's compliance.
However, the Commission has considered that, based on its experience
with the existing requirements, this information may not enhance the
usefulness of the ACR. Therefore, the Commission does not believe that
the proposed amendments would negatively impact its ability to assess
the SEF, which is intended, in part, to protect market participants.
The proposed requirement that a SEF annually update its response to
the Questionnaire should facilitate the Commission's oversight of a
SEF's systems safeguard program, and in turn, benefit the swaps markets
by promoting more robust automated systems and enhanced cybersecurity.
This should decrease the likelihood of disruptions and market-wide
closures, systems compliance issues, and systems intrusions. The
receipt of an annually-updated response to Exhibit Q should further the
protection of market participants and the public by helping to ensure
that automated systems are available, reliable and secure; adequate in
scalable capacity; and effectively overseen.
Second, the proposed requirements under Sec. 37.201(c) should
protect market participants and the public by mandating that SEF
trading specialists meet fitness and proficiency standards, undergo
periodic ethics training, and be subject to standards of conduct and
diligent supervision by SEFs. The Commission expects that the proposed
requirements should reduce abusive and fraudulent conduct and increase
the professionalism of, and fair dealing by, SEF trading specialists
who facilitate trading between SEF market participants. Furthermore,
the proposed requirements should promote compliance with legal and
regulatory obligations and SEF rules that are aimed at protecting
market participants. These improvements may be attenuated if the costs
of meeting the new standards reduce the number of SEF trading
specialists.
Third, in addition to promoting the Commission's ability to assess
a SEF's compliance with the Act and Commission regulations, some of the
requirements should protect market participants and the public by
improving a SEF's ability to detect potential rule violations. For
example, the proposed amendments to Sec. 37.203(f)(2) and Sec.
37.206(b) would permit a SEF to determine the timeframe within which to
complete an investigation and how to administer its
[[Page 62074]]
disciplinary program, respectively. A SEF would be better able to
prioritize its completion of investigations and disciplinary cases that
have a greater impact on the SEF's markets, its market participants,
and the public. These benefits may be reduced if SEFs excessively delay
investigations or do not prioritize appropriately. Furthermore,
proposed Sec. 37.204(b) should permit a SEF's RSP to make substantive
decisions, which would allow an RSP to take action more promptly to
protect the SEF's markets, market participants, and the public against
misconduct, with a reduced risk of delay that could be incurred if the
SEF was required to take action. There may be a risk of erroneous
decisions or inappropriate delays by the RSP, however. By shifting
existing Sec. 37.205(c)'s focus from audit trail enforcement to audit
trail reconstruction, proposed Sec. 37.205(c) should enable a SEF to
better detect inaccurate or incomplete audit trail data that could
potentially impair the SEF's ability to conduct effective surveillance.
As a whole, the Commission believes that the requirements as amended
should continue to allow a SEF to better protect its markets, market
participants, and the public by providing it with greater discretion to
carry out these self-regulatory responsibilities.
The proposed changes to the existing audit trail requirements may
reduce the scope of information that would be captured in a SEF's audit
trail, but the Commission believes that these changes are not likely to
materially affect the protection of market participants and the public.
For example, the Commission proposes to eliminate the requirement that
a SEF capture post-execution allocation information. The Commission
notes that this information has generally not been captured because
SEFs have operated under no-action relief, which was provided by
Commission staff due to the general inability of SEFs to access this
information. Thus, elimination of the requirement should not have a
material effect.
The Commission believes that certain proposed amendments to current
requirements reflect existing market realities, which preclude SEFs
from complying with some of these requirements. In particular, the
proposal would (i) move the requirement that audit trail data be
sufficient to reconstruct indications of interest, requests for quotes,
orders and trades, to the guidance to Core Principle 2 in Appendix B;
and (ii) eliminate the requirement under existing Sec. 37.205(b)(2)
that a SEF's electronic history database include all indications of
interest, requests for quotes, orders, and trades entered into a SEF's
trading system or platform. Further, the proposed regulations would no
longer require a SEF that offers a voice-based trading system or
platform to maintain regular voice audit trail surveillance programs to
reconstruct and review voice trades for possible trading violations.
Notwithstanding the regulatory requirements in this area, the
Commission emphasizes that SEF Core Principle 2 and its requirements
remain and a SEF must still capture all audit trail data related to
each of its offered execution methods that is necessary to reconstruct
all trading on its facility, detect and investigate customer and market
abuses, and take disciplinary action.
Fourth, the proposed requirements should protect market
participants by promoting the integrity of the transactions executed on
the SEF. For example, proposed Sec. 37.203(e)--which would require a
SEF to adopt policies to address and resolve error trades on its
facility--should help to ensure that SEFs promptly address error trades
to facilitate fair and equitable treatment between market participants
on the SEF. To the extent that market participants better understand
how a SEF addresses error trades and its approach for resolving such
errors, these market participants should have more confidence in
transacting on the SEF. Furthermore, the proposal should lead to SEFs
adopting more consistent approaches to addressing trading errors, which
should better protect market participants from basing their trading on
erroneous information provided in market data feeds. Additionally, the
proposal should lead to market participants receiving more effective
notice of potential and resolved errors, which should minimize the
market harm from price misinformation, which can lead to price
distortion and inefficiency in the market, and indirectly impact the
public. The extent of these improvements may depend on the quality of
error trade policies adopted by SEFs and the effectiveness of their
implementation.
Fifth, the proposed requirements should continue to promote the
legal certainty of transactions executed on the SEF. Proposed Sec.
37.6(b)(1)(ii), which would require a SEF to provide the counterparties
to an uncleared swap transaction with a ``trade evidence record'' that
memorializes the terms of the swap transaction agreed upon between the
counterparties on the SEF, specifies that such documentation must be
legally binding and memorialize the terms of the transaction. The
Commission notes that this approach differs from the existing no-action
relief provided by Commission staff, under which SEFs have incorporated
terms by reference in a confirmation for an uncleared swap that have
been previously established via privately-negotiated underlying
agreements. While the proposed requirement would limit the scope of
terms and conditions that must be included in SEF-issued documentation
for uncleared swaps, the Commission believes that this approach is not
likely to diminish the protection of market participants. The trade
evidence record would continue to serve as evidence of a legally-
binding swap transaction between the counterparties, who would still
have the ability to supplement the record with additional terms that
they had already previously agreed upon.
The protection of market participants and the public may be
adversely affected to the extent that risks noted in the discussion of
the costs of the proposed amendments occur. For example, increased
flexibility in the implementation of compliance programs may lead to a
reduction of their effectiveness in some circumstances.
(2) Efficiency, Competitiveness, and Financial Integrity of Markets
The Commission believes that the proposed amendments to the SEF
requirements listed above should further promote efficiency,
competitiveness, and financial integrity of the swaps markets.
Requiring a SEF to adopt error trade policies under proposed Sec.
37.203(e) should also promote efficiency and financial integrity on a
SEF's markets. Although many SEFs currently maintain error trade
policies as noted, the proposed rule should help to establish a more
consistent and transparent approach to addressing and resolving error
trades that should benefit market participants, including those that
may rely on trading data derived from the SEF's trading activity.
Accordingly, requiring SEFs to provide notification of potential errors
and a pending review should mitigate the potential for subsequent
trading based on an erroneous transaction that could create market
distortions interfering with efficient and competitive markets. The
requirement should encourage efficiency by minimizing the risk that the
SEF's pricing information does not reflect existing market conditions,
thereby increasing market participants' confidence to participate on
the SEF's facility. The extent of these improvements may depend on the
[[Page 62075]]
quality of error trade policies adopted by SEFs, and the effectiveness
of their implementation.
The proposed amendments under Core Principle 2 would generally
allow a SEF greater discretion to tailor its compliance program to
identify and address rule violations among its markets and market
participants. The Commission believes that proposed Sec. 37.203(f) and
Sec. 37.206 may improve a SEF's operational efficiency, and thereby
the efficiency and integrity of its markets, by allowing a SEF to
determine how to complete an investigation and take disciplinary action
to address misconduct more efficiently. Further, proposed Sec.
37.204(b), which would allow a SEF's RSP more leeway to make
substantive decisions related to a SEF's compliance program, should
also improve the efficiency and integrity of a SEF's operations by
allowing the RSP to take action with less delay once it identifies
misconduct among market participants. These efficiency gains may be
reduced by inappropriate decisions made by RSPs. Additionally, the
Commission believes that the audit trail reconstruction requirement
under proposed Sec. 37.205(c) should improve a SEF's ability to detect
potential rule violations, and may thereby enhance the overall
integrity of its markets.
The requirements in proposed Sec. Sec. 37.201(c)(2)-(3) should
enhance efficiency, competitiveness, and financial integrity of swap
markets by helping to ensure that SEF trading specialists, who are
responsible for facilitating orderly, efficient, and fair trading on
SEFs, have better fitness and proficiency to do so. The requirements
pertaining to ethics training and SEF standards of conduct in proposed
Sec. Sec. 37.201(c)(4)-(5) should better ensure that SEF trading
specialists are more aware of applicable regulatory obligations and SEF
rules aimed at maintaining efficiency, competiveness, and market
integrity. These gains may not be as extensive if the costs of meeting
these standards reduce the number of SEF trading specialists. The
proposed supervision requirement under Sec. 37.201(c)(6) should
increase compliance by SEF trading specialists with its obligations.
The Commission believes that related amendments proposed under Core
Principle 15 should also promote efficiency and integrity of a SEF's
market by allowing a more streamlined compliance approach that does not
require the board of directors to assume primary oversight
responsibility for the CCO. This proposed approach should in many
circumstances permit the CCO to more efficiently make changes to the
regulatory program in response to potential trading violations, which
should aid in protecting the financial integrity of the market.
Furthermore, the proposal's focus of the CCO's duties on reasonably
designed procedures to address noncompliance issues and material
conflicts of interest should improve the CCO's efficiency by specifying
that this is the appropriate standard. This increased efficiency should
permit CCOs to better allocate resources to focus on detecting and
deterring material rule violations, which otherwise may harm the
market's efficiency, competitiveness, and integrity.
(3) Price Discovery
The Commission believes that the proposed amendments related to
compliance and self-regulatory responsibilities should protect the
price discovery functions provided by a SEF's trading system or
platform. For example, the proposed amendments under Core Principle 2,
which the Commission believes would allow a SEF to develop the most
efficient approach to identify and address rule violations based on its
markets and market participants, should help to facilitate orderly
trading and promote integrity in the market. Price discovery may be
impaired, however, if SEFs are less successful in addressing rule
violations or have difficulty in maintaining orderly trading under the
framework of the proposed rules. By promoting market integrity and
orderly trading--particularly through identifying and resolving abusive
trading practices in an efficient manner--the Commission believes that
a SEF's trading system or platform should be able to serve as a more
robust mechanism for price discovery.
To the extent that SEF trading specialists facilitate the trading
of swaps transactions, they may be active participants in the price
discovery process. The proposed fitness, proficiency, and ethics rules
would help ensure that SEF trading specialists perform these tasks
ethically and competently, which should contribute to the smooth
functioning of the price discovery process.
The Commission believes that requiring SEFs to adopt and maintain a
formal error trade policy under proposed Sec. 37.203(e) should
similarly promote the SEF's ability to facilitate price discovery. The
error trade policy should protect the price discovery process on the
SEF's facility, and promote confidence in the prices market
participants use to hedge risk. This may depend on the quality of the
policy and the effectiveness of its implementation. If a SEF does not
promptly address an error trade, market participants may mistakenly
rely on inaccurate pricing information.
(4) Sound Risk Management Practices
The Commission believes that the proposed amendments related to
compliance and self-regulatory responsibilities should promote sound
risk management practices. The gains in this regard may depend on the
quality and effective implementation of the policies and practices that
SEFs would adopt under the proposed amendments.
The Commission notes that proposed Sec. 37.203(e) is intended to
encourage SEFs to implement and maintain error trade policies that
reduce operational risks for market participants, and are therefore
sound risk management policies. This proposed rule should reduce the
harm to a market participant when it enters into an error trade, and
reduce harm to the market generally by decreasing the risk of reliance
on pricing information from an error trade.
(5) Other Public Interest Considerations
The Commission has not identified any effects of the proposed rules
identified above on other public interest considerations.
Request for Comment
The Commission requests comment on all aspects of the consideration
of the costs and benefits of the provisions related to Compliance and
SRO Responsibilities.
6. Design and Monitoring of Swaps
a. Overview
(1) Swaps Not Readily Susceptible to Manipulation
The Commission proposes to revise the guidance relating to how a
SEF should demonstrate that a new swap contract is not readily
susceptible to manipulation under Sec. 37.301. The Commission proposes
to adopt rules that would create an Appendix C to part 37 (and update
the cross reference under Sec. 37.301) and make conforming changes to
the guidance found in Appendix B. The proposed revision to the guidance
to Core Principle 3 in Appendix B would eliminate the explanatory
guidance, which the Commission is proposing to address in the proposed
guidance to Appendix C to part 37 and replace the existing Appendix B
guidance's cross reference to sections of Appendix C to part 38 with a
general reference to Appendix C to part 37. The guidance in Appendix C
to part 38 partly focuses on futures
[[Page 62076]]
products, which is not applicable in part 37. The proposed guidance is
intended to clarify a SEF's obligations pursuant to Core Principle 3,
and specifically addresses only swap contracts.
(2) Monitoring of Trading and Trade Processing
The proposed changes to the regulations implementing Core Principle
4 are intended to establish more practical trade monitoring
requirements. First, the Commission proposes to amend existing Sec.
37.401(c) \1029\ to require that a SEF conduct real-time market
monitoring of ``trading activity'' only on its own facility and in
order to identify disorderly trading, any market or system anomalies,
and instances or threats of manipulation, price distortion, and
disruption. Second, the Commission proposes to amend existing Sec.
37.401(a) \1030\ to specify that a SEF has discretion to determine when
(in place of the current requirement that it do so on an ``ongoing
basis'') to collect and evaluate market participant's trading activity
beyond its market, i.e., as necessary to detect and prevent
manipulation, price distortion, and, where possible, disruptions of the
physical-delivery or cash-settlement processes. Third, the Commission
proposes to eliminate the Sec. 37.403(a) requirement that SEFs monitor
the ``pricing'' of the reference price used to determine cash flows or
settlement. Fourth, with regards to the Sec. 37.404(b) requirement
that a SEF require its market participants to keep records of their
trading, the Commission proposes to eliminate the current information
maintenance and collection exemption that permits SEFs to limit the
application of the requirement for market participants to keep and
provide records of their activity to only those market participants
that conduct ``substantial'' trading on the SEF as set forth in the
guidance to Core Principle 4 in Appendix B. Fifth, the Commission
proposes to amend Sec. 37.405 to state that a SEF must have risk
control mechanisms to prevent and reduce market disruptions as well as
price distortions only on its own facility, rather than on and off
facility.
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\1029\ This requirement is in proposed Sec. 37.401(a).
\1030\ This requirement is in proposed Sec. 37.401(b).
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In addition to these substantive changes, the Commission proposes a
number of clarifying and streamlining changes that would not result in
any new costs or benefits and are not discussed below. The Commission
proposes to partially incorporate existing Sec. 37.203(e), which
requires that a SEF conduct real-time market monitoring, into Sec.
37.401(a),\1031\ and to consolidate the trade reconstruction
requirements under Sec. 37.401(d) and Sec. 37.406 into proposed Sec.
37.401(d). The Commission proposes clarifying amendments to Sec.
37.402 and Sec. 37.403, regarding SEF monitoring obligations with
respect to physical-delivery and cash-settled swaps, which would not
impose new obligations.
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\1031\ The Commission notes that existing Sec. 37.203(e)
specifies that a SEF must conduct real-time market monitoring of all
trading activity on its system(s) or platform(s) to identify
``disorderly trading and any market or system anomalies.'' As
discussed above, the Commission is proposing to eliminate this
provision and establish these requirements under Sec. 37.401(a) to
streamline the existing regulations.
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b. Benefits
(1) Swaps Not Readily Susceptible to Manipulation
The Commission believes that SEFs should benefit from the swap
focused discussion in proposed Appendix C to part 37. Similar to
Appendix C to part 38, the guidance outlined in proposed Appendix C to
part 37 would set forth information that should be provided to the
Commission for new products and rule amendments under Sec. 37.301,
based on best practices developed over the past three decades by the
Commission and other regulators. This guidance should provide greater
efficiency for SEFs so that they do not have to try to apply to swaps
products the futures-related provisions in Appendix C to part 38. The
guidance would also likely reduce the time and costs that SEFs would
incur in providing the appropriate information and should mitigate the
need for extensive follow-up discussions with the Commission. In
addition, it should reduce the amount of time it takes Commission staff
to analyze whether a new product or rule amendment is in compliance
with the CEA.
Furthermore, the proposed Appendix C to part 37 should not diminish
the current benefits from the implementing regulations for Core
Principle 3. The proposed Appendix C to part 37 should continue to aid
SEFs to list contracts that are not readily susceptible to manipulation
and should contribute to integrity and stability of the marketplace by
giving traders more confidence that the prices associated with swaps
reflect the true supply of and demand for the underlying commodities or
financial instruments.
(2) Monitoring of Trading and Trade Processing
The Commission acknowledges that trading abuses may take place
across trading platforms and markets. However, the Commission
understands that the requirement that a SEF monitor the trading
activity of its market participants, whether or not the activity occurs
on the SEF's own platform, has in practice been highly costly and
burdensome, and in some instances these costs and burdens effectively
preclude compliance. Moreover, requiring every SEF to monitor trading
on every other regulated trading facility is redundant and therefore
provides little incremental benefit.
The Commission believes that the proposed regulations should
substantially reduce these very high monitoring costs for SEFs with
relatively little impact on the benefits of the regulation, as
discussed above. Under the proposed regulations, a SEF would not have
to monitor trading activity in real-time beyond its facility or the
pricing of reference prices for cash-settled swaps, and would not have
to collect and evaluate its market participants trading activity on an
ongoing basis--only as needed to detect and prevent abusive trading
practices. Accordingly, this should save SEF resources.
Proposed Sec. 37.401(a) and, for cash-settled swaps, the removal
of existing Sec. 37.403(a),\1032\ would limit certain monitoring
obligations to a SEF's facility, and should significantly reduce the
hours that a SEF's employees and officers must spend reviewing both the
SEF's market participants' trading activity off of its facility and
also market data (including the pricing information as required under
Sec. 37.403(a)) from other exchanges, index providers, and over-the-
counter (``OTC'') trading. SEFs would not have to pay third party
exchanges and providers for this market data and trading information
because a SEF would no longer have to monitor trading beyond its
facility (although it would still have to collect and evaluate market
participant's trading data as needed per Sec. 37.401(b)). As a
practical matter, SEFs would also not have to establish and implement
protocols to reformat third party data for import and use with the
SEF's internal systems. While existing SEFs have already incurred cost
to establish protocols to import third party data, there would be
[[Page 62077]]
some savings for new SEFs because they would not have to develop
protocols.
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\1032\ The Commission notes that the proposed elimination of
Sec. 37.403(a) only creates a cost savings for a SEF's monitoring
of cash-settled swap products.
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Furthermore, SEFs generally would no longer have to implement or
maintain these protocols to import third party data. Consistent with
these changes, proposed Sec. 37.405 would require a SEF to maintain
risk control mechanisms to prevent and reduce the potential risk of
price distortions and market disruptions on its facility. A SEF would
no longer have to incur costs to monitor other trading facilities and
OTC trading for purposes of its risk controls. As noted above, since
these other trading facilities also have risk control mechanisms, the
benefits of requiring SEFs to monitor other trading facilities may be
incremental.
Additionally, under proposed Sec. 37.401(b), a SEF would only be
required to collect and evaluate data on its market participant's
activity that occurs away from the SEF to the extent that doing so is
necessary to detect and prevent abusive trading practices. The cost for
SEFs to collect market data should decrease because SEFs would no
longer collect information on an ongoing basis. To the extent that SEFs
were requesting that market participants provide trading data, market
participants should also incur fewer costs. Furthermore, SEFs would no
longer have to obtain trading data from third parties since all market
participants would be required to provide trading data upon request
under Sec. 37.404(b), including those market participants that a SEF
currently may not require to provide trading activity information to
the SEF.\1033\ These market participants that currently do not collect
or provide trading data would incur some additional costs to provide
such information. Overall, SEFs should be required to spend less money
importing and analyzing its market participants' off-SEF trading, and
market participants should incur less cost in exporting this data.
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\1033\ Section 37.404(b) and the associated guidance to Core
Principle 4 in Appendix B permits a SEF to limit the application of
the requirement for market participants to keep and provide records
of their activity in the index or instrument used as a reference
price, the underlying commodity, and related derivatives markets, to
only those market participants that conduct substantial trading on
its facility. 17 CFR part 37 app. B.
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Consistent with these changes, proposed Sec. 37.405 would require
a SEF to maintain risk control mechanisms to prevent and reduce the
potential risk of price distortions and market disruptions only on its
facility. A SEF would no longer have to monitor or coordinate its risk
controls with other SEFs and activity on the OTC market.
Notwithstanding these potential savings due to proposed Sec. Sec.
37.401(a)-(b), Sec. 37.405, and removal of existing Sec. 37.403(a),
the Commission understands that most SEFs have (in light of the
infeasibility of compliance as discussed above) interpreted the
existing regulations to be less demanding than as described in the
preamble to the part 37 SEF final rule, and, in practice, have
implemented monitoring programs and risk controls that primarily focus
on their respective facility. These SEFs may not realize a meaningful
reduction in costs because they already have implemented many of these
more limited monitoring programs and risk controls.
c. Costs
(1) Swaps Not Readily Susceptible to Manipulation
Compliance with the guidance in proposed Appendix C to part 37
should not impose any additional costs on SEFs or the market generally.
SEFs submitting products for the Commission's certification under Sec.
37.301 could incur some costs applying the guidance if the proposed
Appendix C to part 37 prompted a SEF to increase the information that
it provided when submitting a new swap product. However, the requested
information set forth in proposed Appendix C to part 37 is intended to
reflect the Commission's prior expectations. For example, the proposed
Appendix C to part 37 includes a specific section for options on swap
contracts that Appendix C to part 38 does not address. This newly
created section is intended to be consistent with previous Commission
expectations regarding contract design and transparency of option
contract terms. The Commission currently requires that a SEF's product
submission specify in an objective manner the following material
option-specific terms of a swap (in addition to appropriately designing
and sufficiently specifying the underlying swap's terms): (i) Exercise
method; (ii) exercise procedure; (iii) strike price provisions; (iv)
automatic exercise provisions; (v) contract size; (vi) option
expiration and last trading day; and (vii) option type and trading
convention. SEFs have provided these option-specific terms in their
submissions for options on swap contracts. The Commission does not
expect SEFs to incur any additional costs because of the guidance.
(2) Monitoring of Trading and Trade Processing
The proposed changes to the implementing regulations under Core
Principle 4 could increase the chance that a SEF does not promptly
identify abusive trading practices that occur away from its facility,
but this risk is mitigated because every transaction occurring on a
regulated platform such as a SEF or DCM would still be subject to
monitoring. The narrowing of a SEF's monitoring obligations under Sec.
37.401(a) may potentially cause the SEF to not identify an abusive
trading practice occurring on another exchange or OTC market, possibly
in coordination with trading on the SEF's facility.
As a mitigating factor, the Commission believes that a SEF should
benefit from its monitoring staff focusing more on trading activity on
its facilities and the SEF's obligation to collect and evaluate its
market participants' trading activity off of the SEF. This refocusing
of the monitoring staff's attention should better enable a SEF to more
quickly identify and address abusive trading practices on its facility.
The removal of SEFs' monitoring obligations under Sec. 37.403(a)
may potentially cause a SEF to not identify an abusive trading practice
occurring on a cash-settled swap's underlier, possibly in coordination
with trading of the cash-settled swap on the SEF's facility. In
practice, the Commission believes that the additional risk of a SEF
failing to promptly identify abusive trading due to this proposed
regulation is minimal because SEFs typically cannot access third
parties' price-forming information, and SEFs would be challenged to
analyze this third party information for abusive activities.
Consequently, the Commission does not anticipate that removing this
requirement will materially impact SEFs current monitoring practices or
effectiveness.\1034\
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\1034\ The Commission notes that SEFs would continue to be
obligated to monitor the continued appropriateness of the index or
instrument and take appropriate actions where there is a threat of
manipulation, price distortion, or market disruption pursuant to
proposed Sec. 37.403(b).
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The reduction in trading information that SEFs have to analyze
under proposed Sec. 37.401(b) could limit a SEF's ability to identify
an abusive trading practice occurring on another SEF or a DCM or OTC,
possibly in coordination with trading on the SEF's facility. However,
the Commission believes that under the proposed regulation, SEFs would
still have the means to collect market participants' trading
information and, in unusual situations when a SEF would benefit from
additional information to identify abusive trading practices, the SEF
would be able to request this information. Moreover, the
[[Page 62078]]
other SEFs and DCMs would be required to monitor for abusive practices
on their own facilities. Thus, requiring SEFs to monitor trading on
other regulated trading facilities is redundant. The Commission
believes that SEFs would be more efficient and effective if they were
required only to ask for this information when needed.
The proposed changes to the risk control mechanisms under Sec.
37.405 could increase the chance that abusive trading practices go
unchecked. A SEF would no longer have to monitor or coordinate its risk
controls with other SEFs and OTC trading, and a market participant may
be able to attempt to engage in an abusive trading practice across
exchanges and OTC due to this lack of coordination. The Commission
believes that this risk is largely mitigated because every SEF and DCM
would be required to have these mechanisms on their own facilities, and
therefore the incremental detriment from removing this requirement
should be minimal. The Commission believes that potential costs
resulting from removing the requirement that SEFs monitor or have risk
controls related to the OTC market are unlikely to be significant,
since such monitoring and risk controls are not practicable. The OTC
market is not required by the CEA or the Commission's regulations to
have risk controls and it is not clear that risk controls in the OTC
market are feasible. The Commission notes that in light of the
Commission's proposed interpretation of the trade execution
requirement, more swaps are likely to be traded on-SEF and thus subject
to monitoring and risk controls. Moreover, SEFs would continue to have
the ability to investigate and address abusive trading practices that
are implemented across multiple trading facilities, and to request
information on a market participant's trading activity.
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
The proposed guidance in Appendix C to part 37 and the monitoring
requirements in proposed Sec. Sec. 37.401-403 should not materially
diminish a SEF's ability to protect market participants and the public.
The proposed guidance in Appendix C to part 37 and the proposed
amendments to Sec. Sec. 37.402-403 are intended to provide additional
clarity for SEFs to help ensure that a contract is not readily
susceptible to manipulation, and to help ensure that SEFs are able to
adequately collect information on market activity, including special
considerations for physical-delivery contracts and cash-settled
contracts. Proposed Sec. Sec. 37.402-403 would require SEFs to take
specific actions to address threats of manipulation, price distortion,
or market disruption, and proposed Sec. 37.405 would continue to
require risk controls to prevent and reduce the potential risk of price
distortions and market disruptions on the SEF.
The Commission does not believe that narrowing a SEF's monitoring
obligation under proposed Sec. 37.401(a) to trading activity on its
facility, requiring a SEF to collect market participants' off facility
trading information only when necessary to detect abusive trading
activity per proposed Sec. 37.401(b), eliminating the SEF's monitoring
of the price formation information for underlying indexes currently set
forth under Sec. 37.403(a), or altering the risk control mechanisms
under Sec. 37.405 would meaningfully increase the risk that abusive
trading practices go undetected. While there is a risk that abusive
trading can lead to market disruptions and create distorted prices or
systemic risks that could harm the economy and the public, the SEF's
requirement to monitor its facility per Sec. 37.401(a) and to collect
additional trading information from market participants as necessary
per Sec. 37.401(b) should mitigate this risk. As a group, these rules
should continue to protect market participants by helping to prevent
price manipulation and trading abuses, as the proposed rules are
designed to protect the public by creating an environment that fosters
prices that reflect actual market conditions.
(2) Efficiency, Competitiveness, and Financial Integrity of the Markets
The proposed guidance in Appendix C to part 37 is intended to
provide more tailored guidance, based on best practices for swaps,
regarding what a SEF should consider when developing a swap or amending
the terms and conditions of an existing swap. This tailored guidance
should help the contracts listed by SEFs, as a whole, to be more
reflective of the underlying cash market, thus providing for more
efficient hedging of commercial risk.
Furthermore, proposed Sec. Sec. 37.401-403 should require SEFs to
continue to detect and promptly address violations and market
anomalies, and ensure that prohibited activities do not distort the
swap market's prices. Therefore, the proposed modifications to SEF
monitoring requirements should not materially diminish market
confidence or reduce the market's ability to operate efficiently.
Additionally, proposed Sec. 37.405 should continue to deter rule
violations by establishing conditions under which trading is paused or
halted.
(3) Price Discovery
The Commission does not believe that the proposed rules would
materially diminish a SEF's ability to implement an effective
monitoring system of its facility to detect rule violations.
Manipulation or other market disruptions interfere with the price
discovery process by artificially distorting prices and preventing
those prices from properly reflecting the fundamental forces of supply
and demand. Although there is some risk, as discussed above, that
modifications to the SEF's monitoring obligations may cause a SEF to
not identify price manipulation, the Commission believes this risk is
not material. These rules would continue to require that SEFs detect,
and where possible prevent, such market mispricing, and detect
disconnects between swaps and their related market prices, e.g.,
between cash market prices and the prices of related futures and swaps.
These rules should continue to promote confidence in the SEF's price
discovery process and market participants' use of swaps to hedge risk.
(4) Sound Risk Management Practices
By following the best practices outlined in the proposed guidance
in Appendix C to part 37 and the requirements of proposed Sec. Sec.
37.402-403, a SEF should be able to minimize the susceptibility of a
swap to manipulation or price distortion at the time it is developing
the contract's terms and conditions. Performing this work early on
should enable a SEF to minimize risks to its clearinghouse and to
market participants. Sound risk management practices rely upon
execution of hedge strategies at market prices that are free of
manipulation or other disruptions. These rules are designed to
facilitate hedging at prices free of distortions that may be
preventable by adequate controls.
Furthermore, proposed Sec. Sec. 37.401-403 should continue to aid
SEFs in deterring, detecting, and addressing operational risks posed by
abusive trading practices or trading activities. These proposed rules
are designed to limit the potential losses and costs to SEFs and market
participants and promote sound risk management practices.
(5) Other Public Interest Considerations
The Commission has not identified any effects that these rules will
have on
[[Page 62079]]
other public interest considerations other than those enumerated above.
Request for Comment
The Commission requests comment on all aspects of the consideration
of the costs and benefits of the provisions related to the Design and
Monitoring of Swaps.
7. Financial Integrity of Transactions
a. Overview
In order to promote financial integrity of transactions, the
Commission is proposing changes with respect to certain straight-
through processing obligations under Core Principle 7 for SEFs and its
implementing regulations and under Sec. 39.12(b)(7) for derivatives
clearing organizations (``DCO''). The Commission will discuss these
changes together in this section since these provisions interact to
form the basis of the Commission's straight-through processing
obligations for SEFs and DCOs.\1035\
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\1035\ For example, the Commission promulgated Sec. 37.702(b)
and Sec. 39.12(b)(7) along with other Commission regulations
related to straight-through processing in the same Commission
rulemaking. See Customer Clearing Documentation, Timing of
Acceptance for Clearing, and Clearing Member Risk Management, 77 FR
21278 (Apr. 9, 2012) (``Timing of Acceptance for Clearing Final
Rule'').
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Proposed Sec. 37.701 would require a SEF to have an independent
clearing agreement with each registered DCO or exempt DCO to which the
SEF routes swaps for clearing, including in those instances where a
SEF, pursuant to a service agreement with a third-party service
provider, routes swaps through the SEF's third-party service provider
to a DCO that maintains its own agreement with the third-party service
provider, but not with the SEF.
Proposed Sec. 37.702(b)(1) would require SEFs to coordinate with
registered DCOs to develop rules and procedures that facilitate the
``prompt, efficient, and accurate'' processing and routing of swap
transactions in accordance with Sec. 39.12(b)(7)(i)(A).\1036\ The
Commission proposes to explicitly interpret the ``prompt, efficient,
and accurate'' standard to establish a qualitative approach for swaps
subject to manual post-execution affirmation to be routed to and
received by the relevant DCO via a third-party affirmation hub that
would account for existing market practices and technology, as well as
current market conditions at the time of execution. The Commission
notes that this proposed interpretation is in contrast to the
Divisions' view discussed in the 2013 Staff STP Guidance, in which the
Divisions interpreted the ``prompt and efficient'' standard in existing
Sec. 37.702(b)(2) to mean that swaps subject to manual post-execution
affirmation via a third-party affirmation hub should be routed to and
received by the relevant DCO in no more than ten minutes after
execution.\1037\
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\1036\ See Section XII.B.--Sec. 37.702--General Financial
Integrity. The proposal would renumber Sec. 37.702(b)(2) to Sec.
37.702(b)(1), delete existing Sec. 37.702(b)(1), and amend the
``prompt and efficient'' standard to ``prompt, efficient, and
accurate'' (emphasis added).
\1037\ The Commission understands that several aspects of
straight-through processing requirements are rendered through the
2013 Staff STP Guidance and the 2015 Staff Supplementary Letter. The
Commission also understands that certain aspects of the guidance may
be unclear when read in conjunction with existing regulations.
Therefore, the Commission seeks to provide greater clarity and
certainty under the proposed framework with respect to the straight-
through processing requirements for SEFs and DCOs through the
proposed clarifications and amendments described herein.
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Proposed Sec. Sec. 37.702(b)(2)-(3), respectively, would mandate
that SEFs (i) require their market participants to identify a clearing
member in advance for each counterparty on an order-by-order basis and
(ii) facilitate pre-execution screening by each clearing FCM in
accordance with the requirements of Sec. 1.73 on an order-by-order
basis. The Commission notes that this is consistent with the Divisions'
view in the 2013 Staff STP Guidance that such requirements are
corollary to a SEF's obligation to facilitate ``prompt and efficient''
transaction processing.\1038\ Further, the Commission notes that pre-
execution credit screening has become a fundamental component of the
swaps clearing infrastructure as SEFs that list Required Transactions
\1039\ for trading or offer clearing for Permitted Transactions \1040\
generally have already established these functionalities, at least in
part, to comply with the Commission's regulations, to be consistent
with the Divisions' views expressed in the 2013 Staff STP Guidance, or
to adhere to existing industry practices.\1041\
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\1038\ See 2013 Staff STP Guidance at 3. The Commission further
notes that it stated in the Timing of Acceptance for Clearing Final
Rule, that the ``parties would need to have clearing arrangement in
place with clearing members in advance of execution'' and that
``[i]n cases where more than once DCO offered clearing services, the
parties also would need to specify in advance where the trade should
be sent for clearing.'' Timing of Acceptance for Clearing Final Rule
at 21284.
\1039\ 17 CFR 37.9(a)(1) (defining a Required Transaction as any
transaction involving a swap that is subject to the trade execution
requirement in section 2(h)(8) of the Act).
\1040\ 17 CFR 37.9(c) (defining a Permitted Transaction as any
transaction not involving a swap that is subject to the trade
execution requirement in section 2(h)(8) of the Act).
\1041\ In the 2013 Staff STP Guidance, the Divisions believed
that pre-trade credit checks would make rejection from clearing for
credit reasons a rare event. See 2013 Staff STP Guidance at 5. The
Commission notes that the proposed amendments to Sec. 37.702(b) are
generally consistent with the Divisions' views articulated in the
2013 Staff STP Guidance.
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The Commission proposes to streamline the applicable straight-
through processing provisions for registered DCOs by consolidating the
existing requirements under Sec. Sec. 39.12(b)(7)(ii)-(iii) into
proposed Sec. 39.12(b)(7)(ii) and would delete existing Sec.
39.12(b)(7)(iii). Specifically, proposed Sec. 39.12(b)(7)(ii) would
establish a single AQATP standard that applies to all ``agreements,
contracts, and transactions'' (emphasis added) regardless of whether a
trade is (1) executed competitively or noncompetitively; (2) executed
on, off, or pursuant to the rules of a DCM; \1042\ or (3) a swap,
futures contract, or option on a futures contract; and (4) would apply
after submission to the DCO (i.e., once the transaction is received by
the DCO) rather than after execution in all circumstances.
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\1042\ The Commission notes that it is proposing to eliminate
the ``pursuant to the rules'' language, given the change to the
block trade definition. See supra Section XXII.A.--Sec. 43.2--
Definition--Block Trade; Sec. 37.203(a)--Elimination of Block Trade
Exception to Pre-Arranged Trading.
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In contrast, existing Sec. Sec. 39.12(b)(7)(ii)-(iii) establish
different standards that apply based on a transaction's
characteristics. Existing Sec. 39.12(b)(7)(ii) applies to (i) any
contract, including futures, options on futures, and swaps, that is
(ii) executed competitively, (iii) on or subject to the rules of a SEF
or DCM, and (iv) the AQATP period applies after the trade's execution
on the SEF or DCM (emphasis added). Existing Sec. 39.12(b)(7)(iii)
applies to any (i) swap (but not other products) that either is (ii)
executed noncompetitively on or subject to the rules of a SEF or DCM or
(iii) not executed on or subject to the rules of a SEF or DCM, and (iv)
the AQATP period applies after submission to the DCO (emphasis added).
Moreover, consistent with the views expressed by the Divisions in the
2013 Staff STP Guidance, the Commission proposes that registered DCOs
must continue to accept or reject trades within ten seconds after
submission under proposed Sec. 39.12(b)(7)(ii)'s AQATP standard.
The Commission would also make several non-substantive amendments.
First, to conform the changes throughout the part 37 proposal, all
references under Sec. Sec. 37.702-703 to
[[Page 62080]]
``member'' would be changed to ``market participant.''
Second, existing Sec. 37.702(b)(2) requires SEFs to develop rules
and procedures to facilitate the ``prompt and efficient transaction
processing'' of swap transactions to the applicable DCO. To conform
this requirement to existing Sec. 39.12(b)(7)(i)(A), which requires
each registered DCO to coordinate with a SEF or DCM to facilitate the
``prompt, efficient, and accurate'' processing of swaps for clearing,
the Commission proposes to add the term ``accurate'' to the existing
``prompt and efficient'' standard for SEFs under Sec.
37.702(b)(2).\1043\ Proposed Sec. 37.702(b)(1) would also apply to the
``routing'' of swap transactions; while the Commission believes that
``processing'' as used in existing Sec. 37.702(b)(2) also encompasses
the routing of swaps from a SEF to a DCO, the Commission proposes to
explicitly include ``routing'' in the regulatory text for avoidance of
doubt.\1044\ As a result, existing Sec. 37.702(b)(1), which required a
SEF to have the ``capacity to route transactions'' to a DCO, would be
deleted as unnecessary due to new proposed Sec. 37.702(b)(1). As a
conforming change to proposed Sec. 37.702(b)(1), the Commission also
proposes to add the term ``routing'' to Sec. 39.12(b)(7)(i)(A). The
Commission also proposes to specify under Sec. 37.702(b)(1) that a
SEF's obligation to coordinate with DCOs should be in accordance with
DCOs' obligations under existing Sec. 39.12(b)(7)(i)(A).\1045\
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\1043\ The Commission proposes to renumber Sec. 37.702(b)(2) to
Sec. 37.702(b)(1).
\1044\ Existing Sec. 37.702(b)(1) requires SEFs to have the
capacity to route transactions to the DCO in a manner acceptable to
the DCO for purposes of clearing. Since proposed Sec. 37.702(b)(3)
would specify that SEFs must also work with DCOs to route
transactions, existing Sec. 37.702(b)(1) would become superfluous
and would be deleted.
\1045\ Existing Sec. 37.702(b)(2) requires SEFs to work with
each DCO in accordance with the requirements of Sec. 39.12(b)(7).
The Commission's proposal would more specifically reference Sec.
39.12(b)(7)(i)(A) (emphasis added), which establishes a
corresponding obligation on DCOs to work with SEFs to develop rules
to facilitate the ``prompt, efficient, and accurate processing'' of
transactions in order to avoid any confusion with the application of
the AQATP standard under existing Sec. Sec. 39.12(b)(7)(ii)-(iii).
---------------------------------------------------------------------------
Third, proposed Sec. 37.702 would clarify that a SEF's obligations
under Sec. 37.702 apply only to registered DCOs, as opposed to exempt
DCOs.
Fourth, proposed Sec. 37.702(b) would specify that its
requirements apply only to those transactions routed through a SEF to a
registered DCO for clearing. The Commission believes that this change
is helpful to clarify that Sec. 37.702(b)'s requirements do not apply
to those SEFs that do not facilitate the clearing of swaps executed on
the SEF.
Fifth, proposed Sec. 39.12(b)(7) would apply to all ``agreements,
contracts, and transactions,'' rather than ``transactions'' as
currently provided, in order to conform with the statutory definition
of ``DCO'' in section 1a(15) of the Act and general scope of product
eligibility under Sec. 39.12(b)(1) and would make conforming changes
in proposed Sec. Sec. 39.12(b)(7)(i)-(ii).
b. Benefits
Proposed Sec. 37.701 is intended to interact with the other
proposed changes in Core Principle 7 and Sec. 39.12(b)(7) to
strengthen the straight-through processing and routing of swaps from
SEFs to DCOs, and increase market integrity. The Commission believes
proposed Sec. 37.701(b)'s requirement that a SEF have a direct
clearing agreement with each DCO to which the SEF submits swaps for
clearing would improve a SEF's ability to establish rules and
procedures that better coordinate with a DCO's clearance and settlement
processes to foster greater financial integrity of swaps sent to the
DCO for clearing. Such an agreement also would instill more confidence
in the ability of swap clearing through the SEF, as under the proposal
the SEF should have the appropriate processes to facilitate swaps
clearing. Further, the terms established in a direct clearing agreement
between the SEF and DCO should help the SEF and DCO resolve any
problems that arise at the DCO that could diminish the SEF's ability to
submit transactions for clearing.
The Commission believes that adopting proposed Sec. Sec.
37.702(b)(2)-(3) would strengthen the straight-through processing and
routing of swaps from SEFs to DCOs, and increase financial integrity of
transactions by ensuring a consistent and timely clearing process.
Specifically, proposed Sec. Sec. 37.702(b)(2)-(3) should benefit
transaction processing, routing, and clearing by codifying the
straight-through processing requirement that SEFs must ensure that
trades are efficiently routed to DCOs, reducing the time between
execution and clearing. However, to the extent counterparties already
comply with proposed Sec. Sec. 37.702(b)(2)-(3) as a result of
standard industry practices or as a result of adopting the Divisions'
view discussed in the 2013 Staff STP Guidance, these benefits may
already have been realized.\1046\
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\1046\ As discussed above, in the 2013 Staff STP Guidance, the
Divisions previously discussed their view that the straight-through
processing requirements under Sec. 37.702(b) require SEFs to have
pre-execution credit screening in certain instances. Id. at 3.
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The Commission believes that its proposed qualitative
interpretation of the ``prompt, efficient, and accurate'' standard in
proposed Sec. 37.702(b)(1), rather than a static bright-line standard
such as the ten-minute standard discussed by the Divisions in the 2015
Supplementary Staff Letter, would benefit the marketplace by
establishing a standard that is conducive to the broader array of swaps
that would be subject to the expanded trade execution requirement, as
well as the additional executed methods that would be permitted under
the Commission's proposal.
The Commission's proposed qualitative interpretation of the
``prompt, efficient, and accurate'' standard should also help ensure
that SEFs have time to use third-party affirmation hubs for all swap
trades instead of merely those trades that can be routed through the
affirmation hub for submission to the DCO within the prescribed time
limit. The Commission believes that permitting the use of affirmation
hubs benefits the marketplace in certain situations by providing an
opportunity for counterparties to identify and correct potential error
trades prior to routing these trades to a DCO for clearing, thereby
reducing the number of error trades.
The Commission believes that streamlining and creating a single
AQATP standard would benefit DCOs, SEFs, and clearing FCMs. The current
bifurcation of the AQATP standard requires a DCO to ascertain the
characteristics of a trade to determine whether the DCO's obligation to
accept or reject a trade subject to AQATP begins after (1) the trade's
execution for a trade that is executed competitively on a SEF or DCM
(and therefore subject to Sec. 39.12(b)(7)(ii)), or (2) the trade's
submission to the DCO for a trade that was either executed non-
competitively or on or subject to the rules of a SEF or DCM or executed
bilaterally (and therefore subject to Sec. 39.12(b)(7)(iii)). The
Commission's proposal to streamline the AQATP standard should simplify
the AQATP standard for DCOs, which in turn may lead to even more
efficient trade processing, routing, and clearing since these extra
steps are being removed from the straight-through processing
requirements.
c. Costs
Proposed Sec. 37.701 would require those SEFs that do not
currently have a direct clearing agreement with a DCO to
[[Page 62081]]
clear swaps executed on the SEF to enter into such an agreement with an
applicable DCO. This requirement could add a marginal cost related to
reviewing and entering into such an agreement with the SEF's DCO.
With respect to the Commission's proposed qualitative
interpretation of the ``prompt, efficient, and accurate'' standard in
proposed Sec. 37.702(b)(1), the Commission believes that the proposed
qualitative standard for swaps routed via third-party affirmation hubs
could reduce the financial integrity of the trades facilitated by the
SEF as compared to the alternative of establishing a bright-line static
deadline, such as the ten-minute timeframe discussed by the Divisions
in the 2015 Supplementary Staff Letter. As a result, a SEF could argue
that it complies with the Commission's qualitative interpretation of
the ``prompt, efficient, and accurate'' standard even though the swap
could have been processed and routed more quickly if the Commission
would have established a bright-line standard, e.g., the ten-minute
timeframe articulated in the 2015 Supplementary Staff Letter.
However, the Commission believes this potential cost would be
mitigated if, as the Commission expects will occur, market and
technological developments enable processing and routing through third-
party affirmation hubs to occur at increasingly shorter time intervals.
The Commission also believes that there is an inherent incentive to
confirm all trades in a timely manner, as a counterparty to the trade
that has entered a trade in its front office system and is trading on
that information needs to ensure that trade is accurate, otherwise, it
may be managing its portfolio with inaccurate information. Further, the
Commission has set forth its expectation that under its proposed
qualitative standard, transactions that can be reasonably affirmed on a
fully automatic basis after execution should be affirmed in that
manner.\1047\ In such cases, the Commission believes that ``prompt,
efficient, and accurate'' processing and routing would occur in a much
shorter time frame, e.g., less than the ten-minute time frame discussed
in the 2015 Supplementary Staff Letter. Accordingly, the Commission
would continue to monitor the post-trade affirmation timeframe and
industry developments with respect to swap processing and routing to
require that SEFs and DCOs comply with their applicable straight-
through processing requirements.
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\1047\ The Commission notes that this statement is consistent
with the views of the Divisions in the 2015 Supplementary Staff
Letter. Id. at 3.
---------------------------------------------------------------------------
Proposed Sec. 37.702(b)(2) would require each market participant
to identify a clearing FCM in advance of each trade for each
counterparty. The Commission notes that market participants must
already identify a clearing FCM, and so does not believe that the
proposed requirement will impose a material cost since it would specify
only that a market participant must identify its clearing FCM before
the trade rather than after. Similarly, proposed Sec. 37.702(b)(3)
would require SEFs to provide pre-execution credit screening, which
could impose a cost on some SEFs to establish a means of communicating
with an FCM. While proposed Sec. Sec. 37.702(b)(2)-(3) could impose
costs by requiring SEFs to update their systems to facilitate these
requirements, the Commission believes that SEFs generally already have
established these functionalities as established market practices.
Moreover, existing Sec. 1.73 requires a clearing FCM to implement pre-
execution risk controls. Consequently, the Commission believes that
most SEFs already comply with proposed Sec. 37.702(b)(3) since
clearing FCMs otherwise would unlikely be able to comply with their
Sec. 1.73 obligations. Accordingly, costs imposed by proposed
Sec. Sec. 37.702(b)(2)-(3) likely have already been realized.\1048\
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\1048\ The Divisions' view in the 2013 Staff STP Guidance
already stipulated that SEFs should adopt the practices that the
Commission has proposed under Sec. Sec. 37.702(b)(2)-(3). As a
result, to the extent that SEFs have followed the Divisions'
interpretation in the 2013 Staff STP Guidance, such costs already
have been realized.
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The Commission believes that the proposed consolidation of the
AQATP standard would not impose any new cost on DCOs since the
Commission is merely clarifying an AQATP standard in existing Sec.
39.12(b)(7)(ii) to more accurately reflect when a DCO's AQATP
obligation begins. The proposed ten-second AQATP standard could impose
new costs by requiring DCOs to establish the ability to accept or
reject trades for clearing within ten seconds. However, the Commission
does not believe that the proposed interpretation of the AQATP standard
would impose any material costs because it conforms to the industry
standard and 99 percent of all trades are accepted or rejected from
clearing within ten seconds or less.\1049\ The proposed ten-second
interpretation of the AQATP standard could dis-incentivize the
development of an even quicker industry AQATP standard, resulting in
the opportunity cost of the development of more efficient and faster
straight-through processing. On the other hand, the ten-second standard
could be too prescriptive, compared to the qualitative approach the
Commission is taking with respect to the ``prompt, efficient, and
accurate'' standard in the context of manual affirmation hubs, and
certain execution methods such as voice execution, that may have a
relatively higher error rate compared to other execution methods such
as electronic trading, could reasonably require more than ten seconds
under the AQATP standard. This issue could be exacerbated by new or
innovative execution methods along with potentially new and complex
swaps that the Commission anticipates may become more common on SEFs
and DCMs under its proposed framework and that otherwise could benefit
from more than ten seconds under the AQATP standard.
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\1049\ See 2015 Supplementary Staff Letter at 5.
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d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
The Commission's proposal on the financial integrity of
transactions and straight-through processing obligations should benefit
market participants and the public by helping to ensure greater
transparency and consistency of straight-through processing, which the
Commission expects would result in market participants and the public
having a better understanding of the relevant market structure. In
turn, this could enable market participants and the public to make more
informed choices and more readily identify and understand possible
risks. The proposal would adopt and codify certain straight-through
processing standards--rather than relying on industry practice or staff
guidance--related to the processing and routing of swaps by SEFs, i.e.,
the ``prompt, efficient, and accurate'' standard and the continued use
of manual affirmation hubs and the clearing or rejection of trades by
registered DCOs, i.e., the ten-second AQATP standard. These
requirements should help market participants and the public obtain
greater transparency of market structure and potential risks related to
timely trade processing and clearing. Similarly, although the
Commission believes that its proposal is consistent with existing
industry practices, by adopting and codifying these straight-through
processing standards, the proposal should better protect market
participants and the public by helping to ensure that FCMs, SEFs, DCMs,
and DCOs adhere to the applicable straight-through processing
[[Page 62082]]
standards. As a result, the proposal would help ensure that market
participants and the public continue to receive the related straight-
through processing benefits.
(2) Efficiency, Competitiveness, and Financial Integrity of Markets
The AQATP standard reflects the Commission's belief that acceptance
or rejection for clearing in close to real time is crucial for the
efficient operation of trading venues, and the Commission's proposal is
intended to reinforce SEFs' and DCOs' mutual obligation to work with
one another to ensure the prompt, efficient, and accurate processing
and routing of swaps from SEFs to DCOs. In turn, this should promote
market efficiency and the financial integrity of transactions by
requiring these market participants to work together to process, route,
and ultimately clear swap transactions as appropriate.
In recognizing that some trading venues may not be fully automated
or may offer execution methods that either are not fully automated or
that have a relatively higher error rate, such as voice execution, the
Commission's proposal would explicitly permit the use of third-party
affirmation hubs pursuant to proposed Sec. 37.702(b) to assist
counterparties in identifying and fixing any errors before routing to a
DCO. Identifying errors before trades are cleared should enhance the
financial integrity of markets by helping to ensure that cleared
transactions reflect counterparties' expectations and thereby avoid
costs associated with fixing any cleared error trades. However, the
absence of a prescribed timeframe to confirm transactions may result in
delayed resolution of trade errors.
Clarifying that a DCO must accept or reject a trade after
submission to the DCO, i.e., when the DCO receives the transaction,
subject to the ten-second AQATP standard should facilitate a regulatory
framework in which DCOs have access to reasonably available technology
to provide their clearing customers with competitive and efficient
timeframes to accurately accept or reject trades for clearing. The
Commission's AQATP standard for DCOs' compliance will allow--and
require--the timeframe for straight-through processing to continue to
adapt with technological advancements and other cleared product
developments.
Proposed Sec. 37.702(b) and the Commission's related
interpretation should promote efficiency by incorporating the use of
third-party affirmation platforms, which provide an opportunity to
identify error trades prior to clearing, pursuant to the ``prompt,
efficient, and accurate'' standards. Similarly, proposed Sec.
37.702(b) should promote financial integrity by reducing instances in
which a DCO inadvertently clears an error trade, which may also
possibly be reported to an SDR that would publish such trades to the
public pursuant to the real-time reporting requirements under part 43
of the Commission's regulations. However, the Commission also
recognizes that to the extent that market participants have adopted
these practices, such as pre-execution screening by FCMs, these
benefits may already have been realized.
(3) Price Discovery
The Commission does not believe the proposed changes will have a
significant effect on price discovery. To the extent that the
Commission's proposal is conducive to permitting new execution methods
(i.e., by establishing a qualitative standard for third-party manual
affirmation hubs), the Commission believes that these changes could
improve price discovery. On the other hand, the absence of a prescribed
timeframe to process and route transactions to a DCO may result in
trades taking longer to clear than they otherwise would have with a
prescribed timeframe, which may affect price discovery. However, as
noted above, the Commission believes that the proposed standard is
consistent with industry practice.
(4) Sound Risk Management Practices
The AQATP standard reflects the Commission's belief that acceptance
or rejection for clearing in close to real time is crucial for
effective risk management. The Commission believes that prudent risk
management dictates that once a trade has been submitted to a clearing
FCM or a DCO, the clearing FCM or DCO must accept or reject it as
quickly as possible. The Commission's proposal would promote sound risk
management practices by ensuring that all intended-to-be-cleared swaps
are subject to straight-through processing on a SEF and that all trades
submitted to a DCO are subject to a consistent AQATP standard.
(5) Other Public Interest Considerations
The Commission has not identified any other public interest
considerations relevant to the proposal on financial integrity and
straight-through processing obligations.
Request for Comment
The Commission requests comment on all aspects of the consideration
of the costs and benefits of the proposal related to the financial
integrity of transactions and straight-through processing obligations.
8. Financial Resources
a. Overview
The proposal would generally adopt Commission staff ``Financial
Resources Guidance,'' \1050\ with certain changes, as part of the
proposed acceptable practices to Core Principle 13 in Appendix B to
part 37 to provide additional guidance for SEFs when determining their
financial obligations under proposed Sec. 37.1301 and Sec. 37.1303,
including what costs a SEF may or may not include in its projected
operating cost calculations.
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\1050\ CFTC Letter No. 17-25 Division of Market Oversight
Guidance on Calculating Projected Operating Costs by Designated
Contract Markets and Swap Execution Facilities (Apr. 28, 2017).
---------------------------------------------------------------------------
Proposed Sec. 37.1301(a) would require a SEF to maintain financial
resources in an amount adequate to cover only those projected operating
costs necessary to enable the SEF to comply with its core principle
obligations under section 5h of the Act and any applicable Commission
regulation for a one-year period, calculated on an ongoing basis. In
contrast, existing Sec. 37.1301(a) requires a SEF to maintain
sufficient financial resources to cover all of its operations for a
one-year period, calculated on an ongoing basis, regardless of whether
such operating costs are necessary for the SEF to comply with its core
principle or other applicable Commission regulations. The Commission
would consolidate Sec. 37.1301(c) with Sec. 37.1301(a) and
accordingly delete Sec. 37.1301(c). Proposed Sec. 37.1301(b) would
permit a SEF to file a consolidated financial report if the SEF also
operates as a DCO.
Pursuant to existing Sec. 37.1303, a SEF currently has reasonable
discretion to determine its financial obligations under Sec.
37.1301.\1051\ The Commission would adopt Acceptable Practices to
further clarify the costs that a SEF may or may not exclude in its
reasonable discretion when determining its projected operating costs
under Sec. 37.1301(a). The proposed Acceptable Practices would
generally be based
[[Page 62083]]
upon the Financial Resources Guidance in which staff discussed the
scope of a SEF's reasonable discretion for determining its obligations
under Sec. 37.1301 and Sec. 37.1303. Specifically, the Financial
Resources Guidance provides that a SEF may reasonably exclude from its
projected operating costs certain expenses, including (1) costs
attributable solely to sales, marketing, business development, or
recruitment; \1052\ (2) compensation and related taxes and benefits for
SEF employees whose functions are not necessary to meet the SEF's
regulatory responsibilities; \1053\ (3) costs for acquiring and
defending patents and trademarks for SEF products and related
intellectual property; (4) magazine, newspaper, and online periodical
subscription fees; (5) tax preparation and audit fees; (6) to the
extent not covered by item (2) above, the variable commissions that a
voice-based SEF may pay to its employee-brokers, calculated as a
percentage of transaction revenue generated by the voice-based SEF; and
(7) any non-cash costs, including depreciation and amortization. The
Commission similarly would incorporate this list with certain
conforming changes into the proposed Acceptable Practices as costs that
the Commission believes may be reasonable for a SEF to exclude from its
projected operating cost calculations.\1054\ In addition to these
enumerated items, the proposed Acceptable Practices additionally would
provide that as long as a SEF offers more than one bona fide execution
method, it may be a reasonable use of a SEF's discretion under proposed
Sec. 37.1304 to include the costs of only one of its bona fide
execution methods in its projected operating costs calculations, while
excluding the costs associated with its other execution methods.\1055\
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\1051\ Section 37.1303 provides that a SEF has reasonable
discretion in determining the methodology used to compute its
projected operating costs in order to determine the amount needed to
meet its requirements under Sec. 37.1301. Because the liquidity
requirement in existing Sec. 37.1305 is based upon a SEF's
financial requirement under Sec. 37.1301, the SEF's application of
its reasonable discretion also implicitly determines its liquidity
obligation under Sec. 37.1305. The Commission proposes to renumber
Sec. 37.1303 to Sec. 37.1304. Other than renumbering the provision
and other conforming changes, such as including a reference to wind-
down costs, the Commission is not proposing substantive changes to
the provision.
\1052\ The costs listed in this item (1) also include costs for
travel, entertainment, events and conferences to the extent that
such costs are not necessary.
\1053\ For example, if a SEF requires a certain number of voice
brokers to run its voice/hybrid platform but hires additional voice
brokers to provide superior customer service, the SEF would only
need to include the minimum number of voice brokers to run its
voice-based or voice-assisted platform based on its current business
volume, and taking into account any projected increase or decrease
in business volume, in its projected operating cost calculations.
\1054\ In order to conform to the Commission's proposed change
to Sec. 37.1301(a), the Commission proposes to slightly alter the
wording of item (2) to provide that a SEF may exclude the costs of a
SEF's employees are not necessary to comply with the core principles
set forth in Sec. 5h of the Act and any applicable Commission
regulations. (emphasis added). Similarly, the Financial Resources
Guidance provides that a reasonable calculation of projected
operating expenses must include all expenses necessary for a SEF to
discharge its responsibilities as a SEF in compliance with the CEA,
the Commission's regulations, and the SEF's rulebooks, which is
consistent with existing Sec. 37.1301(a). However, in order to
conform with proposed Sec. 37.1301(a), the proposed acceptable
practices would instead provide that a SEF must include all expenses
necessary for the SEF ``to comply'' with the core principles and any
applicable Commission regulations.
\1055\ For example, if a SEF offers both an Order Book and RFQ
System, the SEF would be permitted to include the costs related to
only one of the execution methods it offers (e.g., if a SEF includes
in its projected operating costs the costs associated with its Order
Book, it may exclude the costs related to its RFQ System, or vice-
versa). A bona fide method would refer to a method actually used by
SEF participants and not established by a SEF on a pro forma basis
for the purpose of complying with--or evading--the financial
resources requirement. In contrast, under the current Financial
Resources Guidance and Commission regulations, a SEF's projected
operating costs generally must include all offered execution
methods.
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Further, based on the Financial Resources Guidance, the proposed
Acceptable Practices would clarify that in order to determine its
obligations under proposed Sec. 37.1301(a), a SEF may pro-rate, but
not exclude, certain expenses in calculating projected operating
costs.\1056\ In pro-rating any of these expenses, however, a SEF would
need to document, identify, and justify is decision to pro-rate such
expenses.
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\1056\ For example, a SEF would be permitted to pro-rate
expenses that are shared with affiliates, e.g., the costs of
administrative staff or seconded employees that a SEF shares with
affiliates. Further, a SEF would also be permitted to pro-rate
expenses that are attributable in part to activities that are not
required to comply with the SEF core principles, e.g., costs of a
SEF's office space to the extent it also houses personnel whose
costs may be excludable under items (1) or (2).
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Proposed Sec. 37.1303 would require a SEF to maintain liquid
assets in an amount equal to the greater of (i) three-months' projected
operating costs necessary to enable the SEF to comply with its core
principle and applicable Commission regulations and (ii) the SEF's
projected wind-down costs. In contrast, a SEF currently must maintain
sufficient liquid assets to cover six-months' projected operating
costs.\1057\ As discussed above, the Commission proposes to adopt the
Acceptable Practices to further clarify the costs that a SEF, based on
its reasonable discretion, may or may not exclude from its projected
operating costs when determining its financial obligations under
proposed Sec. 37.1303.
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\1057\ The proposal would renumber Sec. 37.1305 to Sec.
37.1303.
---------------------------------------------------------------------------
Since SEFs currently are not required to provide GAAP-compliant
financial submissions, proposed Sec. 37.1306(a) would require a SEF's
quarterly financial submissions to conform to GAAP, or in the case of a
non-U.S. domiciled SEF that is not otherwise required to prepare GAAP-
compliant statements, to prepare its statements in accordance with
either the International Financial Reporting Standards issued by the
International Accounting Standards Board, or a comparable international
standard that the Commission may accept in its discretion. Proposed
Sec. 37.1306(c) would provide that a SEF's quarterly financial
statements must explicitly (i) identify all the SEF's expenses without
any exclusions, (ii) identify all expenses and corresponding amounts
that the SEF excluded or pro-rated when it determined its projected
operating costs, (iii) explain why the SEF excluded or pro-rated any
expenses, and (iv) identify and explain all costs necessary to wind
down the SEF's operations. Section 37.1306(c)(1) currently requires
SEFs to provide ``[s]ufficient documentation'' explaining how the SEF
determined its financial resources obligations, and the Commission
believes that the items specified in proposed Sec. 37.1306(c)
constitute such sufficient documentation and are already being provided
by compliant SEFs. Proposed Sec. 37.1306(d) would extend the deadline
for a SEF's fourth quarter financial statement from sixty to ninety
days after the end of such fiscal quarter to conform to the extended
deadline for a SEF's annual compliance report. Proposed Sec.
37.1306(e) would require a SEF to provide notice no later than forty-
eight hours after it knows or reasonably should know it no longer meets
its financial resources obligations.
b. Benefits
Proposed Sec. 37.1301(a) is expected to reduce the total financial
assets that most SEFs must maintain since a SEF would be required to
maintain sufficient resources to cover only its operations necessary to
comply with its core principle obligations and applicable Commission
regulations rather than all of its operating costs as currently
provided in existing Sec. 37.1301(a). With respect to proposed Sec.
37.1301(a), the proposed Acceptable Practices would provide further
guidance regarding the scope of a SEF's reasonable discretion when
determining the SEF's financial requirements under Sec. 37.1301(a) to
exclude certain expenses from its projected operating cost
calculations, thereby reducing the amount of total financial assets
that a SEF must maintain under proposed Sec. 37.1301(a). To the extent
that the proposed Acceptable Practices generally adopt the staff's
existing Financial Resources Guidance, SEFs may also already have
realized the benefits associated with reduced financial resources
[[Page 62084]]
requirements. However, in addition to the expenses enumerated in the
Financial Resources Guidance, the proposed Acceptable Practices also
would clarify that when determining its financial obligations under
Sec. 37.1301(a), as long as a SEF includes the costs of one bona fide
execution method, a SEF could reasonably exclude from its projected
operating costs the expenses associated with its other execution
methods.\1058\ As a result, the Commission anticipates that a SEF's
projected operating costs related to a SEF's execution platforms would
generally not be significantly more than the least costly bona fide
execution method offered by the SEF, which the Commission notes could
be in the millions of dollars for certain SEFs.\1059\
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\1058\ For example, if a SEF offers both an Order Book and RFQ
System, the SEF would be permitted to include the costs related to
only one of the execution methods it offers (e.g., if a SEF includes
in its projected operating costs the costs associated with its Order
Book, it may exclude the costs related to its RFQ System, or vice-
versa). A bona fide method would refer to a method actually used by
SEF participants and not established by a SEF on a pro forma basis
for the purpose of complying with--or evading--the financial
resources requirement.
\1059\ The Commission anticipates that SEFs that offer execution
methods that are more costly for a SEF to maintain, such as voice-
based or voice-assisted execution methods, are likely to see the
greatest relative reduction in projected operating costs.
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Proposed Sec. 37.1301(b) could result in a marginal cost reduction
since an entity would no longer be required to submit a separate
financial submission for its affiliated SEF and DCO. However, the
Commission believes that this would be a de minimis reduction.
Proposed Sec. 37.1303's liquidity requirement would significantly
reduce the amount of liquid financial assets that must be maintained by
most SEFs. Currently, a SEF must maintain liquid financial assets equal
to six-months' projected operating costs, while proposed Sec. 37.1303
would require most SEFs to hold three-months' projected operating
costs. As a result, proposed Sec. 37.1303 generally would reduce the
liquidity requirement for most SEFs by 50 percent.\1060\ Similar to the
discussion above under proposed Sec. 37.1301(a), the proposed
Acceptable Practices would broaden the reasonable discretion that a SEF
has under proposed Sec. 37.1304 for computing its projected operating
costs to exclude certain expenses from its projected three-months'
operating cost calculations, thereby reducing the amount of total
financial assets that a SEF must maintain under proposed Sec.
37.1303.\1061\ In addition, a SEF currently must maintain liquid assets
equal to six-months' operating costs even if the SEF's actual wind-down
costs are greater. For certain SEFs with wind-down costs that exceed
six-months' operating costs, proposed Sec. 37.1303 would augment
market integrity for such SEFs by requiring them to maintain additional
liquid assets to cover their wind-down costs, even if the SEF's wind-
down would exceed six-months, but in no event would a SEF be permitted
to maintain less than three-months' operating costs.
---------------------------------------------------------------------------
\1060\ The Commission notes that the current liquidity
requirement in existing Sec. 37.1305 as well as proposed Sec.
37.1303 permits a SEF to acquire a ``committed line of credit'' to
satisfy the liquidity requirement. However, the Commission notes
that most SEFs satisfy this requirement through maintaining liquid
assets rather than obtaining a line of credit. Accordingly, as a
practical matter, the Commission expects proposed Sec. 37.1303 to
reduce the amount of liquid assets that a SEF must maintain.
Moreover, the Commission notes that there would be additional
associated costs if a SEF were to obtain a committed line of credit.
\1061\ This assumes that a SEF's projected wind-down costs are
less than the SEF's three-months' projected operating costs;
otherwise, proposed Sec. 37.1303 would require the SEF to maintain
liquid financial resources in an amount equal to its wind-down
costs.
---------------------------------------------------------------------------
The Commission believes that the proposal provides a SEF with
greater flexibility in terms of establishing its financial resources.
This, in turn, may lead to greater efficiencies in terms of financing
and capital allocation and investment. However, the Commission
acknowledges, as discussed below, this flexibility may increase the
level of financial risk at the SEF.
Proposed Sec. Sec. 37.1306(a) and (c) would benefit transparency
and augment the Commission's oversight by requiring SEFs to provide
standardized, GAAP-compliant financial submissions that explicitly
identify any cost a SEF has excluded or pro-rated in determining its
projected operating costs. In its experience conducting ongoing SEF
oversight, Commission staff has devoted additional effort to obtain
appropriate clarity and sufficient documentation from SEFs. Therefore,
the Commission believes that clarifying the minimum documentation that
a SEF must provide would mitigate the time and resources required both
by staff in conducting its oversight and by SEFs in responding to
staff's requests for additional information. Proposed Sec. 37.1306(e)
would benefit market integrity by ensuring that the Commission is aware
of any non-compliance forty-eight hours after the SEF knows or
reasonably should know that it fails to satisfy its financial resources
obligations rather than when the SEF submits its quarterly financial
statement under Sec. 37.1306(a), increasing the Commission's ability
to promptly respond.
c. Costs
Proposed Sec. 37.1301(a) would reduce the amount of financial
resources that a SEF must maintain to an amount that would enable the
SEF to comply with its core principle obligations and applicable
Commission regulations for a one-year period, calculated on an ongoing
basis, rather than in an amount necessary to cover all of the SEF's
operations as required under existing Sec. 37.1301(a). The proposed
Acceptable Practices further would clarify the costs that a SEF may
exclude when determining its obligations under proposed Sec.
37.1301(a). As a result, proposed Sec. 37.1301(a) as contemplated in
the proposed Acceptable Practices likely would induce SEFs to reduce
the current level of total financial resources that they maintain under
Sec. 37.1301. In turn, this could decrease market participants'
confidence and could harm a SEF's stability during adverse market
conditions because the SEF may not have adequate financial resources to
cover its costs. However, the Commission believes that the potential
harm to a SEF's financial stability and to the market is minimal since
proposed Sec. 37.1301(a) addresses only the amount of a SEF's total
financial assets, which includes illiquid assets, rather than focusing
only on a SEF's liquid assets. The Commission notes that illiquid
assets are less important compared to the amount of liquid financial
assets that a SEF must maintain under proposed Sec. 37.1303 since it
is more difficult for a SEF to timely liquidate its illiquid assets to
cover its operating costs, especially during periods of market
instability. Accordingly, the Commission believes a SEF's liquid
financial assets, which the Commission addresses in proposed Sec.
37.1303 below, is more important for sustaining a SEF's financial
health and continuing operations.
Proposed Sec. 37.1303 could require some SEFs to maintain
additional liquid financial assets, compared to the current liquidity
requirement, where a SEF's wind-down costs exceed six-months' operating
costs. However, as explained above under the discussion of benefits,
the Commission believes that most SEFs would not have wind-down costs
that exceed six-months' operating costs. Accordingly, proposed Sec.
37.1303 should not increase the liquidity requirement for most SEFs.
Proposed Sec. 37.1304 would require a SEF to incur an additional
marginal cost to calculate its wind-down costs, in addition to its
projected operating costs as currently required, in order to determine
its financial resources
[[Page 62085]]
obligations under Sec. 37.1301 and Sec. 37.1303. The Commission
estimates that this proposed change would impose an initial, minimal,
one-time cost for each SEF related to determining the length of time
and associated costs associated with an orderly wind down.
Proposed Sec. 37.1306 would impose greater costs on a SEF.
Specifically, proposed Sec. 37.1306(a) would require a SEF to submit
GAAP-compliant quarterly reports. Because GAAP-compliant financial
statements generally require additional effort compared to non-GAAP
compliance financial statements, the Commission estimates that the
proposed change would increase annual costs for each SEF to create
GAAP-compliance financial report. However, the Commission does not
believe that proposed Sec. 37.1306(c) would increase costs. Under
existing Sec. 37.1306(c), a SEF must provide sufficient documentation
explaining the methodology it used to compute its financial resources
requirements; accordingly, proposed Sec. 37.1306(c) is merely
clarifying the type of information that is already required.\1062\
Similarly, the Commission does not believe that proposed Sec.
37.1306(e) would increase costs since a SEF currently is required to
maintain continuous compliance with its financial resources
obligations. By requiring a SEF to notify the Commission within 48
hours of non-compliance, rather than informing the Commission through a
SEF's quarterly financial submission, proposed Sec. 37.1306(e) could
impose a de minimis cost to prepare a notice from a non-compliant SEF.
---------------------------------------------------------------------------
\1062\ See Sec. 37.1306(c).
---------------------------------------------------------------------------
d. Section 15(a) Factors
(1) Protection of Market Participants and the Public
The Commission previously noted that the financial resources
requirements protect market participants and the public by establishing
uniform standards and a system of Commission oversight that ensures
that trading occurs on a financially stable facility, which in turn,
mitigates the risk of market disruptions, financial losses, and system
problems that could arise from a SEF's failure to maintain adequate
financial resources.\1063\ In the event that a SEF must wind down its
operations, proposed Sec. 37.1303 would explicitly require a SEF to
maintain sufficient liquid financial resources to conduct an orderly
wind-down of its operations, or three-months' operating costs if
greater than the SEF's wind-down costs.\1064\ The Commission believes
that the proposed SEF financial requirements are better calibrated to
the inherent risks of a SEF, which should not diminish the financial
integrity of the SEF, but should result in greater efficiencies.
---------------------------------------------------------------------------
\1063\ See Core Principles Final Rule at 33580.
\1064\ As the Commission previously noted, a SEF that has
sufficient amounts of liquid financial resources would be better
positioned to close out trading in a manner not disruptive to market
participants or to members of the public who rely on SEF prices. See
Core Principles Final Rule at 33580.
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Moreover, a SEF would be required to provide notice under proposed
Sec. 37.1306(e) no later than forty-eight hours after it knows or
reasonably should have known that it no longer satisfies its financial
resources obligations, ensuring that the Commission can take prompt
action to protect market participants and the public. In contrast, the
Commission currently is notified of non-compliance in a SEF's quarterly
financial statements. Lastly, a SEF would be required to submit GAAP-
compliant quarterly financial submissions under proposed Sec.
37.1306(c) that explicitly identify the costs a SEF has excluded or
pro-rated in determining its projected operating costs. As a result,
the Commission would more easily be able to compare SEFs' financial
health and take pro-active steps to protect market participants and the
public if the Commission identifies a SEF with weak financial health or
the development of negative financial trends among SEFs that could
endanger the market participants or the public.
(2) Efficiency, Competitiveness, and Financial Integrity of the Markets
Proposed Sec. 37.1301(a) and Sec. 37.1303, as further clarified
through the proposed Acceptable Practices, together should benefit
market efficiency by reducing capital costs since SEFs would no longer
be required to maintain an excessive amount of financial resources.
Accordingly, a SEF should be able to more efficiently allocate its
financial resources, which in turn should encourage market growth and
innovation. For example, as noted above, in the case of proposed Sec.
37.1303, the Commission expects that most SEFs would need to hold
approximately 50 percent less liquid financial assets as reserve
capital to cover operating costs. The current financial resources
requirements dis-incentivize a SEF by imposing higher capital
requirements if the SEF wishes to offer new or experimental technology,
execution methods, or related products and services--especially if such
business lines, products, or services are not expected to be
immediately profitable or would have low margins.
The existing regulations may discourage a SEF from offering more
capital intensive activities, such as execution methods that involve
human brokers compared to fully electronic trading that are less
capital intensive. Accordingly, the Commission believes that the
proposed capital resources requirements would be more neutral with
respect to a SEF's chosen technology and business model, and therefore
should encourage a greater variety of execution methods and related
services and products in the market place.
Reducing capital costs would promote the entry of new entrants into
the market by reducing start-up costs and initial capital requirements,
thereby further encouraging competition and innovation. The increase in
competition and innovation could depend on the extent to which
potential new entrants respond to this encouragement.
Proposed Sec. 37.1306(e) should improve the financial integrity of
markets by requiring a SEF to notify the Commission within 48 hours
after it knows or reasonably should have known that it no longer
satisfies its financial resources obligations, ensuring that the
Commission can take prompt action to protect market integrity. Lastly,
proposed Sec. 37.1306(c) would improve SEF financial submissions by
requiring GAAP-compliant statements as well as clarifying that a SEF
must explicitly identify any costs that it has exclude or pro-rated in
determining its projected operating costs. These changes should improve
the Commission's ability to conduct its oversight responsibilities to
protect market integrity.
(3) Price Discovery
The Commission has not identified any effects of the proposed rules
identified above on price discovery.
(4) Sound Risk Management Practices
By establishing specific standards with respect to how SEFs should
assess and monitor the adequacy of their financial resources, the
financial resources rules should promote sound risk management
practices by SEFs. As noted above, proposed Sec. 37.1303 would require
a SEF to identify its wind-down costs and associated timing and ensure
that it has sufficient liquid assets to maintain an orderly wind down.
Similarly, proposed Sec. 37.1306(c) would require a SEF to explain the
basis of its determination for its estimate of its
[[Page 62086]]
wind-down costs and timing. Proposed Sec. 37.1307(e) would require a
SEF to notify the Commission no later than 48 hours after it knows or
reasonably should have known that it no longer satisfies its financial
resources obligations. As a result, a SEF would be required to ensure
that it maintains the necessary procedures to identify, and to notify
the Commission of, any non-compliance.
(5) Other Public Interest Considerations
The Commission has not identified any effects that these rules will
have on other public interest considerations other than those
enumerated above.
Request for Comment
The Commission requests comment on all aspects of the consideration
of the costs and benefits of the provisions related to SEF financial
resources.
D. Antitrust Considerations
CEA section 15(b) requires the Commission to ``take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of this Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of this Act.'' \1065\
---------------------------------------------------------------------------
\1065\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the proposal implicates any other specific
public interest to be protected by the antitrust laws.
The Commission has considered the proposal to determine whether it
is anticompetitive and does not anticipate that the proposal, viewed in
its entirety, will have material anticompetitive effects or result in
anticompetitive behavior. As described in detail in the preamble above,
the proposal is expected to generally provide greater flexibility and
competition in connection with swap trading on SEFs largely as a result
of the proposed approach that would permit SEFs to offer a variety of
innovative execution methods rather than being limited to specific,
mandated execution methods. The Commission believes that such
innovation is expected to promote greater competition between SEFs in
order to attract additional trading and market participation.
The Commission also believes that achieving the SEF statutory goals
of promoting trading on SEFs and pre-trade price transparency requires
both (i) increasing the number of swaps that are subject to the trade
execution requirement; and (ii) concurrently providing flexibility of
execution methods. The Commission believes that requiring market
participants to conduct a larger portion of their swaps trading on SEFs
would, among other things, foster additional competition among a more
concentrated number of market participants resulting in increased
market efficiency and decreased transaction costs.
The Commission also notes that the proposal would enhance the
available third party regulatory service providers that a SEF could
hire to perform a variety of regulatory functions required of SEFs
under the Act and Commission regulations. Specifically, as noted in the
preamble, the Commission has proposed to expand the scope of entities
that may provide regulatory services under Sec. 37.204(a) to include
any non-registered entity approved by the Commission. This proposed
change is expected to potentially increase competition among existing
and potential regulatory service providers and, thereby, reduce
operating costs for SEFs, and mitigate barriers to entry for new SEFs.
Although the Commission does not anticipate that the proposal,
viewed in its entirety, will have material anticompetitive effects or
result in anticompetitive behavior, the Commission encourages comments
on any aspect of the proposal that may be inconsistent with the
antitrust laws or anticompetitive in nature. For example, the impartial
access requirements proposed under Sec. 37.202(a) would not require an
all-to-all market as envisioned by the current SEF rules, and therefore
may inhibit the ability of certain market participants to access
certain trading markets and liquidity pools. The Commission notes,
however, that the current SEF market structure and participation
patterns already have generally developed along these traditional
lines, absent the proposed access criteria. The Commission underscores
that its proposed changes to the impartial access requirements would
require a SEF to allow access to prospective participants who are able
to meet the SEF's participation criteria. As discussed in this
proposal, although the Commission believes that this approach should
prevent potential anticompetitive harms, it may still provide potential
barriers to access.\1066\ The Commission requests comment on whether
and in what circumstances adopting the proposed rule could be
anticompetitive.
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\1066\ The Commission previously applied the impartial access
requirement to ISVs on the basis that such types of vendors would
provide various benefits to the market and market participants. SEF
Core Principles Final Rule at 33,508 n.423. However, based on the
Commission's experience and notwithstanding the existing impartial
access requirement, ISVs have not established a significant level of
participation on SEFs, nor have they achieved a broad level of
adoption among market participants, absent the proposed access
criteria. See supra VII.A.1.a.--Sec. 37.202(a)(1)--Impartial Access
Criteria.
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Further, the Commission has preliminarily determined that the
proposal serves the regulatory goals set forth in CEA section 5h(e) to
promote trading on SEFs and pre-trade transparency in the swaps market.
In addition, the Commission also preliminary believes that the proposal
serves the general regulatory purpose in CEA section 3(b) to ``promote
responsible innovation and fair competition among boards of trade,
other markets and market participants.'' \1067\
Although the Commission has not identified any less anticompetitive
means to effectuate the purposes of CEA sections 5h(e) and 3(b) in
connection with the SEF regulatory framework, nonetheless, the
Commission requests comment on whether there are other less
anticompetitive means of achieving the relevant purposes of the Act.
The Commission notes that it is not required to follow the least
anticompetitive course of action.
List of Subjects
17 CFR Part 9
Administrative practice and procedure, Commodity exchanges,
Commodity futures, Reporting and recordkeeping requirements.
17 CFR Part 36
Designated contract markets, Registered entities, Swap execution
facilities, Swaps, Trade execution requirement.
17 CFR Part 37
Commodity futures, Registered entities, Registration application,
Reporting and recordkeeping requirements, Swap execution facilities,
Swaps.
17 CFR Part 38
Commodity futures, Designated contract markets, Registered
entities, Reporting and recordkeeping
[[Page 62087]]
requirements, Swaps, Trade execution requirement.
17 CFR Part 39
Consumer protection, Derivatives clearing organizations, Reporting
and recordkeeping requirements, Risk management, Straight-through
processing, Swaps.
17 CFR Part 43
Block trades, Consumer protection, Reporting and recordkeeping
requirements, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR chapter I as follows:
PART 9--RULES RELATING TO REVIEW OF EXCHANGE DISCIPLINARY, ACCESS
DENIAL OR OTHER ADVERSE ACTIONS
0
1. The authority citation for part 9 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6b-1, 6c, 7, 7a-2, 7b-3, 8, 9, 9a,
12, 12a, 12c, 13b, 16a, 18, 19, and 21.
0
2. Amend Sec. 9.1 by:
0
a. Redesignating paragraph (c) as paragraph (d);
0
b. Redesignating paragraph (b)(4) as paragraph (c);
0
c. Revising paragraphs (b)(2), (b)(3), and newly redesignated paragraph
(c).
The revisions read as follows:
Sec. 9.1 Scope of rules.
* * * * *
(b) * * *
(2) Except as provided in Sec. Sec. 9.11(a), (b)(3)(i) through
(v), (c), 9.12(a), and 9.13 (concerning the notice, effective date and
publication of a disciplinary or access denial action), any summary
action permitted under the rules of the swap execution facility
imposing a minor penalty for the violation of rules relating to
recordkeeping or reporting, or permitted under Core Principle 13,
paragraph (a)(6) in appendix B to part 38 of this chapter imposing a
minor penalty for the violation of exchange rules relating to decorum
or attire, or relating to the timely submission of accurate records
required for clearing or verifying each day's transactions or other
similar activities; and
(3) Any exchange action arising from a claim, grievance, or dispute
involving cash market transactions which are not a part of, or directly
connected with, any transaction for the purchase, sale, delivery or
exercise of a commodity for future delivery, a commodity option, or a
swap.
(c) The Commission will, upon its own motion or upon motion filed
pursuant to Sec. 9.21(b), promptly notify the appellant and the
exchange that it will not accept the notice of appeal or petition for
stay of matters specified in paragraph (b) of this section. The
determination to decline to accept a notice of appeal will be without
prejudice to the appellant's right to seek alternate forms of relief
that may be available in any other forum.
0
3. In Sec. 9.2, revise paragraph (k) to read as follows:
Sec. 9.2 Definitions.
* * * * *
(k) Summary action means a disciplinary action resulting in the
imposition of a penalty on a person for violation of rules of the
exchange permitted under the rules of the swap execution facility for
impeding the progress of a hearing; Core Principle 13, paragraph (a)(4)
in appendix B to part 38 of this chapter (penalty for impeding progress
of hearing); Core Principle 2, paragraph (a)(8) in appendix B to part
37 of this chapter (emergency disciplinary actions); Core Principle 13,
paragraph (a)(7) in appendix B to part 38 of this chapter (emergency
disciplinary actions); the rules of the swap execution facility for
summary fines for violations of rules regarding recordkeeping or
reporting; or Core Principle 13, paragraph (a)(6) in appendix B to part
38 of this chapter (summary fines for violations of rules regarding
timely submission of records, decorum, or other similar activities).
0
4. In Sec. 9.11, revise paragraph (b)(2) to read as follows:
Sec. 9.11 Form, contents and delivery of notice of disciplinary or
access denial action.
* * * * *
(b) * * *
(2) The written notice of a disciplinary action or access denial
action provided to the person against whom the action was taken by a
swap execution facility must be a copy of a written decision which
includes the items listed in paragraphs (b)(3)(i) through (vi) of this
section.
* * * * *
0
5. In Sec. 9.12, revise paragraphs (a)(1) through (3) to read as
follows:
Sec. 9.12 Effective date of disciplinary or access denial action.
(a) * * *
(1) As permitted by Core Principle 2, paragraph (a)(8) in appendix
B to part 37 of this chapter (emergency disciplinary actions) or Core
Principle 13, paragraph (a)(7) in appendix B to part 38 of this chapter
(emergency disciplinary actions), the exchange reasonably believes, and
so states in its written decision, that immediate action is necessary
to protect the best interests of the marketplace;
(2) As permitted by the rules of the swap execution facility or
Core Principle 13, paragraph (a)(4) in appendix B to part 38 of this
chapter (hearings), the exchange determines, and so states in its
written decision, that the actions of a person who is within the
exchange's jurisdiction has impeded the progress of a disciplinary
hearing;
(3) As permitted by the rules of the swap execution facility for
recordkeeping or reporting violations or Core Principle 13, paragraph
(a)(6) in appendix B to part 38 of this chapter (summary fines for
violations of rules regarding timely submission of records, decorum, or
other similar activities), the exchange determines that a person has
violated exchange rules relating to decorum or attire, or timely
submission of accurate records required for clearing or verifying each
day's transactions or other similar activities; or
* * * * *
0
6. In Sec. 9.24, revise paragraph (a)(2) to read as follows:
Sec. 9.24 Petition for stay pending review.
(a) * * *
(2) Within ten days after a notice of summary action has been
delivered in accordance with Sec. 9.12(b) to a person who is the
subject of a summary action permitted by Core Principle 2, paragraph
(a)(8) in appendix B to part 37 of this chapter (emergency disciplinary
actions) or Core Principle 13, paragraph (a)(7) in appendix B to part
38 of this chapter (emergency disciplinary actions), that person may
petition the Commission to stay the effectiveness of the summary action
pending completion of the exchange proceeding.
* * * * *
0
7. Add part 36 to read as follows:
PART 36--TRADE EXECUTION REQUIREMENT
Sec.
36.1 Trade execution requirement.
36.2 Registry of registered entities listing swaps subject to the
trade execution requirement.
36.3 Trade execution requirement compliance schedule.
Appendix A to Part 36--Form TER
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3, 2a2, and 21,
as amended by Titles VII and VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Public Law 111-203, 124 Stat.
1376 (2010).
[[Page 62088]]
Sec. 36.1 Trade execution requirement.
(a) Except as provided in this section, counterparties shall
execute a transaction involving a swap subject to the clearing
requirement of section 2(h)(1) of the Act on a designated contract
market, a swap execution facility, or a swap execution facility that is
exempt from registration under section 5h(g) of the Act, that lists the
swap for trading.
(b) Paragraph (a) of this section does not apply to a swap
transaction that is listed only by a swap execution facility that is
exempt from registration under section 5h(g) of the Act.
(c) Paragraph (a) of this section does not apply to a swap
transaction for which the clearing exception under section 2(h)(7) of
the Act or the exceptions or exemptions under part 50 of this chapter
have been elected, and the associated requirements met.
(d) Paragraph (a) of this section does not apply to a swap
transaction that is executed as a component of a package transaction
that includes a component transaction that is the issuance of a bond in
a primary market.
(1) For purposes of this paragraph (d), a package transaction
consists of two or more component transactions executed between two or
more counterparties where:
(i) Execution of each component transaction is contingent upon the
execution of all other components transactions; and
(ii) The component transactions are priced or quoted together as
one economic transaction with simultaneous or near simultaneous
execution of all components.
(2) [Reserved]
(e) Paragraph (a) of this section does not apply to a swap
transaction that is executed between counterparties that have eligible
affiliate counterparty status pursuant to Sec. 50.52(a) of this
chapter even if the eligible affiliate counterparties clear the swap
transaction.
Sec. 36.2 Registry of registered entities listing swaps subject to
the trade execution requirement.
(a) Registry. The Commission shall publish and maintain on its
website a list that specifies the swaps that are subject to the trade
execution requirement under section 2(h)(8) of the Act as set forth in
Sec. 36.1 and the designated contract markets and swap execution
facilities where such swaps are listed for trading.
(b) Required filing. A designated contract market or swap execution
facility shall file electronically to the Commission a complete Form
TER set forth in appendix A to this part for each swap, or any group,
category, type or class of swaps that it lists for trading and is
subject to or becomes subject to the clearing requirement of section
2(h)(1) of the Act, as follows:
(1) For any swap, or any group, category, type or class of swaps
subject to the clearing requirement of section 2(h)(1) of the Act, to
be listed for trading, a designated contract market or a swap execution
facility shall submit a complete Form TER or amend its Form TER
concurrently with the submission of a product listing pursuant to Sec.
40.2 or Sec. 40.3 of this chapter;
(2) For any swap, or any group, category, type or class of swaps
currently listed for trading and subject to the clearing requirement of
section 2(h)(1) of the Act, a designated contract market or a swap
execution facility shall submit a complete Form TER ten business days
prior to the effective date of this rule in the Federal Register; or
(3) For any swap, or any group, category, type or class of swaps
that a designated contract market or a swap execution facility lists
for trading that subsequent to listing is determined to become subject
to the clearing requirement of section 2(h)(1) of the Act, the
designated contract market or the swap execution facility shall submit
a complete Form TER or amend its Form TER ten business days prior to
the effective date of the same swap, or same group, category, type or
class of swaps becoming subject to the clearing requirement.
(c) Required posting. A designated contract market and a swap
execution facility shall publicly post the most recent version of its
Form TER on its website pursuant to the timeline in paragraph (b) of
this section. If any information reported on Form TER, or in any
amendment thereto, is or becomes inaccurate for any reason, the
designated contract market or the swap execution facility shall
promptly file an amendment on Form TER updating such information.
Sec. 36.3 Trade execution requirement compliance schedule.
(a) Definitions. For the purposes of this section:
Category 1 entity means a swap dealer; a security-based swap
dealer; a major swap participant; or a major security-based swap
participant.
Category 2 entity means a commodity pool; a private fund as defined
in section 202(a) of the Investment Advisers Act of 1940; or a person
predominantly engaged in activities that are in the business of
banking, or in activities that are financial in nature as defined in
section 4(k) of the Bank Holding Company Act of 1956.
(b) For swaps subject to the requirements of section 2(h)(8) of the
Act prior to the effective date of this rule, counterparties must
continue to comply with the requirements of section 2(h)(8) of the Act.
(c) Schedule for compliance. Upon the effective date of this rule,
the following schedule for compliance with the trade execution
requirement under section 2(h)(8) of the Act as set forth in Sec. 36.1
shall apply with respect to swaps that on the effective date of this
rule in the Federal Register become subject to the requirements of
section 2(h)(8) of the Act:
(1) Category 1 entities. A Category 1 entity must comply with the
requirements of section 2(h)(8) of the Act as set forth in Sec. 36.1
no later than ninety (90) days from the effective date of this rule in
the Federal Register when it executes a swap transaction with another
Category 1 entity or a non-Category 1 entity that voluntarily seeks to
execute the swap on a swap execution facility, designated contract
market, or swap execution facility that is exempt from registration
under section 5h(g) of the Act.
(2) Category 2 entities. A Category 2 entity must comply with the
requirements of section 2(h)(8) of the Act as set forth in Sec. 36.1
no later than one hundred and eighty (180) days from the effective date
of this rule in the Federal Register when it executes a swap
transaction with another Category 2 entity, a Category 1 entity, or
other counterparties that voluntarily seek to execute the swap on a
swap execution facility, designated contract market, or swap execution
facility that is exempt from registration under section 5h(g) of the
Act.
(3) Other counterparties. All other counterparties must comply with
the requirements of section 2(h)(8) of the Act as set forth in Sec.
36.1 no later than two hundred and seventy (270) days from the
effective date of this rule in the Federal Register.
(d) Nothing in this rule shall be construed to prohibit any person
from voluntarily complying with the requirements of section 2(h)(8) of
the Act as set forth in Sec. 36.1 sooner than required under the
implementation schedule provided under paragraph (c) of this section.
(e) Future compliance schedules. After the effective date of this
rule and upon the issuance of additional clearing requirement
determinations under section 2(h)(2) of the Act that a swap, or any
group, category, type or class of swaps is required to be cleared, the
[[Page 62089]]
Commission shall determine the appropriate schedule for compliance with
the trade execution requirement under section 2(h)(8) of the Act as set
forth in Sec. 36.1 for that swap, group, category, type or class of
swap.
Appendix A to Part 36--Form TER
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0
8. Revise part 37 to read as follows:
PART 37--SWAP EXECUTION FACILITIES
Subpart A--General Provisions
Sec.
37.1 Scope.
37.2 Applicable provisions and definitions.
37.3 Requirements and procedures for registration.
37.4 Procedures for implementing rules.
37.5 Provision of information relating to a swap execution facility.
37.6 Enforceability.
37.7 Boards of trade operating both a designated contract market and
a swap execution facility.
Subpart B--Compliance With Core Principles
37.100 Core Principle 1--Compliance with core principles.
37.101 [Reserved]
Subpart C--Compliance With Rules
37.200 Core Principle 2--Compliance with rules.
37.201 Requirements for swap execution facility execution methods.
37.202 Access requirements.
37.203 Rule enforcement program.
37.204 Regulatory services provided by a third party.
37.205 Audit trail.
37.206 Disciplinary procedures and sanctions.
Subpart D--Swaps Not Readily Susceptible to Manipulation
37.300 Core Principle 3--Swaps not readily susceptible to
manipulation.
37.301 General requirements.
Subpart E--Monitoring of Trading and Trade Processing
37.400 Core Principle 4--Monitoring of trading and trade processing.
37.401 General requirements.
37.402 Additional requirements for physical-delivery swaps.
37.403 Additional requirements for cash-settled swaps.
37.404 Ability to obtain information.
37.405 Risk controls for trading.
37.406 Regulatory service provider.
37.407 Additional sources for compliance.
Subpart F--Ability To Obtain Information
37.500 Core Principle 5--Ability to obtain information.
37.501 Establish and enforce rules.
37.502 Provide information to the Commission.
37.503 Information-sharing.
37.504 Prohibited use of data collected for regulatory purposes.
Subpart G--Position Limits or Accountability
37.600 Core Principle 6--Position limits or accountability.
37.601 [Reserved].
Subpart H--Financial Integrity of Transactions
37.700 Core Principle 7--Financial integrity of transactions.
37.701 Required clearing.
37.702 General financial integrity.
37.703 Monitoring for financial soundness.
Subpart I--Emergency Authority
37.800 Core Principle 8--Emergency authority.
37.801 Additional sources for compliance.
Subpart J--Timely Publication of Trading Information
37.900 Core Principle 9--Timely publication of trading information.
37.901 General requirements.
Subpart K--Recordkeeping and Reporting
37.1000 Core Principle 10--Recordkeeping and reporting.
37.1001 Recordkeeping.
Subpart L--Antitrust Considerations
37.1100 Core Principle 11--Antitrust considerations.
37.1101 Additional sources for compliance.
Subpart M--Conflicts of Interest
37.1200 Core Principle 12--Conflicts of interest.
37.1201 [Reserved].
Subpart N--Financial Resources
37.1300 Core Principle 13--Financial resources.
37.1301 General requirements.
37.1302 Types of financial resources.
37.1303 Liquidity of financial resources.
37.1304 Computation of costs to meet financial resources
requirement.
37.1305 Valuation of financial resources.
37.1306 Reporting to the Commission.
37.1307 Delegation of authority.
Subpart O--System Safeguards
37.1400 Core Principle 14--System safeguards.
37.1401 Requirements.
Subpart P--Designation of Chief Compliance Officer
37.1500 Core Principle 15--Designation of chief compliance officer.
37.1501 Chief compliance officer.
Appendix A to Part 37--Form SEF
Appendix B to Part 37--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
Appendix C to Part 37--Demonstration of Compliance That a Swap
Contract Is Not Readily Susceptible to Manipulation
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3 and 12a, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376
(2010).
Subpart A--General Provisions
Sec. 37.1 Scope.
The provisions of this part shall apply to every swap execution
facility that is registered or is applying to become registered as a
swap execution facility under section 5h of the Commodity Exchange Act
(``the Act'').
Sec. 37.2 Applicable provisions and definitions.
(a) Applicable provisions. A swap execution facility shall comply
with the requirements of this part and all other applicable Commission
regulations, including Sec. 1.60 of this chapter and any related
definitions and cross-referenced sections.
(b) Definitions. For the purposes of this part, market participant
means any person who accesses a swap execution facility in the
following manner:
(1) Through direct access provided by a swap execution facility;
(2) Through access or functionality provided by a third-party; or
(3) Through directing an intermediary that accesses a swap
execution facility on behalf of such person to trade on its behalf.
Sec. 37.3 Requirements and procedures for registration.
(a) Requirements for registration. Any person operating a facility
that offers a trading system or platform in which more than one market
participant has the ability to execute or trade any swap, regardless of
whether such swap is subject to the trade execution requirement under
section 2(h)(8) of the Act as set forth in Sec. 36.1 of this chapter,
with more than one other market participant on the system or platform
shall register the facility as a swap execution facility under this
part or as a designated contract market under part 38 of this chapter.
(b) Procedures for registration--(1) Application for registration.
An applicant requesting registration as a swap execution facility
shall:
(i) File electronically a complete Form SEF as set forth in
appendix A to this part, or any successor forms, and all information
and documentation described in such forms with the Secretary of the
Commission in the form and manner specified by the Commission;
(ii) Provide to the Commission, upon the Commission's request, any
additional information and documentation necessary to review an
application; and
(iii) Obtain a legal entity identifier code for the purpose of
identifying the swap execution facility pursuant to part 45 of this
chapter.
(2) Request for confidential treatment. (i) An applicant requesting
registration as a swap execution facility shall identify with
particularity any information in the application that will be subject
to a request for confidential
[[Page 62095]]
treatment pursuant to Sec. 145.9 of this chapter.
(ii) Section 40.8 of this chapter sets forth those sections of the
application that will be made publicly available, notwithstanding a
request for confidential treatment pursuant to Sec. 145.9 of this
chapter.
(3) Amendment of application for registration. An applicant
amending a pending application for registration as a swap execution
facility shall file an amended Form SEF electronically with the
Secretary of the Commission in the manner specified by the Commission.
(4) Effect of incomplete application. If an application is
incomplete pursuant to paragraph (b)(1) of this section, the Commission
shall notify the applicant that its application will not be deemed to
have been submitted for purposes of the Commission's review.
(5) Commission review period. The Commission shall review an
application for registration as a swap execution facility pursuant to
the 180-day timeframe and procedures specified in section 6(a) of the
Act.
(6) Commission determination. (i) The Commission shall issue an
order granting registration upon a Commission determination, in its own
discretion, that the applicant has demonstrated compliance with the Act
and the Commission's regulations applicable to swap execution
facilities. If deemed appropriate, the Commission may issue an order
granting registration subject to conditions.
(ii) The Commission may issue an order denying registration upon a
Commission determination, in its own discretion, that the applicant has
not demonstrated compliance with the Act and the Commission's
regulations applicable to swap execution facilities.
(c) Amendment of an order of registration. (1) A swap execution
facility requesting an amendment to an order of registration shall
electronically file such request with the Secretary of the Commission
in the form and manner specified by the Commission.
(2) A swap execution facility shall provide to the Commission, upon
the Commission's request, any additional information and documentation
necessary to review a request to amend an order of registration.
(3) The Commission shall issue an amended order of registration
upon a Commission determination, in its own discretion, that the swap
execution facility would maintain compliance with the Act and the
Commission's regulations upon amendment to the order. If deemed
appropriate, the Commission may issue an amended order of registration
subject to conditions.
(4) The Commission may decline to issue an amended order based upon
a Commission determination, in its own discretion, that the SEF would
not continue to maintain compliance with the Act and the Commission's
regulations upon amendment to the order.
(d) Reinstatement of dormant registration. A dormant swap execution
facility as defined in Sec. 40.1 of this chapter may reinstate its
registration under the procedures of paragraph (b) of this section. The
applicant may rely upon previously submitted materials if such
materials accurately describe the dormant swap execution facility's
conditions at the time that it applies for reinstatement of its
registration.
(e) Request for transfer of registration. (1) A swap execution
facility seeking to transfer its registration from its current legal
entity to a new legal entity as a result of a corporate change shall
file a request for approval to transfer such registration with the
Secretary of the Commission in the form and manner specified by the
Commission.
(2) Timeline for filing a request for transfer of registration. A
swap execution facility shall file a request for transfer of
registration as soon as practicable prior to the anticipated corporate
change.
(3) Required information. The request for transfer of registration
shall include the following:
(i) The underlying documentation that governs the corporate change;
(ii) A description of the corporate change, including the reason
for the change and its impact on the swap execution facility, including
its governance and operations, and its impact on the rights and
obligations of market participants;
(iii) A discussion of the transferee's ability to comply with the
Act, including the core principles applicable to swap execution
facilities, and the Commission's regulations thereunder;
(iv) The governing documents adopted by the transferee, including a
copy of any constitution, articles or certificate of incorporation,
organization, formation, or association with all amendments thereto,
partnership or limited liability agreements, and any existing bylaws,
operating agreement, or rules or instruments corresponding thereto;
(v) The transferee's rules marked to show changes from the current
rules of the swap execution facility;
(vi) A representation by the transferee that it:
(A) Will be the surviving entity and successor-in-interest to the
transferor swap execution facility and will retain and assume the
assets and liabilities of the transferor, except if otherwise indicated
in the request;
(B) Will assume responsibility for complying with all applicable
provisions of the Act and the Commission's regulations promulgated
thereunder, including all self-regulatory responsibilities except if
otherwise indicated in the request; and
(C) Will notify market participants of all changes to the
transferor's rulebook prior to the transfer, including those changes
that may affect the rights and obligations of market participants, and
will further notify market participants of the concurrent transfer of
the registration to the transferee upon Commission approval and
issuance of an order permitting this transfer.
(4) Commission determination. Upon review of a request for transfer
of registration, the Commission, as soon as practicable, shall issue an
order either approving or denying the request.
(f) Request for withdrawal of application for registration. An
applicant for registration as a swap execution facility may withdraw
its application submitted pursuant to paragraph (b) of this section by
filing a withdrawal request electronically with the Secretary of the
Commission. Withdrawal of an application for registration shall not
affect any action taken or to be taken by the Commission based upon
actions, activities, or events occurring during the time that the
application was pending with the Commission.
(g) Request for vacation of registration. A swap execution facility
may request that its registration be vacated under section 7 of the Act
by filing a vacation request electronically with the Secretary of the
Commission. Vacation of registration shall not affect any action taken
or to be taken by the Commission based upon actions, activities, or
events occurring during the time that the swap execution facility was
registered by the Commission.
(h) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, upon consultation with the General Counsel
or the General Counsel's delegate, authority to notify an applicant
seeking registration that its application is incomplete and that it
will not be deemed to have been submitted for purposes of the
Commission's review, and to notify an
[[Page 62096]]
applicant seeking registration under section 6(a) of the Act that its
application is materially incomplete and the running of the 180-day
period is stayed. The Director may submit to the Commission for its
consideration any matter that has been delegated in this paragraph.
Nothing in this paragraph prohibits the Commission, at its election,
from exercising the authority delegated in this paragraph.
Sec. 37.4 Procedures for implementing rules.
(a) Any rule, except for swap product terms and conditions,
submitted as part of a swap execution facility's application for
registration shall be considered for approval by the Commission at the
time the Commission issues the swap execution facility's order of
registration.
(b) Any rule, except for swap product terms and conditions,
submitted as part of an application to reinstate the registration of a
dormant swap execution facility, as defined in Sec. 40.1 of this
chapter, shall be considered for approval by the Commission at the time
the Commission approves the dormant swap execution facility's
reinstatement of registration.
Sec. 37.5 Provision of information relating to a swap execution
facility.
(a) Request for information. Upon the Commission's request, a swap
execution facility shall file with the Commission information related
to its business as a swap execution facility in the form and manner and
within the time period as the Commission specifies in its request.
(b) Demonstration of compliance. Upon the Commission's request, a
swap execution facility shall file with the Commission a written
demonstration, containing supporting data, information, and documents
that it is in compliance with its obligations under the Act and the
Commission's regulations as the Commission specifies in its request.
The swap execution facility shall file such written demonstration in
the form and manner and within the time period as the Commission
specifies in its request.
(c) Equity interest transfer--(1) Equity interest transfer
notification. A swap execution facility shall file with the Commission
a notification of each transaction involving the direct or indirect
transfer of fifty percent or more of the equity interest in the swap
execution facility. The Commission may, upon receiving such
notification, request that the swap execution facility provide
supporting documentation of the transaction.
(2) Timing of notification. The equity interest transfer notice
described in paragraph (c)(1) of this section shall be filed
electronically with the Secretary of the Commission at its Washington,
DC headquarters at [email protected] and the Division of Market
Oversight at [email protected], at the earliest possible time but
in no event later than the open of business ten business days following
the date upon which a firm obligation is made to transfer, directly or
indirectly, fifty percent or more of the equity interest in the swap
execution facility.
(3) Certification. Upon a transfer, whether directly or indirectly,
of an equity interest of fifty percent or more in a swap execution
facility, the swap execution facility shall file electronically with
the Secretary of the Commission at its Washington, DC headquarters at
[email protected] and the Division of Market Oversight at
[email protected], a certification that the swap execution
facility meets all of the requirements of section 5h of the Act and the
Commission regulations adopted thereunder, no later than two business
days following the date on which the equity interest of fifty percent
or more was acquired.
(d) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, the authority set forth in this section to the
Director of the Division of Market Oversight or such other employee or
employees as the Director may designate from time to time. The Director
may submit to the Commission for its consideration any matter that has
been delegated in this paragraph. Nothing in this paragraph prohibits
the Commission, at its election, from exercising the authority
delegated in this paragraph.
Sec. 37.6 Enforceability.
(a) Enforceability of transactions. A swap transaction executed on
a swap execution facility shall not be void, voidable, subject to
rescission, otherwise invalidated, or rendered unenforceable as a
result of:
(1) A violation by the swap execution facility of the provisions of
section 5h of the Act or this part;
(2) Any Commission proceeding to alter or supplement a rule, term,
or condition under section 8a(7) of the Act or to declare an emergency
under section 8a(9) of the Act; or
(3) Any other proceeding the effect of which is to:
(i) Alter or supplement a specific term or condition or trading
rule or procedure; or
(ii) Require a swap execution facility to adopt a specific term or
condition, trading rule or procedure, or to take or refrain from taking
a specific action.
(b) Swap documentation--(1) Legally binding documentation--(i)
Cleared swaps. (A) A swap execution facility shall provide a
confirmation document to each counterparty to a cleared swap
transaction that is executed on the swap execution facility.
(B) Confirmation document means a legally binding written
documentation (electronic or otherwise) that memorializes the agreement
to all terms of a swap transaction and legally supersedes any previous
agreement (electronic or otherwise) that relates to the swap
transaction between the counterparties.
(ii) Uncleared swaps. (A) A swap execution facility shall provide a
trade evidence record to each counterparty to an uncleared swap
transaction that is executed on the swap execution facility.
(B) Trade evidence record means a legally binding written
documentation (electronic or otherwise) that memorializes the terms of
a swap transaction agreed upon by the counterparties and legally
supersedes any conflicting term in any previous agreement (electronic
or otherwise) that relates to the swap transaction between the
counterparties.
(2) Requirements for swap documentation. (i) A swap execution
facility shall issue the confirmation document or trade evidence record
to the counterparties as soon as technologically practicable after the
execution of the swap transaction on the swap execution facility.
(ii) Specific customer identifiers for accounts included in bunched
orders involving swap transactions need not be included in a
confirmation document or a trade evidence record provided by a swap
execution facility if the applicable requirements of Sec. 1.35(b)(5)
of this chapter are met.
(iii) The swap execution facility may issue the confirmation
document or trade evidence record to the person acting as an
intermediary on behalf of the counterparty to the swap transaction. The
swap execution facility shall establish and enforce rules that require
such intermediary to send the confirmation document or trade evidence
record to the respective counterparty as soon as technologically
practicable upon receipt of the confirmation document or trade evidence
record from the swap execution facility.
Sec. 37.7 Boards of trade operating both a designated contract
market and a swap execution facility.
(a) An entity that intends to operate both a designated contract
market and a swap execution facility shall separately
[[Page 62097]]
register the two entities pursuant to the designated contract market
designation procedures set forth in part 38 of this chapter and the
swap execution facility registration procedures set forth in this part.
(b) A board of trade, as defined in section 1a(6) of the Act, that
operates both a designated contract market and a swap execution
facility and that uses the same electronic trade execution system for
executing and trading swaps on the designated contract market and on
the swap execution facility shall clearly identify to market
participants for each swap whether the execution or trading of such
swaps is taking place on the designated contract market or on the swap
execution facility.
Subpart B--Compliance With Core Principles
Sec. 37.100 Core Principle 1--Compliance with core principles.
(a) In general. To be registered, and maintain registration, as a
swap execution facility, the swap execution facility shall comply
with--
(1) The core principles described in section 5h of the Act; and
(2) Any requirement that the Commission may impose by rule or
regulation pursuant to section 8a(5) of the Act.
(b) Reasonable discretion of a swap execution facility. Unless
otherwise determined by the Commission by rule or regulation, a swap
execution facility described in paragraph (a) of this section shall
have reasonable discretion in establishing the manner in which the swap
execution facility complies with the core principles described in
section 5h of the Act.
Sec. 37.101 [Reserved]
Subpart C--Compliance With Rules
Sec. 37.200 Core Principle 2--Compliance with rules.
A swap execution facility shall:
(a) Establish and enforce compliance with any rule of the swap
execution facility, including the terms and conditions of the swaps
traded or processed on or through the swap execution facility and any
limitation on access to the swap execution facility;
(b) Establish and enforce trading, trade processing, and
participation rules that will deter abuses and have the capacity to
detect, investigate, and enforce those rules, including means to
provide market participants with impartial access to the market and to
capture information that may be used in establishing whether rule
violations have occurred;
(c) Establish rules governing the operation of the facility,
including rules specifying trading procedures to be used in entering
and executing orders traded or posted on the facility, including block
trades; and
(d) Provide by its rules that when a swap dealer or major swap
participant enters into or facilitates a swap that is subject to the
mandatory clearing requirement of section 2(h) of the Act, the swap
dealer or major swap participant shall be responsible for compliance
with the mandatory trading requirement under section 2(h)(8) of the
Act.
Sec. 37.201 Requirements for swap execution facility execution
methods.
(a) Required swap execution facility rules. A swap execution
facility shall establish rules governing the operation of the swap
execution facility that specify:
(1) The protocols and procedures for trading and execution,
including entering, amending, cancelling, or executing orders for each
execution method;
(2) The manner or circumstances in which the swap execution
facility may exercise discretion in facilitating trading and execution
for each execution method; and
(3) The sources and methodology for generating any market pricing
information provided to facilitate trading and execution for each
execution method.
(b) Pre-execution communications. A swap execution facility shall
establish rules governing the operation of the swap execution facility
that specify a prohibition on engaging in any communications away from
the swap execution facility regarding any swap subject to the trade
execution requirement of section 2(h)(8) of the Act as set forth in
Sec. 36.1 of this chapter.
(1) Counterparties to a swap that is subject to the trade execution
requirement of section 2(h)(8) of the Act as set forth in Sec. 36.1 of
this chapter may engage in communications away from the swap execution
facility if the swap is executed as a component of a package
transaction that includes a component transaction that is not subject
to section 2(h)(8) of the Act as set forth in Sec. 36.1 of this
chapter. For purposes of this paragraph (b)(1), a package transaction
consists of two or more component transactions executed between two or
more counterparties where:
(i) Execution of each component transaction is contingent upon the
execution of all other components transactions; and
(ii) The component transactions are each priced or quoted together
as part of one economic transaction with simultaneous or near
simultaneous execution of all components.
(2) [Reserved]
(c) SEF trading specialist--(1) Definition. For purposes of this
part, the term SEF trading specialist means any natural person who,
acting as an employee (or in a similar capacity) of a swap execution
facility, facilitates the trading or execution of swaps transactions
(other than in a ministerial or clerical capacity), or who is
responsible for direct supervision of such persons.
(2) Fitness. (i) No swap execution facility shall permit a person
who is subject to a statutory disqualification under sections 8a(2) or
8a(3) of the Act to serve as a SEF trading specialist if the swap
execution facility knows, or in the exercise of reasonable care should
know, of the statutory disqualification.
(ii) The prohibition set forth in paragraph (c)(2)(i) of this
section shall not apply to:
(A) Any person listed as a principal or registered with the
Commission as an associated person of a futures commission merchant,
retail foreign exchange dealer, introducing broker, commodity pool
operator, commodity trading advisor, or leverage transaction merchant,
or any person registered as a floor broker or floor trader,
notwithstanding that such person is subject to a disqualification from
registration under sections 8a(2) or 8a(3) of the Act; or
(B) Any person otherwise subject to a disqualification from
registration under sections 8a(2) or 8a(3) of the Act for whom a
registered futures association provides a notice stating that, if the
person applied for registration with the Commission as an associated
person, the registered futures association would not deny the
application on the basis of the statutory disqualification.
(3) Proficiency requirements. (i) A swap execution facility shall
establish and enforce standards and procedures to ensure that its SEF
trading specialists have the proficiency and knowledge necessary to:
(A) Fulfill their responsibilities to the swap execution facility
as SEF trading specialists; and
(B) Comply with applicable provisions of the Act, the Commission's
regulations, and the rules of the swap execution facility.
(ii) Qualification testing. A swap execution facility shall require
any person serving as a SEF trading specialist to demonstrate that:
[[Page 62098]]
(A) Such person has taken and passed any examination for swaps
proficiency developed and administered by a registered futures
association; and
(B) There is no continuous two-year period subsequent to such
person passing a swaps proficiency examination during which the person
has not served as a SEF trading specialist.
(iii) Compliance with the qualification testing requirements under
paragraph (c)(3)(ii) of this section shall constitute compliance with
the proficiency requirements under paragraph (c)(3)(i) of this section.
(4) Ethics training. A swap execution facility shall establish and
enforce policies and procedures to ensure that its SEF trading
specialists receive ethics training on a periodic basis.
(5) Standards of conduct. A swap execution facility shall establish
and enforce policies and procedures that require its SEF trading
specialists in dealing with market participants and fulfilling their
responsibilities to the swap execution facility to satisfy standards of
conduct as established by the swap execution facility.
(6) Duty to supervise. A swap execution facility shall diligently
supervise the activities of its SEF trading specialists in the
facilitation of trading and execution on the swap execution facility.
(7) Additional sources for compliance. A swap execution facility
may refer to the guidance and/or acceptable practices in appendix B of
this part to demonstrate to the Commission compliance with the
requirements of Sec. 37.201.
Sec. 37.202 Access requirements.
(a) Impartial access to markets, market services, and execution
methods. (1) A swap execution facility shall establish rules specifying
impartial access criteria for its markets, market services, and
execution methods, including any indicative quote screens or any
similar pricing data displays. Such impartial access criteria shall be
transparent, fair, and non-discriminatory and applied to all or
similarly situated market participants.
(2) A swap execution facility shall establish fee structures and
fee practices that are fair and non-discriminatory to market
participants.
(b) Limitations on access. A swap execution facility shall
establish and impartially enforce rules governing any decision to deny,
suspend, permanently bar, or otherwise limit market participants'
access to the swap execution facility, including when such decisions
are made as part of a disciplinary or emergency action taken by the
swap execution facility. The swap execution facility shall maintain
documentation of any decision to deny, suspend, permanently bar, or
otherwise limit access of a market participant to the swap execution
facility.
(c) Eligibility. A swap execution facility shall require its market
participants to provide the swap execution facility with written
confirmation (electronic or otherwise) of their status as eligible
contract participants, as defined by the Act and Commission
regulations, prior to obtaining access.
(d) Jurisdiction. Prior to granting any market participant access
to its facilities, a swap execution facility shall require that the
market participant consent to its jurisdiction.
Sec. 37.203 Rule enforcement program.
(a) Abusive trading practices prohibited. A swap execution facility
shall prohibit abusive trading practices on its markets by market
participants. Swap execution facilities that permit intermediation
shall prohibit customer-related abuses including, but not limited to,
trading ahead of customer orders, trading against customer orders,
accommodation trading, and improper cross trading. Specific trading
practices that shall be prohibited include front-running, wash trading,
pre-arranged trading, fraudulent trading, money passes, and any other
trading practices that a swap execution facility deems to be abusive. A
swap execution facility shall also prohibit any other manipulative or
disruptive trading practices prohibited by the Act or by the Commission
pursuant to Commission regulation.
(b) Authority to collect information. A swap execution facility
shall have the authority to collect information required to be kept by
persons subject to the swap execution facility's recordkeeping rules.
(c) Compliance staff and resources. A swap execution facility shall
establish and maintain sufficient compliance staff and resources to
ensure that it can fulfill its self-regulatory obligations under the
Act and Commission regulations.
(d) Automated trade surveillance system. A swap execution facility
shall maintain an automated trade surveillance system capable of
detecting and reconstructing potential trade practice violations. Any
trade executed by voice or by entry into a swap execution facility's
electronic trading system or platform and any order entered into an
electronic trading system or platform shall be loaded and processed
into the automated trade surveillance system no later than 24 hours
after the completion of the trading day on which such trade was
executed or such order was entered.
(e) Error trade policy--(1) Definition. As used in this paragraph
(e), the term error trade means any swap transaction executed on a swap
execution facility that contains an error in any term of the swap
transaction, including price, size, or direction.
(2) A swap execution facility shall establish and maintain rules
and procedures that facilitate the resolution of error trades in a
fair, transparent, consistent, and timely manner. Such rules and
procedures shall:
(i) Provide the swap execution facility with the authority to
adjust trade terms or cancel trades; and
(ii) Specify the rules and procedures for market participants to
notify the swap execution facility of an error trade, including any
time limits for notification.
(3) A swap execution facility shall, as soon as practicable,
provide notice to all market participants of:
(i) Any swap transaction that is under review by the swap execution
facility pursuant to error trade rules and procedures;
(ii) Any determination by the swap execution facility that a swap
transaction under review is or is not an error trade; and
(iii) The resolution of any error trade, including any trade term
adjustment or trade cancellation.
(4) The requirements of paragraph (e) of this section shall not
preclude the swap execution facility from establishing non-reviewable
ranges.
(f) Investigations--(1) Procedures. A swap execution facility shall
establish and maintain procedures that require its compliance staff to
conduct investigations, including the commencement of an investigation
upon the receipt of a request from Commission staff or upon the
discovery or receipt of information by the swap execution facility that
indicates a reasonable basis for finding that a violation may have
occurred or will occur.
(2) Timeliness. Each investigation shall be completed in a timely
manner, taking into account the facts and circumstances of the
investigation.
(3) Investigation reports. Compliance staff shall prepare a written
investigation report to document the conclusion of each investigation.
The investigation report shall include the reason the investigation was
initiated; a summary of the complaint, if any; the relevant facts;
compliance staff's analysis and conclusions; and a
[[Page 62099]]
recommendation as to whether disciplinary action should be pursued.
(g) Additional sources for compliance. A swap execution facility
may refer to the guidance and/or acceptable practices in appendix B of
this part to demonstrate to the Commission compliance with the
requirements of Sec. 37.203.
Sec. 37.204 Regulatory services provided by a third party.
(a) Use of regulatory service provider permitted. A swap execution
facility may choose to contract with a registered futures association
or another registered entity, as such terms are defined under the Act,
or any non-registered entity (collectively, ``regulatory service
providers''), for the provision of services to assist in complying with
the Act and Commission regulations thereunder, as approved by the
Commission. Any swap execution facility that chooses to contract with a
regulatory service provider shall ensure that such provider has the
capabilities and resources necessary to provide timely and effective
regulatory services, including adequate staff and automated
surveillance systems. A swap execution facility shall at all times
remain responsible for the performance of any regulatory services
received, for compliance with the swap execution facility's obligations
under the Act and Commission regulations, and for the regulatory
service provider's performance on its behalf.
(b) Duty to supervise regulatory service provider. A swap execution
facility that elects to use the service of a regulatory service
provider shall retain sufficient compliance staff and resources to
supervise the quality and effectiveness of the regulatory services
provided on its behalf. A swap execution facility shall determine the
necessary processes for a swap execution facility to supervise such
provider. Such processes shall include, at a minimum, the swap
execution facility's involvement in all substantive decisions, such as
decisions involving:
(1) The adjustment or cancellation of trades;
(2) Whether or not to issue disciplinary charges; and
(3) Denials of access to the swap execution facility for
disciplinary reasons. Such decisions shall be documented as agreed upon
by the swap execution facility and its regulatory service provider.
(c) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, the authority to approve any regulatory
service provider chosen by a swap execution facility for the provision
of regulatory services. The Director may submit to the Commission for
its consideration any matter that has been delegated in this paragraph.
Nothing in this paragraph prohibits the Commission, at its election,
from exercising the authority delegated in this paragraph.
Sec. 37.205 Audit trail.
(a) Audit trail required. A swap execution facility shall capture
and retain all audit trail data necessary to reconstruct all trading on
its facility, detect and investigate customer and market abuses, and
take appropriate disciplinary action. An acceptable audit trail shall
also permit the swap execution facility to track a customer order from
the time of receipt through execution on the swap execution facility.
(b) Elements of an acceptable audit trail program--(1) Original
source documents. A swap execution facility's audit trail shall include
original source documents. Original source documents include
unalterable, sequentially-identified records on which trade execution
information is originally recorded, whether recorded manually or
electronically.
(2) Transaction history database. A swap execution facility's audit
trail program shall include an electronic transaction history database.
An adequate transaction history database includes a history of any
trade executed by voice or by entry into a swap execution facility's
electronic trading system or platform and any order entered into its
electronic trading system or platform, including any order modification
and cancellation.
(3) Electronic analysis capability. A swap execution facility's
audit trail program shall include electronic analysis capability with
respect to all audit trail data in the transaction history database.
Such electronic analysis capability shall ensure that the swap
execution facility has the ability to reconstruct any trade executed by
voice or by entry into a swap execution facility's electronic trading
system or platform and any order entered into its electronic trading
system or platform, and identify possible trading violations with
respect to both customer and market abuse.
(c) Audit trail reconstruction. A swap execution facility shall
establish a program to verify its ability to comprehensively and
accurately reconstruct all trading on its facility in a timely manner.
Sec. 37.206 Disciplinary procedures and sanctions.
(a) Enforcement staff. A swap execution facility shall establish
and maintain sufficient enforcement staff and resources to effectively
and promptly enforce possible rule violations within the disciplinary
jurisdiction of the swap execution facility.
(b) Disciplinary program. A swap execution facility shall establish
a disciplinary program to enforce its rules. A swap execution facility
shall administer its disciplinary program through one or more
disciplinary panels or its compliance staff. Notwithstanding the
requirements of Sec. 37.2, if a swap execution facility elects to
administer its disciplinary program through its compliance staff, the
requirements of Sec. 1.64(c)(4) of this chapter shall not apply to
such compliance staff. Any disciplinary panel or appellate panel
established by a swap execution facility shall meet the composition
requirements of applicable Commission regulations, and shall not
include any member of the swap execution facility's compliance staff or
any person involved in adjudicating any other stage of the same
proceeding.
(c) Warning letters and sanctions. (1) All warning letters and
sanctions imposed by a swap execution facility or its disciplinary
panels shall be commensurate with the violations committed and shall be
clearly sufficient to deter recidivism or similar violations by other
market participants. All such warning letters and sanctions (including
summary fines and sanctions imposed pursuant to an accepted settlement
offer) shall take into account the respondent's disciplinary history.
In the event of demonstrated customer harm, any sanction shall also
include full customer restitution, except where the amount of
restitution or to whom it should be provided cannot be reasonably
determined.
(2) A swap execution facility's compliance staff or disciplinary
panel may not issue more than one warning letter to the same individual
found to have committed the same rule violation within a rolling
twelve-month period, except for rule violations related to minor
recordkeeping or reporting infractions.
(d) Additional sources for compliance. A swap execution facility
may refer to the guidance and/or acceptable practices in appendix B of
this part to demonstrate to the
[[Page 62100]]
Commission compliance with the requirements of Sec. 37.206.
Subpart D--Swaps Not Readily Susceptible to Manipulation
Sec. 37.300 Core Principle 3--Swaps not readily susceptible to
manipulation.
The swap execution facility shall permit trading only in swaps that
are not readily susceptible to manipulation.
Sec. 37.301 General requirements.
To demonstrate to the Commission compliance with the requirements
of Sec. 37.300, a swap execution facility shall, at the time it
submits a new swap contract in advance to the Commission pursuant to
part 40 of this chapter, provide the applicable information as set
forth in appendix C to this part, Demonstration of Compliance that a
Swap Contract is Not Readily Susceptible to Manipulation.
Subpart E--Monitoring of Trading and Trade Processing
Sec. 37.400 Core Principle 4--Monitoring of trading and trade
processing.
The swap execution facility shall:
(a) Establish and enforce rules or terms and conditions defining,
or specifications detailing:
(1) Trading procedures to be used in entering and executing orders
traded on or through the facilities of the swap execution facility; and
(2) Procedures for trade processing of swaps on or through the
facilities of the swap execution facility; and
(b) Monitor trading in swaps to prevent manipulation, price
distortion, and disruptions of the delivery or cash settlement process
through surveillance, compliance, and disciplinary practices and
procedures, including methods for conducting real-time monitoring of
trading and comprehensive and accurate trade reconstructions.
Sec. 37.401 General requirements.
A swap execution facility shall:
(a) Conduct real-time market monitoring of all trading activity on
the swap execution facility to identify disorderly trading, any market
or system anomalies, and instances or threats of manipulation, price
distortion, and disruption;
(b) Collect and evaluate data on its market participants' trading
activity away from its facility, including trading in the index or
instrument used as a reference price, the underlying commodity for its
listed swaps, or in related derivatives markets, as necessary to detect
and prevent manipulation, price distortion, and, where possible,
disruptions of the physical-delivery or cash-settlement processes;
(c) Monitor and evaluate general market data as necessary to detect
and prevent manipulative activity that would result in the failure of
the market price to reflect the normal forces of supply and demand; and
(d) Have the ability to comprehensively and accurately reconstruct
all trading activity on its facility for the purpose of detecting
instances or threats of manipulation, price distortion, and
disruptions.
Sec. 37.402 Additional requirements for physical-delivery swaps.
For a physical-delivery swap listed on the swap execution facility,
the swap execution facility shall:
(a) Monitor the swap's terms and conditions as it relates to the
underlying commodity market by reviewing the convergence between the
swap's price and the price of the underlying commodity and make a good-
faith effort to resolve conditions that are interfering with
convergence or notify the Commission of such conditions; and
(b) Monitor the availability of the supply of the commodity
specified by the delivery requirements of the swap and make a good-
faith effort to resolve conditions that threaten the adequacy of
supplies or the delivery process or notify the Commission of such
conditions.
Sec. 37.403 Additional requirements for cash-settled swaps.
(a) For cash-settled swaps listed on the swap execution facility
where the reference price is formulated and computed by the swap
execution facility, the swap execution facility shall monitor the
continued appropriateness of its methodology for deriving that price
and take appropriate action, including amending the methodology, where
there is a threat of manipulation, price distortion, or market
disruption.
(b) For cash-settled swaps listed on the swap execution facility
where the reference price relies on a third-party index or instrument,
the swap execution facility shall monitor the continued appropriateness
of the index or instrument and take appropriate action, including
selecting an alternate index or instrument for deriving the reference
price, where there is a threat of manipulation, price distortion, or
market disruption.
Sec. 37.404 Ability to obtain information.
(a) A swap execution facility shall maintain access to sufficient
information to assess whether trading in swaps that it lists, in the
index or instrument used as a reference price, or in the underlying
commodity for its listed swaps is being used to affect prices on its
market.
(b) A swap execution facility shall have rules that require its
market participants to keep records of their trading, including records
of their activity in the index or instrument used as a reference price,
the underlying commodity, and related derivatives markets, and make
such records available, upon request, to the swap execution facility
or, if applicable, to its regulatory service provider, and the
Commission.
Sec. 37.405 Risk controls for trading.
The swap execution facility shall establish and maintain risk
control mechanisms to prevent and reduce the potential risk of price
distortions and market disruptions on its facility, including, but not
limited to, market restrictions that pause or halt trading under market
conditions prescribed by the swap execution facility.
Sec. 37.406 Regulatory service provider.
A swap execution facility shall comply with the regulations in this
subpart through a dedicated regulatory department or by contracting
with a regulatory service provider pursuant to Sec. 37.204.
Sec. 37.407 Additional sources for compliance.
A swap execution facility may refer to the guidance and/or
acceptable practices in appendix B of this part to demonstrate to the
Commission compliance with the requirements of Sec. 37.400.
Subpart F--Ability To Obtain Information
Sec. 37.500 Core Principle 5--Ability to obtain information.
The swap execution facility shall:
(a) Establish and enforce rules that will allow the facility to
obtain any necessary information to perform any of the functions
described in section 5h of the Act;
(b) Provide the information to the Commission on request; and
(c) Have the capacity to carry out such international information-
sharing agreements as the Commission may require.
Sec. 37.501 Establish and enforce rules.
A swap execution facility shall establish and enforce rules that
will allow the swap execution facility to have the ability and
authority to obtain sufficient information to allow it to fully perform
its operational, risk management, governance, and
[[Page 62101]]
regulatory functions and any requirements under this part.
Sec. 37.502 Provide information to the Commission.
A swap execution facility shall provide information in its
possession to the Commission upon request, in a form and manner that
the Commission approves.
Sec. 37.503 Information-sharing.
A swap execution facility shall share information as required by
the Commission or as appropriate to fulfill its self-regulatory and
reporting responsibilities. Appropriate information-sharing agreements
can be established or the Commission can act in conjunction with the
swap execution facility to carry out such information sharing.
Sec. 37.504 Prohibited use of data collected for regulatory
purposes.
A swap execution facility shall not use for business or marketing
purposes, nor permit such use of, any proprietary data or personal
information it collects or receives, from or on behalf of any person,
for the purpose of fulfilling its regulatory obligations; provided,
however, that a swap execution facility may use or permit the use of
such data or information for business or marketing purposes if the
person from whom it collects or receives such data or information
clearly consents to the use of such data or information in such manner.
A swap execution facility shall not condition access to its markets or
market services on a person's consent to the swap execution facility's
use of proprietary data or personal information for business or
marketing purposes.
Subpart G--Position Limits or Accountability
Sec. 37.600 Core Principle 6--Position limits or accountability.
(a) In general. To reduce the potential threat of market
manipulation or congestion, especially during trading in the delivery
month, a swap execution facility that is a trading facility shall adopt
for each of the contracts of the facility, as is necessary and
appropriate, position limitations or position accountability for
speculators.
(b) Position limits. For any contract that is subject to a position
limitation established by the Commission pursuant to section 4a(a) of
the Act, the swap execution facility shall:
(1) Set its position limitation at a level no higher than the
Commission limitation; and
(2) Monitor positions established on or through the swap execution
facility for compliance with the limit set by the Commission and the
limit, if any, set by the swap execution facility.
Sec. 37.601 [Reserved]
Subpart H--Financial Integrity of Transactions
Sec. 37.700 Core Principle 7--Financial integrity of transactions.
The swap execution facility shall establish and enforce rules and
procedures for ensuring the financial integrity of swaps entered on or
through the facilities of the swap execution facility, including the
clearance and settlement of the swaps pursuant to section 2(h)(1) of
the Act.
Sec. 37.701 Required clearing.
(a) Transactions executed on the swap execution facility that are
required to be cleared under section 2(h)(1)(A) of the Act or are
voluntarily cleared by the counterparties shall be cleared through a
Commission-registered derivatives clearing organization, or a
derivatives clearing organization that the Commission has determined is
exempt from registration.
(b) A swap execution facility shall have an independent clearing
agreement with each Commission-registered derivatives clearing
organization, or derivatives clearing organization that the Commission
has determined is exempt from registration, to which the swap execution
facility submits a swap for clearing.
Sec. 37.702 General financial integrity.
A swap execution facility shall provide for the financial integrity
of its transactions:
(a) By establishing minimum financial standards for its market
participants, which shall, at a minimum, require that each market
participant qualifies as an eligible contract participant as defined in
section 1a(18) of the Act;
(b) For transactions routed through a swap execution facility to a
registered derivatives clearing organization for clearing:
(1) By coordinating with each registered derivatives clearing
organization to which the swap execution facility submits transactions
for clearing, in the development of rules and procedures to facilitate
prompt, efficient, and accurate processing and routing of transactions
to registered derivatives clearing organizations in accordance with the
requirements of Sec. 39.12(b)(7)(i)(A) of this chapter;
(2) By requiring that each market participant identify a clearing
member in advance for each counterparty on an order-by-order basis; and
(3) By facilitating pre-execution screening by each clearing
futures commission merchant in accordance with the requirements of
Sec. 1.73 of this chapter on an order-by-order basis.
Sec. 37.703 Monitoring for financial soundness.
A swap execution facility shall monitor its market participants to
ensure that they continue to qualify as eligible contract participants
as defined in section 1a(18) of the Act.
Subpart I--Emergency Authority
Sec. 37.800 Core Principle 8--Emergency authority.
The swap execution facility shall adopt rules to provide for the
exercise of emergency authority, in consultation or cooperation with
the Commission, as is necessary and appropriate, including the
authority to liquidate or transfer open positions in any swap or to
suspend or curtail trading in a swap.
Sec. 37.801 Additional sources for compliance.
A swap execution facility may refer to the guidance and/or
acceptable practices in appendix B of this part to demonstrate to the
Commission compliance with the requirements of Sec. 37.800.
Subpart J--Timely Publication of Trading Information
Sec. 37.900 Core Principle 9--Timely publication of trading
information.
(a) In general. The swap execution facility shall make public
timely information on price, trading volume, and other trading data on
swaps to the extent prescribed by the Commission.
(b) Capacity of swap execution facility. The swap execution
facility shall be required to have the capacity to electronically
capture and transmit trade information with respect to transactions
executed on the facility.
Sec. 37.901 General requirements.
With respect to swaps traded on or through a swap execution
facility, each swap execution facility shall:
(a) Report specified swap data as provided under parts 43 and 45 of
this chapter; and
(b) Meet the requirements of part 16 of this chapter.
Subpart K--Recordkeeping and Reporting
Sec. 37.1000 Core Principle 10--Recordkeeping and reporting.
(a) In general. A swap execution facility shall:
[[Page 62102]]
(1) Maintain records of all activities relating to the business of
the facility, including a complete audit trail, in a form and manner
acceptable to the Commission for a period of five years;
(2) Report to the Commission, in a form and manner acceptable to
the Commission, such information as the Commission determines to be
necessary or appropriate for the Commission to perform the duties of
the Commission under the Act; and
(3) Keep any such records relating to swaps defined in section
1a(47)(A)(v) of the Act open to inspection and examination by the
Securities and Exchange Commission.
(b) Requirements. The Commission shall adopt data collection and
reporting requirements for swap execution facilities that are
comparable to corresponding requirements for derivatives clearing
organizations and swap data repositories.
Sec. 37.1001 Recordkeeping.
A swap execution facility shall maintain records of all activities
relating to the business of the facility, in a form and manner
acceptable to the Commission, for a period of at least five years. A
swap execution facility shall maintain such records, including a
complete audit trail for all swaps executed on the swap execution
facility, investigatory files, and disciplinary files, in accordance
with the requirements of Sec. 1.31 and part 45 of this chapter.
Subpart L--Antitrust Considerations
Sec. 37.1100 Core Principle 11--Antitrust considerations.
Unless necessary or appropriate to achieve the purposes of the Act,
the swap execution facility shall not:
(a) Adopt any rules or take any actions that result in any
unreasonable restraint of trade; or
(b) Impose any material anticompetitive burden on trading or
clearing.
Sec. 37.1101 Additional sources for compliance.
A swap execution facility may refer to the guidance and/or
acceptable practices in appendix B of this part to demonstrate to the
Commission compliance with the requirements of Sec. 37.1100.
Subpart M--Conflicts of Interest
Sec. 37.1200 Core Principle 12--Conflicts of interest.
The swap execution facility shall:
(a) Establish and enforce rules to minimize conflicts of interest
in its decision-making process; and
(b) Establish a process for resolving the conflicts of interest.
Sec. 37.1201 [Reserved]
Subpart N--Financial Resources
Sec. 37.1300 Core Principle 13--Financial resources.
(a) In general. The swap execution facility shall have adequate
financial, operational, and managerial resources to discharge each
responsibility of the swap execution facility.
(b) Determination of resource adequacy. The financial resources of
a swap execution facility shall be considered to be adequate if the
value of the financial resources exceeds the total amount that would
enable the swap execution facility to cover the operating costs of the
swap execution facility for a one-year period, as calculated on a
rolling basis.
Sec. 37.1301 General requirements.
(a) A swap execution facility shall maintain financial resources on
an ongoing basis that are adequate to enable it to comply with the core
principles set forth in section 5h of the Act and any applicable
Commission regulations. Financial resources shall be considered
adequate if their value exceeds the total amount that would enable the
swap execution facility to cover its projected operating costs
necessary for the swap execution facility to comply with section 5h of
the Act and applicable Commission regulations for a one-year period, as
calculated on a rolling basis pursuant to Sec. 37.1304.
(b) An entity that operates as both a swap execution facility and a
derivatives clearing organization shall also comply with the financial
resource requirements of Sec. 39.11 of this chapter. In lieu of filing
separate reports under Sec. 37.1306(a) and Sec. 39.11(f) of this
chapter, such an entity may file a single report in accordance with
Sec. 39.11 of this chapter.
Sec. 37.1302 Types of financial resources.
Financial resources available to satisfy the requirements of Sec.
37.1301 may include:
(a) The swap execution facility's own capital, meaning its assets
minus its liabilities calculated in accordance with generally accepted
accounting principles in the United States; and
(b) Any other financial resource deemed acceptable by the
Commission.
Sec. 37.1303 Liquidity of financial resources.
The financial resources allocated by the swap execution facility to
meet the ongoing requirements of Sec. 37.1301 shall include
unencumbered, liquid financial assets (i.e., cash and/or highly liquid
securities) equal to at least the greater of three months of projected
operating costs, as calculated on a rolling basis, or the projected
costs needed to wind down the swap execution facility's operations, in
each case as determined under Sec. 37.1304. If a swap execution
facility lacks sufficient unencumbered, liquid financial assets to
satisfy its obligations under this section, the swap execution facility
may satisfy this requirement by obtaining a committed line of credit or
similar facility in an amount at least equal to such deficiency.
Sec. 37.1304 Computation of costs to meet financial resources
requirement.
A swap execution facility shall each fiscal quarter, make a
reasonable calculation of its projected operating costs and wind-down
costs in order to determine its applicable obligations under Sec.
37.1301 and Sec. 37.1303. The swap execution facility shall have
reasonable discretion in determining the methodologies used to compute
such amounts. The Commission may review the methodologies and require
changes as appropriate.
Sec. 37.1305 Valuation of financial resources.
No less than each fiscal quarter, a swap execution facility shall
compute the current market value of each financial resource used to
meet its obligations under Sec. 37.1301 and Sec. 37.1303. Reductions
in value to reflect market and credit risk (``haircuts'') shall be
applied as appropriate.
Sec. 37.1306 Reporting to the Commission.
(a) Each fiscal quarter, or at any time upon Commission request, a
swap execution facility shall provide a report to the Commission that
includes:
(1) The amount of financial resources necessary to meet the
requirements of Sec. 37.1301 and Sec. 37.1303, computed in accordance
with the requirements of Sec. 37.1304, and the market value of each
available financial resource, computed in accordance with the
requirements of Sec. 37.1305; and
(2) Financial statements, including the balance sheet, income
statement, and statement of cash flows of the swap execution facility.
(i) The financial statements shall be prepared in accordance with
generally accepted accounting principles in the United States, prepared
in English, and denominated in U.S. dollars.
(ii) The financial statements of a swap execution facility that is
not domiciled in the United States, and is not otherwise required to
prepare financial statements in accordance with generally
[[Page 62103]]
accepted accounting principles in the United States, may satisfy the
requirement in paragraph (a)(2)(i) of this section if such financial
statements are prepared in accordance with either International
Financial Reporting Standards issued by the International Accounting
Standards Board, or a comparable international standard as the
Commission may otherwise accept in its discretion.
(b) The calculations required by paragraph (a) of this section
shall be made as of the last business day of the swap execution
facility's applicable fiscal quarter.
(c) With each report required under paragraph (a) of this section,
the swap execution facility shall also provide the Commission with
sufficient documentation explaining the methodology used to compute its
financial requirements under Sec. 37.1301 and Sec. 37.1303. Such
documentation shall:
(1) Allow the Commission to reliably determine, without additional
requests for information, that the swap execution facility has made
reasonable calculations pursuant to Sec. 37.1304; and
(2) Include, at a minimum:
(i) A total list of all expenses, without any exclusion;
(ii) All expenses and the corresponding amounts, if any, that the
swap execution facility excluded or pro-rated when determining its
operating costs, calculated on a rolling basis, required under Sec.
37.1301 and Sec. 37.1303, and the basis for any determination to
exclude or pro-rate any such expenses;
(iii) Documentation demonstrating the existence of any committed
line of credit or similar facility relied upon for the purpose of
meeting the requirements of Sec. 37.1303 (e.g., copies of agreements
establishing or amending a credit facility or similar facility); and
(iv) All costs that a swap execution facility would incur to wind
down the swap execution facility's operations, the projected amount of
time for any such wind-down period, and the basis of its determination
for the estimation of its costs and timing.
(d) The reports and supporting documentation required by this
section shall be filed not later than 40 calendar days after the end of
the swap execution facility's first three fiscal quarters, and not
later than 90 calendar days after the end of the swap execution
facility's fourth fiscal quarter, or at such later time as the
Commission may permit, in its discretion, upon request by the swap
execution facility.
(e) A swap execution facility shall provide notice to the
Commission no later than 48 hours after it knows or reasonably should
have known that it no longer meets its obligations under Sec. 37.1301
or Sec. 37.1303.
Sec. 37.1307 Delegation of authority.
(a) The Commission hereby delegates, until it orders otherwise, to
the Director of the Division of Market Oversight or such other employee
or employees as the Director may designate from time to time, authority
to:
(1) Determine whether a particular financial resource under Sec.
37.1302 may be used to satisfy the requirements of Sec. 37.1301;
(2) Review and make changes to the methodology used to compute
projected operating costs and wind-down costs under Sec. 37.1304 and
the valuation of financial resources under Sec. 37.1305;
(3) Request reports, in addition to those required in Sec.
37.1306, or additional documentation or information under Sec.
37.1306(a), (c), and (e); and
(4) Grant an extension of time to file fiscal quarter reports under
Sec. 37.1306(d).
(b) The Director may submit to the Commission for its consideration
any matter that has been delegated in this section. Nothing in this
section prohibits the Commission, at its election, from exercising the
authority delegated in this section.
Subpart O--System Safeguards
Sec. 37.1400 Core Principle 14--System safeguards.
The swap execution facility shall:
(a) Establish and maintain a program of risk analysis and oversight
to identify and minimize sources of operational risk, through the
development of appropriate controls and procedures, and automated
systems, that:
(1) Are reliable and secure; and
(2) Have adequate scalable capacity;
(b) Establish and maintain emergency procedures, backup facilities,
and a plan for disaster recovery that allow for:
(1) The timely recovery and resumption of operations; and
(2) The fulfillment of the responsibilities and obligations of the
swap execution facility; and
(c) Periodically conduct tests to verify that the backup resources
of the swap execution facility are sufficient to ensure continued:
(1) Order processing and trade matching;
(2) Price reporting;
(3) Market surveillance; and
(4) Maintenance of a comprehensive and accurate audit trail.
Sec. 37.1401 Requirements.
(a) A swap execution facility's program of risk analysis and
oversight with respect to its operations and automated systems shall
address each of the following categories of risk analysis and
oversight:
(1) Enterprise risk management and governance. This category
includes, but is not limited to: Assessment, mitigation, and monitoring
of security and technology risk; security and technology capital
planning and investment; board of directors and management oversight of
technology and security; information technology audit and controls
assessments; remediation of deficiencies; and any other elements of
enterprise risk management and governance included in generally
accepted best practices;
(2) Information security. This category includes, but is not
limited to, controls relating to: Access to systems and data (including
least privilege, separation of duties, account monitoring and control);
user and device identification and authentication; security awareness
training; audit log maintenance, monitoring, and analysis; media
protection; personnel security and screening; automated system and
communications protection (including network port control, boundary
defenses, encryption); system and information integrity (including
malware defenses, software integrity monitoring); vulnerability
management; penetration testing; security incident response and
management; and any other elements of information security included in
generally accepted best practices;
(3) Business continuity-disaster recovery planning and resources.
This category includes, but is not limited to: Regular, periodic
testing and review of business continuity-disaster recovery
capabilities, the controls and capabilities described in paragraphs
(c), (d), and (k) of this section; and any other elements of business
continuity-disaster recovery planning and resources included in
generally accepted best practices;
(4) Capacity and performance planning. This category includes, but
is not limited to: Controls for monitoring the swap execution
facility's systems to ensure adequate scalable capacity (including
testing, monitoring, and analysis of current and projected future
capacity and performance, and of possible capacity degradation due to
planned automated system changes); and any other elements of capacity
and performance planning included in generally accepted best practices;
(5) Systems operations. This category includes, but is not limited
to: System maintenance; configuration management (including baseline
[[Page 62104]]
configuration, configuration change and patch management, least
functionality, inventory of authorized and unauthorized devices and
software); event and problem response and management; and any other
elements of system operations included in generally accepted best
practices;
(6) Systems development and quality assurance. This category
includes, but is not limited to: Requirements development; pre-
production and regression testing; change management procedures and
approvals; outsourcing and vendor management; training in secure coding
practices; and any other elements of systems development and quality
assurance included in generally accepted best practices; and
(7) Physical security and environmental controls. This category
includes, but is not limited to: Physical access and monitoring; power,
telecommunication, and environmental controls; fire protection; and any
other elements of physical security and environmental controls included
in generally accepted best practices.
(b) In addressing the categories of risk analysis and oversight
required under paragraph (a) of this section, a swap execution facility
shall follow generally accepted standards and best practices with
respect to the development, operation, reliability, security, and
capacity of automated systems.
(c) A swap execution facility shall maintain a business continuity-
disaster recovery plan and business continuity-disaster recovery
resources, emergency procedures, and backup facilities sufficient to
enable timely recovery and resumption of its operations and resumption
of its ongoing fulfillment of its responsibilities and obligations as a
swap execution facility following any disruption of its operations.
Such responsibilities and obligations include, without limitation:
Order processing and trade matching; transmission of matched orders to
a derivatives clearing organization for clearing, where appropriate;
price reporting; market surveillance; and maintenance of a
comprehensive audit trail protected from alteration, accidental
erasure, or other loss. A swap execution facility's business
continuity-disaster recovery plan and resources generally should enable
resumption of trading and clearing of swaps executed on the swap
execution facility during the next business day following the
disruption. A swap execution facility shall update its business
continuity-disaster recovery plan and emergency procedures at a
frequency determined by an appropriate risk analysis, but at a minimum
no less frequently than annually.
(d) A swap execution facility satisfies the requirement to be able
to resume its operations and resume its ongoing fulfillment of its
responsibilities and obligations during the next business day following
any disruption of its operations by maintaining either:
(1) Infrastructure and personnel resources of its own that are
sufficient to ensure timely recovery and resumption of its operations
and resumption of its ongoing fulfillment of its responsibilities and
obligations as a swap execution facility following any disruption of
its operations; or
(2) Contractual arrangements with other swap execution facilities
or disaster recovery service providers, as appropriate, that are
sufficient to ensure continued trading and clearing of swaps executed
on the swap execution facility, and ongoing fulfillment of all of the
swap execution facility's responsibilities and obligations with respect
to such swaps, in the event that a disruption renders the swap
execution facility temporarily or permanently unable to satisfy this
requirement on its own behalf.
(e) A swap execution facility shall notify Commission staff
promptly of all:
(1) Electronic trading halts and material system malfunctions;
(2) Cyber security incidents or targeted threats that actually or
potentially jeopardize automated system operation, reliability,
security, or capacity; and
(3) Activations of the swap execution facility's business
continuity-disaster recovery plan.
(f) A swap execution facility shall provide Commission staff timely
advance notice of all material:
(1) Planned changes to automated systems that may impact the
reliability, security, or adequate scalable capacity of such systems;
and
(2) Planned changes to the swap execution facility's program of
risk analysis and oversight.
(g) A swap execution facility shall annually prepare and submit to
the Commission an up-to-date Exhibit Q to Form SEF--Program of Risk
Analysis and Oversight Technology Questionnaire--in appendix A to this
part. The annual filing shall be submitted electronically to the
Commission not later than 90 calendar days after the end of the swap
execution facility's fiscal year. The swap execution facility shall
file Exhibit Q with the annual financial report and the annual
compliance report pursuant to Sec. 37.1306(d) and Sec. 37.1501(e)(2),
respectively.
(h) As part of a swap execution facility's obligation to produce
books and records in accordance with Sec. 1.31 of this chapter, Core
Principle 10 (Recordkeeping and Reporting), and Sec. 37.1000 and Sec.
37.1001, a swap execution facility shall provide to the Commission the
following system safeguards-related books and records, promptly upon
the request of any Commission representative:
(1) Current copies of its business continuity-disaster recovery
plans and other emergency procedures;
(2) All assessments of its operational risks or system safeguards-
related controls;
(3) All reports concerning system safeguards testing and assessment
required by this chapter, whether performed by independent contractors
or by employees of the swap execution facility; and
(4) All other books and records requested by Commission staff in
connection with Commission oversight of system safeguards pursuant to
the Act or Commission regulations, or in connection with Commission
maintenance of a current profile of the swap execution facility's
automated systems.
(5) Nothing in this paragraph (h) shall be interpreted as reducing
or limiting in any way a swap execution facility's obligation to comply
with Sec. 1.31 of this chapter, Core Principle 10 (Recordkeeping and
Reporting), or Sec. 37.1000 or Sec. 37.1001.
(i) A swap execution facility shall conduct regular, periodic,
objective testing and review of its automated systems to ensure that
they are reliable, secure, and have adequate scalable capacity. It
shall also conduct regular, periodic testing and review of its business
continuity-disaster recovery capabilities. Such testing and review
shall include, without limitation, all of the types of testing set
forth in this paragraph (i).
(1) Definitions. As used in paragraph (i):
Controls means the safeguards or countermeasures employed by the
swap execution facility in order to protect the reliability, security,
or capacity of its automated systems or the confidentiality, integrity,
and availability of its data and information, and in order to enable
the swap execution facility to fulfill its statutory and regulatory
responsibilities.
Controls testing means assessment of the swap execution facility's
controls to determine whether such controls are implemented correctly,
are operating as intended, and are enabling the swap execution facility
to meet the requirements established by this section.
[[Page 62105]]
Enterprise technology risk assessment means a written assessment
that includes, but is not limited to, an analysis of threats and
vulnerabilities in the context of mitigating controls. An enterprise
technology risk assessment identifies, estimates, and prioritizes risks
to swap execution facility operations or assets, or to market
participants, individuals, or other entities, resulting from impairment
of the confidentiality, integrity, and availability of data and
information or the reliability, security, or capacity of automated
systems.
External penetration testing means attempts to penetrate the swap
execution facility's automated systems from outside the systems'
boundaries to identify and exploit vulnerabilities. Methods of
conducting external penetration testing include, but are not limited
to, methods for circumventing the security features of an automated
system.
Internal penetration testing means attempts to penetrate the swap
execution facility's automated systems from inside the systems'
boundaries, to identify and exploit vulnerabilities. Methods of
conducting internal penetration testing include, but are not limited
to, methods for circumventing the security features of an automated
system.
Key controls means those controls that an appropriate risk analysis
determines are either critically important for effective system
safeguards or intended to address risks that evolve or change more
frequently and therefore require more frequent review to ensure their
continuing effectiveness in addressing such risks.
Security incident means a cyber security or physical security event
that actually jeopardizes or has a significant likelihood of
jeopardizing automated system operation, reliability, security, or
capacity, or the availability, confidentiality or integrity of data.
Security incident response plan means a written plan documenting
the swap execution facility's policies, controls, procedures, and
resources for identifying, responding to, mitigating, and recovering
from security incidents, and the roles and responsibilities of its
management, staff and independent contractors in responding to security
incidents. A security incident response plan may be a separate document
or a business continuity-disaster recovery plan section or appendix
dedicated to security incident response.
Security incident response plan testing means testing of a swap
execution facility's security incident response plan to determine the
plan's effectiveness, identify its potential weaknesses or
deficiencies, enable regular plan updating and improvement, and
maintain organizational preparedness and resiliency with respect to
security incidents. Methods of conducting security incident response
plan testing may include, but are not limited to, checklist completion,
walk-through or table-top exercises, simulations, and comprehensive
exercises.
Vulnerability testing means testing of a swap execution facility's
automated systems to determine what information may be discoverable
through a reconnaissance analysis of those systems and what
vulnerabilities may be present on those systems.
(2) Vulnerability testing. A swap execution facility shall conduct
vulnerability testing of a scope sufficient to satisfy the requirements
set forth in paragraph (k) of this section.
(i) A swap execution facility shall conduct such vulnerability
testing at a frequency determined by an appropriate risk analysis.
(ii) Such vulnerability testing shall include automated
vulnerability scanning, which shall follow generally accepted best
practices.
(iii) A swap execution facility shall conduct vulnerability testing
by engaging independent contractors or by using employees of the swap
execution facility who are not responsible for development or operation
of the systems or capabilities being tested.
(3) External penetration testing. A swap execution facility shall
conduct external penetration testing of a scope sufficient to satisfy
the requirements set forth in paragraph (k) of this section.
(i) A swap execution facility shall conduct such external
penetration testing at a frequency determined by an appropriate risk
analysis.
(ii) A swap execution facility shall conduct external penetration
testing by engaging independent contractors or by using employees of
the swap execution facility who are not responsible for development or
operation of the systems or capabilities being tested.
(4) Internal penetration testing. A swap execution facility shall
conduct internal penetration testing of a scope sufficient to satisfy
the requirements set forth in paragraph (k) of this section.
(i) A swap execution facility shall conduct such internal
penetration testing at a frequency determined by an appropriate risk
analysis.
(ii) A swap execution facility shall conduct internal penetration
testing by engaging independent contractors or by using employees of
the swap execution facility who are not responsible for development or
operation of the systems or capabilities being tested.
(5) Controls testing. A swap execution facility shall conduct
controls testing of a scope sufficient to satisfy the requirements set
forth in paragraph (k) of this section.
(i) A swap execution facility shall conduct controls testing, which
includes testing of each control included in its program of risk
analysis and oversight, at a frequency determined by an appropriate
risk analysis. Such testing may be conducted on a rolling basis.
(ii) A swap execution facility shall conduct controls testing by
engaging independent contractors or by using employees of the swap
execution facility who are not responsible for development or operation
of the systems or capabilities being tested.
(6) Security incident response plan testing. A swap execution
facility shall conduct security incident response plan testing
sufficient to satisfy the requirements set forth in paragraph (k) of
this section.
(i) A swap execution facility shall conduct such security incident
response plan testing at a frequency determined by an appropriate risk
analysis.
(ii) A swap execution facility's security incident response plan
shall include, without limitation, the swap execution facility's
definition and classification of security incidents, its policies and
procedures for reporting security incidents and for internal and
external communication and information sharing regarding security
incidents, and the hand-off and escalation points in its security
incident response process.
(iii) A swap execution facility may coordinate its security
incident response plan testing with other testing required by this
section or with testing of its other business continuity-disaster
recovery and crisis management plans.
(iv) A swap execution facility may conduct security incident
response plan testing by engaging independent contractors or by using
employees of the swap execution facility.
(7) Enterprise technology risk assessment. A swap execution
facility shall conduct enterprise technology risk assessment of a scope
sufficient to satisfy the requirements set forth in paragraph (k) of
this section.
(i) A swap execution facility shall conduct enterprise technology
risk assessment at a frequency determined by an appropriate risk
analysis. A swap execution facility that has conducted an enterprise
technology risk assessment that complies with this section may
[[Page 62106]]
conduct subsequent assessments by updating the previous assessment.
(ii) A swap execution facility may conduct enterprise technology
risk assessments by using independent contractors or employees of the
swap execution facility who are not responsible for development or
operation of the systems or capabilities being assessed.
(j) To the extent practicable, a swap execution facility shall:
(1) Coordinate its business continuity-disaster recovery plan with
those of the market participants it depends upon to provide liquidity,
in a manner adequate to enable effective resumption of activity in its
markets following a disruption causing activation of the swap execution
facility's business continuity-disaster recovery plan;
(2) Initiate and coordinate periodic, synchronized testing of its
business continuity-disaster recovery plan with those of the market
participants it depends upon to provide liquidity; and
(3) Ensure that its business continuity-disaster recovery plan
takes into account the business continuity-disaster recovery plans of
its telecommunications, power, water, and other essential service
providers.
(k) Scope of testing and assessment. The scope for all system
safeguards testing and assessment required by this part shall be broad
enough to include the testing of automated systems and controls that
the swap execution facility's required program of risk analysis and
oversight and its current cybersecurity threat analysis indicate is
necessary to identify risks and vulnerabilities that could enable an
intruder or unauthorized user or insider to:
(1) Interfere with the swap execution facility's operations or with
fulfillment of its statutory and regulatory responsibilities;
(2) Impair or degrade the reliability, security, or adequate
scalable capacity of the swap execution facility's automated systems;
(3) Add to, delete, modify, exfiltrate, or compromise the integrity
of any data related to the swap execution facility's regulated
activities; or
(4) Undertake any other unauthorized action affecting the swap
execution facility's regulated activities or the hardware or software
used in connection with those activities.
(l) Internal reporting and review. Both the senior management and
the Board of Directors of a swap execution facility shall receive and
review reports setting forth the results of the testing and assessment
required by this section. A swap execution facility shall establish and
follow appropriate procedures for the remediation of issues identified
through such review, as provided in paragraph (m) of this section, and
for evaluation of the effectiveness of testing and assessment
protocols.
(m) Remediation. A swap execution facility shall identify and
document the vulnerabilities and deficiencies in its systems revealed
by the testing and assessment required by this section. The swap
execution facility shall conduct and document an appropriate analysis
of the risks presented by such vulnerabilities and deficiencies, to
determine and document whether to remediate or accept the associated
risk. When the swap execution facility determines to remediate a
vulnerability or deficiency, it must remediate in a timely manner given
the nature and magnitude of the associated risk.
Subpart P--Designation of Chief Compliance Officer
Sec. 37.1500 Core Principle 15--Designation of chief compliance
officer.
(a) In general. Each swap execution facility shall designate an
individual to serve as a chief compliance officer.
(b) Duties. The chief compliance officer shall:
(1) Report directly to the board or to the senior officer of the
facility;
(2) Review compliance with the core principles in this subsection;
(3) In consultation with the board of the facility, a body
performing a function similar to that of a board, or the senior officer
of the facility, resolve any conflicts of interest that may arise;
(4) Be responsible for establishing and administering the policies
and procedures required to be established pursuant to this section;
(5) Ensure compliance with the Act and the rules and regulations
issued under the Act, including rules prescribed by the Commission
pursuant to section 5h of the Act; and
(6) Establish procedures for the remediation of noncompliance
issues found during compliance office reviews, look backs, internal or
external audit findings, self-reported errors, or through validated
complaints.
(c) Requirements for procedures. In establishing procedures under
paragraph (b)(6) of this section, the chief compliance officer shall
design the procedures to establish the handling, management response,
remediation, retesting, and closing of noncompliance issues.
(d) Annual reports--(1) In general. In accordance with rules
prescribed by the Commission, the chief compliance officer shall
annually prepare and sign a report that contains a description of:
(i) The compliance of the swap execution facility with the Act; and
(ii) The policies and procedures, including the code of ethics and
conflict of interest policies, of the swap execution facility.
(2) Requirements. The chief compliance officer shall:
(i) Submit each report described in paragraph (d)(1) of this
section with the appropriate financial report of the swap execution
facility that is required to be submitted to the Commission pursuant to
section 5h of the Act; and
(ii) Include in the report a certification that, under penalty of
law, the report is accurate and complete.
Sec. 37.1501 Chief compliance officer.
(a) Definitions. For purposes of this part, the term--
Board of directors means the board of directors of a swap execution
facility, or for those swap execution facilities whose organizational
structure does not include a board of directors, a body performing a
function similar to a board of directors.
Senior officer means the chief executive officer or other
equivalent officer of the swap execution facility.
(b) Chief compliance officer--(1) Authority of chief compliance
officer. (i) The position of chief compliance officer shall carry with
it the authority and resources to develop, in consultation with the
board of directors or senior officer, the policies and procedures of
the swap execution facility and enforce such policies and procedures to
fulfill the duties set forth for chief compliance officers in the Act
and Commission regulations.
(ii) The chief compliance officer shall have supervisory authority
over all staff acting at the direction of the chief compliance officer.
(2) Qualifications of chief compliance officer. (i) The individual
designated to serve as chief compliance officer shall have the
background and skills appropriate for fulfilling the responsibilities
of the position.
(ii) No individual disqualified from registration pursuant to
sections 8a(2) or 8a(3) of the Act may serve as a chief compliance
officer.
(3) Appointment and removal of chief compliance officer. (i) Only
the board of directors or the senior officer may appoint or remove the
chief compliance officer.
(ii) The swap execution facility shall notify the Commission within
two business days of the appointment or removal, whether interim or
permanent, of a chief compliance officer.
(4) Compensation of the chief compliance officer. The board of
[[Page 62107]]
directors or the senior officer shall approve the compensation of the
chief compliance officer.
(5) Annual meeting with the chief compliance officer. The chief
compliance officer shall meet with the board of directors or senior
officer of the swap execution facility at least annually.
(6) Information requested of the chief compliance officer. The
chief compliance officer shall provide any information regarding the
self-regulatory program of the swap execution facility as requested by
the board of directors or the senior officer.
(c) Duties of chief compliance officer. The duties of the chief
compliance officer shall include, but are not limited to, the
following:
(1) Overseeing and reviewing compliance of the swap execution
facility with section 5h of the Act and any related rules adopted by
the Commission;
(2) Taking reasonable steps, in consultation with the board of
directors or the senior officer of the swap execution facility, to
resolve any material conflicts of interest that may arise;
(3) Establishing and administering written policies and procedures
reasonably designed to prevent violations of the Act and the rules of
the Commission;
(4) Taking reasonable steps to ensure compliance with the Act and
the rules of the Commission;
(5) Establishing procedures reasonably designed to handle, respond,
remediate, retest, and resolve noncompliance issues identified by the
chief compliance officer through any means, including any compliance
office review, look-back, internal or external audit finding, self-
reported error, or validated complaint;
(6) Establishing and administering a compliance manual designed to
promote compliance with the applicable laws, rules, and regulations and
a written code of ethics for the swap execution facility designed to
prevent ethical violations and to promote honesty and ethical conduct
by personnel of the swap execution facility;
(7) Supervising the self-regulatory program of the swap execution
facility with respect to trade practice surveillance; market
surveillance; real-time market monitoring; compliance with audit trail
requirements; enforcement and disciplinary proceedings; audits,
examinations, and other regulatory responsibilities (including taking
reasonable steps to ensure compliance with, if applicable, financial
integrity, financial reporting, sales practice, recordkeeping, and
other requirements); and
(8) Supervising the effectiveness and sufficiency of any regulatory
services provided to the swap execution facility by a regulatory
service provider in accordance with Sec. 37.204.
(d) Preparation of annual compliance report. The chief compliance
officer shall, not less than annually, prepare and sign an annual
compliance report that covers the prior fiscal year. The report shall,
at a minimum, contain:
(1) A description and self-assessment of the effectiveness of the
written policies and procedures of the swap execution facility,
including the code of ethics and conflict of interest policies to
reasonably ensure compliance with the Act and applicable Commission
regulations;
(2) Any material changes made to compliance policies and procedures
during the coverage period for the report and any areas of improvement
or recommended changes to the compliance program;
(3) A description of the financial, managerial, and operational
resources set aside for compliance with the Act and applicable
Commission regulations;
(4) Any material non-compliance matters identified and an
explanation of the corresponding action taken to resolve such non-
compliance matters; and
(5) A certification by the chief compliance officer that, to the
best of his or her knowledge and reasonable belief, and under penalty
of law, the annual compliance report is accurate and complete in all
material respects.
(e) Submission of annual compliance report and related matters--(1)
Furnishing the annual compliance report prior to submission to the
Commission. Prior to submission to the Commission, the chief compliance
officer shall provide the annual compliance report for review to the
board of directors of the swap execution facility or, in the absence of
a board of directors, to the senior officer of the swap execution
facility. Members of the board of directors and the senior officer
shall not require the chief compliance officer to make any changes to
the report.
(2) Submission of annual compliance report to the Commission. The
annual compliance report shall be submitted electronically to the
Commission not later than 90 calendar days after the end of the swap
execution facility's fiscal year. The swap execution facility shall
concurrently file the annual compliance report with the fourth quarter
financial report pursuant to Sec. 37.1306.
(3) Amendments to annual compliance report. (i) Promptly upon
discovery of any material error or omission made in a previously filed
annual compliance report, the chief compliance officer shall file an
amendment with the Commission to correct the material error or
omission. The chief compliance officer shall submit the amended annual
compliance report to the board of directors, or in the absence of a
board of directors, to the senior officer of the swap execution
facility, pursuant to paragraph (e)(1) of this section.
(ii) An amendment shall contain the certification required under
paragraph (d)(5) of this section.
(4) Request for extension. A swap execution facility may request an
extension of time to file its annual compliance report from the
Commission. Reasonable and valid requests for extensions of the filing
deadline may be granted at the discretion of the Commission.
(f) Recordkeeping. The swap execution facility shall maintain all
records demonstrating compliance with the duties of the chief
compliance officer and the preparation and submission of annual
compliance reports consistent with Sec. Sec. 37.1000 and 37.1001.
(g) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, the authority to grant or deny a request
for an extension of time for a swap execution facility to file its
annual compliance report under paragraph (e)(4) of this section. The
Director may submit to the Commission for its consideration any matter
that has been delegated in this paragraph. Nothing in this paragraph
prohibits the Commission, at its election, from exercising the
authority delegated in this paragraph.
Appendix A to Part 37--Form SEF
BILLING CODE 6351-01-P
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Appendix B to Part 37--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
1. This appendix provides guidance on complying with core
principles, both initially and on an ongoing basis, to maintain
registration under section 5h of the Act and this part. Where
provided, guidance is set forth in paragraph (a) following the
relevant heading and can be used to demonstrate to the Commission
compliance with the selected requirements of a core principle of
this part. The guidance for the core principle is illustrative only
of the types of matters a swap execution facility may address, as
applicable, and is not intended to be used as a mandatory checklist.
Addressing the issues set forth in this appendix would help the
Commission in its consideration of whether the swap execution
facility is in compliance with the selected requirements of a core
principle; provided however, that the guidance is not intended to
diminish or replace, in any event, the obligations and requirements
of applicants and swap execution facilities to comply with the
regulations provided under this part.
2. Where provided, acceptable practices meeting selected
requirements of core principles are set forth in paragraph (b)
following the guidance. Swap execution facilities that follow
specific practices outlined in the acceptable practices for a core
principle in this appendix will meet the selected requirements of
the applicable core principle; provided however, that the acceptable
practice is not intended to diminish or replace, in any event, the
obligations and requirements of applicants and swap execution
facilities to comply with the regulations provided under this part.
The acceptable practices are for illustrative purposes only and do
not state the exclusive means for satisfying a core principle.
Core Principle 1 of Section 5h of the Act--Compliance With Core
Principles
(A) In general. To be registered, and maintain registration, as
a swap execution facility, the swap execution facility shall comply
with--the core principles described in section 5h of the Act; and
any requirement that the Commission may impose by rule or regulation
pursuant to section 8a(5) of the Act.
(B) Reasonable discretion of swap execution facility. Unless
otherwise determined by the Commission by rule or regulation, a swap
execution facility described in paragraph (A) shall have reasonable
discretion in establishing the manner in which the swap execution
facility complies with the core principles described in section 5h
of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 2 of Section 5h of the Act--Compliance With Rules
A swap execution facility shall:
(A) Establish and enforce compliance with any rule of the swap
execution facility, including the terms and conditions of the swaps
traded or processed on or through the swap execution facility and
any limitation on access to the swap execution facility;
(B) Establish and enforce trading, trade processing, and
participation rules that will deter abuses and have the capacity to
detect, investigate, and enforce those rules, including means to
provide market participants with impartial access to the market and
to capture information that may be used in establishing whether rule
violations have occurred;
(C) Establish rules governing the operation of the facility,
including rules specifying trading procedures to be used in entering
and executing orders traded or posted on the facility, including
block trades; and
(D) Provide by its rules that when a swap dealer or major swap
participant enters into or facilitates a swap that is subject to the
mandatory clearing requirement of section 2(h) of the Act, the swap
dealer or major swap participant shall be responsible for compliance
with the mandatory trading requirement under section 2(h)(8) of the
Act.
(a) Guidance. (1) Ethics training. (i) Section 37.201(c)(4)
requires a swap execution facility to ensure that its SEF trading
specialists receive ethics training on a periodic basis. Such
training should help SEF trading specialists be aware, and remain
abreast, of, their continuing obligations with respect to the rules,
policies, and procedures of the swap execution facility, as well as
the applicable provisions of the Act and Commission regulations
thereunder.
(ii) Ethics training for SEF trading specialists should account
for the level and nature of SEF trading specialists'
responsibilities within a swap execution facility. The training
should address topics such as an explanation of applicable laws and
regulations and the rules, policies, and procedures of the swap
execution facility; how to act honestly and fairly and with due
skill, care, and diligence in furtherance of the interests of market
participants and the integrity of the market; protection of
confidential information; and avoidance, proper disclosure, and
handling of conflicts of interest. Such ethics training should also
seek to ensure that SEF trading specialists remain current with
regard to the ethical ramifications of new developments with respect
to evolving technology, trading practices, products, and other
relevant changes.
(iii) A swap execution facility, at its discretion, may develop
and implement its own ethics training program or utilize a program
offered by a third-party provider, or may implement some combination
thereof. Third-party providers may include independent persons,
firms, or industry associations. No specific format or class
training is required, as the needs of a swap execution facility may
vary according to its size and number of personnel that are SEF
trading specialists. A swap execution facility may utilize
electronic media, such as video presentations, internet-based
transmissions, and interactive software programs as part of its
ethics training program. A swap execution facility should ascertain
the credentials of any provider of ethics training or training
materials and should ensure that such persons have the appropriate
level of industry experience and knowledge, including with respect
to the swap execution facility's rules, policies, procedures, and
operations.
(iv) A swap execution facility may determine the frequency and
duration of ethics training but such frequency and duration should
promote a corporate culture of high ethical and professional conduct
and a continuous awareness of industry standards and practices.
(2) Investigations--Timeliness. A swap execution facility has
reasonable discretion to determine the timely manner in which to
complete investigations under Sec. 37.203(f)(2).
(3) Investigations--Investigation reports. A swap execution
facility's compliance staff should submit all investigation reports
to the Chief Compliance Officer or other compliance department staff
responsible for reviewing such reports and determining the next
steps in the process. The Chief Compliance Officer or other
responsible staff should have reasonable discretion to decide
whether to take any action, such as presenting the investigation
report to a disciplinary panel for disciplinary action.
(4) Audit trail required. A swap execution facility's audit
trail data should be sufficient to reconstruct all indications of
interest, requests for quotes, orders, and trades within a
reasonable period of time and to provide evidence of any violations
of the rules of the swap execution facility.
(5) Audit trail reconstruction. An effective audit trail
reconstruction program should annually review an adequate sample of
executed and unexecuted orders and trades from each execution method
offered by the swap execution facility to verify the swap execution
facility's ability to comprehensively and accurately reconstruct
trading in a timely manner. A swap execution facility should have
reasonable discretion to determine the meaning of adequate sample as
used in this paragraph.
(6) Enforcement staff. A swap execution facility's enforcement
staff should not include either members of the swap execution
facility or persons whose interests conflict with their enforcement
duties. A member of the enforcement staff should not operate under
the direction or control of any person or persons with trading
privileges at the swap execution facility.
(7) Disciplinary panel procedures. The rules of a swap execution
facility governing the requirements that apply to the adjudication
of a matter by a swap execution facility disciplinary panel should
be fair, equitable, and publicly available. Such rules should
require the disciplinary panel to promptly issue a written decision
following a hearing or the acceptance of a settlement offer.
(8) Emergency disciplinary actions. A swap execution facility
may impose a sanction, including suspension, or take other summary
action against a person or entity subject to its jurisdiction upon a
reasonable belief that such immediate action is necessary to protect
the best interest of the marketplace.
(9) Warning letters and sanctions. A swap execution facility
should have reasonable discretion to determine when to issue warning
letters and apply sanctions under Sec. 37.206(c)(1).
(b) Acceptable Practices. [Reserved]
[[Page 62133]]
Core Principle 3 of Section 5h of the Act--Swaps Not Readily
Susceptible to Manipulation
The swap execution facility shall permit trading only in swaps
that are not readily susceptible to manipulation.
(a) Guidance. Guidance in appendix C to this part--
``Demonstration of Compliance that a Swap Contract is Not Readily
Susceptible to Manipulation''--may be used as guidance in meeting
this core principle for both new product listings and existing
listed contracts.
(b) Acceptable Practices. [Reserved]
Core Principle 4 of Section 5h of the Act--Monitoring of Trading and
Trade Processing
The swap execution facility shall:
(A) Establish and enforce rules or terms and conditions
defining, or specifications detailing:
(1) Trading procedures to be used in entering and executing
orders traded on or through the facilities of the swap execution
facility; and
(2) Procedures for trade processing of swaps on or through the
facilities of the swap execution facility; and
(B) Monitor trading in swaps to prevent manipulation, price
distortion, and disruptions of the delivery or cash settlement
process through surveillance, compliance, and disciplinary practices
and procedures, including methods for conducting real-time
monitoring of trading and comprehensive and accurate trade
reconstructions.
(a) Guidance. The swap execution facility should have rules in
place that allow it to intervene to prevent and reduce disorderly
trading and disruptions. Once threatened or actual disorderly
trading or disruption is detected, the swap execution facility
should take steps to prevent the disorderly trading or disruption,
or reduce its severity.
(1) General requirements. Real-time monitoring for disorderly
trading and market or system anomalies is the most effective, but
the swap execution facility's program may also be acceptable if some
of the monitoring is accomplished on a T+1 basis. The monitoring of
trading should use automated alerts to detect disorderly trading and
any market or system anomalies, including abnormal price movements
and unusual trading volumes in real-time and instances or threats of
manipulation, price distortion, and disruptions on at least a T+1
basis. The T+1 detection and analysis should incorporate any
additional data that becomes available on a T+1 basis, including the
trade reconstruction data. In some cases, a swap execution facility
may demonstrate that its manual processes are effective. The swap
execution facility should act promptly to address the conditions
that are causing price distortions or disruptions, including, when
appropriate, changes to contract terms.
(2) Physical-delivery swaps. For a physical-delivery swap listed
on the swap execution facility, the swap execution facility should
monitor for conditions that may cause the swap to become susceptible
to manipulation, price distortion, or market disruptions, including:
Conditions influencing the convergence between the swap's price and
the price of the underlying commodity such as the general
availability of the commodity specified by the swap, the commodity's
characteristics, and the delivery locations; and if available,
information related to the size and ownership of deliverable
supplies. Price convergence refers to the process whereby the price
of a physically-delivered swap converges to the spot price of the
underlying commodity, as the swap nears expiration. The hedging
effectiveness of a physically-delivered swap depends in part upon
the extent to which the swap price reliably converges to the
comparable cash market price, or to a predictable differential to
the comparable cash market price.
(3) Ability to obtain information. The swap execution facility
should be able to obtain position and trading information directly
from the market participants that conduct trading on its facility.
(4) Risk controls for trading. In developing and implementing an
acceptable program for preventing and reducing the potential risk of
price distortions and market disruptions, a swap execution facility
should establish and maintain appropriate trading risk controls, in
addition to pauses and halts. Risk controls should be adapted to the
unique characteristics of the swap execution facility's trading
system or platform and the swap contracts listed for trading and
should be designed to avoid price distortions and market disruptions
without unduly interfering with that market's price discovery
function. The swap execution facility may choose from among controls
that include: Pre-trade limits on order size, price collars or bands
around the current price, message throttles, and daily price limits,
or design other types of controls, as well as clear order-
cancellation policies. Within the specific array of controls that
are selected, the swap execution facility should set the parameters
for those controls, so that the specific parameters are reasonably
likely to serve the purpose of preventing price distortions and
market disruptions. If a swap is fungible with, linked to, or a
substitute for other swaps on the swap execution facility or
contracts on other trading venues, such risk controls should, to the
extent practicable, be coordinated with any similar controls placed
on those other swaps or contracts. If a swap is based on the level
of an equity index, such risk controls should, to the extent
practicable, be coordinated with any similar controls placed on
national security exchanges.
(b) Acceptable Practices. [Reserved]
Core Principle 5 of Section 5h of the Act--Ability To Obtain
Information
The swap execution facility shall:
(A) Establish and enforce rules that will allow the facility to
obtain any necessary information to perform any of the functions
described in section 5h of the Act;
(B) Provide the information to the Commission on request; and
(C) Have the capacity to carry out such international
information-sharing agreements as the Commission may require.
(a) Guidance. If position and trading information is available
through information-sharing agreements with other trading venues or
a third-party regulatory service provider, the swap execution
facility should cooperate, to the extent practicable, in such
information-sharing agreements.
(b) Acceptable Practices. [Reserved]
Core Principle 6 of Section 5h of the Act--Position Limits or
Accountability
(A) In general. To reduce the potential threat of market
manipulation or congestion, especially during trading in the
delivery month, a swap execution facility that is a trading facility
shall adopt for each of the contracts of the facility, as is
necessary and appropriate, position limitations or position
accountability for speculators.
(B) Position limits. For any contract that is subject to a
position limitation established by the Commission pursuant to
section 4a(a) of the Act, the swap execution facility shall:
(1) Set its position limitation at a level no higher than the
Commission limitation; and
(2) Monitor positions established on or through the swap
execution facility for compliance with the limit set by the
Commission and the limit, if any, set by the swap execution
facility.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 7 of Section 5h of the Act--Financial Integrity of
Transactions
The swap execution facility shall establish and enforce rules
and procedures for ensuring the financial integrity of swaps entered
on or through the facilities of the swap execution facility,
including the clearance and settlement of the swaps pursuant to
section 2(h)(1) of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 8 of Section 5h of the Act--Emergency Authority
The swap execution facility shall adopt rules to provide for the
exercise of emergency authority, in consultation or cooperation with
the Commission, as is necessary and appropriate, including the
authority to liquidate or transfer open positions in any swap or to
suspend or curtail trading in a swap.
(a) Guidance.
(1) A swap execution facility should have rules that authorize
it to take certain actions in the event of an emergency, as defined
in Sec. 40.1(h) of this chapter. A swap execution facility should
have the authority to intervene as necessary to maintain markets
with fair and orderly trading and to prevent or address manipulation
or disruptive trading practices, whether the need for intervention
arises exclusively from the swap execution facility's market or as
part of a coordinated, cross-market intervention. A swap execution
facility should have the flexibility and independence to address
market emergencies in an effective and timely manner consistent with
the nature of the emergency, as long as all such actions taken by
the swap execution facility are made in good faith to protect the
integrity of the markets. However, the swap execution facility
should also have rules that allow it to take market actions as may
be directed by the Commission, including actions that the Commission
requires the swap execution facility to take as part of a
coordinated, cross-market intervention.
[[Page 62134]]
Additionally, in situations where a swap is traded on more than one
platform, emergency action should be taken as directed or agreed to
by the Commission or the Commission's staff. A swap execution
facility's rules should include procedures and guidelines for
decision-making and implementation of emergency intervention that
avoid conflicts of interest and include alternate lines of
communication and approval procedures to address emergencies
associated with real time events. To address perceived market
threats, the swap execution facility should have rules that allow it
to take emergency actions, including imposing or modifying position
limits, imposing or modifying price limits, imposing or modifying
intraday market restrictions, ordering the fixing of a settlement
price, extending or shortening the expiration date or the trading
hours, suspending or curtailing trading in any contract, or altering
any contract's settlement terms or conditions, or, if applicable,
providing for the carrying out of such actions through its
agreements with its third-party provider of clearing or regulatory
services.
(2) A swap execution facility should promptly notify the
Commission of its exercise of emergency action, explaining its
decision-making process, the reasons for using its emergency
authority, and how conflicts of interest were minimized, including
the extent to which the swap execution facility considered the
effect of its emergency action on the underlying markets and on
markets that are linked or referenced to the contracts traded on its
facility, including similar markets on other trading venues.
Information on all regulatory actions carried out pursuant to a swap
execution facility's emergency authority should be included in a
timely submission of a certified rule pursuant to part 40 of this
chapter.
(b) Acceptable Practices. [Reserved]
Core Principle 9 of Section 5h of the Act--Timely Publication of
Trading Information
(A) In general. The swap execution facility shall make public
timely information on price, trading volume, and other trading data
on swaps to the extent prescribed by the Commission.
(B) Capacity of swap execution facility. The swap execution
facility shall be required to have the capacity to electronically
capture and transmit trade information with respect to transactions
executed on the facility.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 10 of Section 5h of the Act--Recordkeeping and Reporting
(A) In general. A swap execution facility shall:
(1) Maintain records of all activities relating to the business
of the facility, including a complete audit trail, in a form and
manner acceptable to the Commission for a period of five years;
(2) Report to the Commission, in a form and manner acceptable to
the Commission, such information as the Commission determines to be
necessary or appropriate for the Commission to perform the duties of
the Commission under the Act; and
(3) Keep any such records relating to swaps defined in section
1a(47)(A)(v) of the Act open to inspection and examination by the
Securities and Exchange Commission.
(B) Requirements. The Commission shall adopt data collection and
reporting requirements for swap execution facilities that are
comparable to corresponding requirements for derivatives clearing
organizations and swap data repositories.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 11 of Section 5h of the Act--Antitrust Considerations
Unless necessary or appropriate to achieve the purposes of the
Act, the swap execution facility shall not:
(A) Adopt any rules or take any actions that result in any
unreasonable restraint of trade; or
(B) Impose any material anticompetitive burden on trading or
clearing.
(a) Guidance. An entity seeking registration as a swap execution
facility may request that the Commission consider under the
provisions of section 15(b) of the Act, any of the entity's rules,
including trading protocols or policies, and including both
operational rules and the terms or conditions of products listed for
trading, at the time of registration or thereafter. The Commission
intends to apply section 15(b) of the Act to its consideration of
issues under this core principle in a manner consistent with that
previously applied to contract markets.
(b) Acceptable Practices. [Reserved]
Core Principle 12 of Section 5h of the Act--Conflicts of Interest
The swap execution facility shall:
(A) Establish and enforce rules to minimize conflicts of
interest in its decision-making process; and
(B) Establish a process for resolving the conflicts of interest.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 13 of Section 5h of the Act--Financial Resources
(A) In general. The swap execution facility shall have adequate
financial, operational, and managerial resources to discharge each
responsibility of the swap execution facility.
(B) Determination of resource adequacy. The financial resources
of a swap execution facility shall be considered to be adequate if
the value of the financial resources exceeds the total amount that
would enable the swap execution facility to cover the operating
costs of the swap execution facility for a one-year period, as
calculated on a rolling basis.
(a) Guidance. [Reserved]
(b) Acceptable Practices.
(1) Reasonable calculation of projected operating costs. In
connection with a swap execution facility calculating its projected
operating costs, the Commission has determined that a reasonable
calculation should include all expenses necessary for the swap
execution facility to comply with the core principles set forth in
section 5h of the Act and any applicable Commission regulations.
This calculation should be based on the swap execution facility's
current level of business and business model, and should take into
account any projected modification to its business model (e.g., the
addition or subtraction of business lines or operations or other
changes), and any projected increase or decrease in its level of
business over the next 12 months. The Commission believes, however,
that it may be reasonable for a swap execution facility to exclude
the following expenses (``excludable expenses'') from its projected
operating cost calculations:
(i) Costs attributable solely to sales, marketing, business
development, product development, or recruitment and any related
travel, entertainment, event, or conference costs;
(ii) Compensation and related taxes and benefits for swap
execution facility personnel who are not necessary to ensure that
the swap execution facility is able to comply with the core
principles set forth in section 5h of the Act and any applicable
Commission regulations;
(iii) If a swap execution facility offers two or more bona fide
execution methods (e.g., it offers both an electronic central limit
order book and voice execution via voice brokers), the swap
execution facility may include the costs related to at least one of
the execution methods that it offers, and may exclude the costs
related to the other execution method(s) that it offers (i.e., if a
swap execution facility includes in its projected operating costs
the costs associated with its central limit order book, it may
exclude the costs related to its voice execution service, or vice-
versa). A bona fide method here refers to a method actually used by
the SEF's market participants and not established by a SEF on a pro
forma basis for the purpose of complying with--or evading--Core
Principle 13.
(iv) Costs for acquiring and defending patents and trademarks
for swap execution facility products and related intellectual
property;
(v) Magazine, newspaper, and online periodical subscription
fees;
(vi) Tax preparation and audit fees;
(vii) To the extent not covered by paragraphs (b)(1)(ii) or
(iii) above, the variable commissions that a voice-based swap
execution facility may pay to its SEF trading specialists (as
defined under Sec. 37.201(c)), calculated as a percentage of
transaction revenue generated by the voice-based swap execution
facility. Unlike fixed salaries or compensation, such variable
commissions are not payable unless and until revenue is collected by
the swap execution facility; and
(viii) Any non-cash costs, including depreciation and
amortization.
(2) Pro-rated expenses. The Commission recognizes that, in the
normal course of a swap execution facility's business, there may be
an expense (e.g., typically related to overhead) that is only
partially attributable to a swap execution facility's ability to
comply with the core principles set forth in section 5h of the Act
and any applicable Commission regulations; accordingly, such expense
may need to be only partially attributed to the swap execution
facility's projected operating costs. For example, if a swap
execution facility's office rental space includes marketing
personnel and compliance personnel, the swap execution facility may
exclude the pro-rated office rental expense
[[Page 62135]]
attributable to the marketing personnel. In order to pro-rate an
expense, a swap execution facility should:
(i) Maintain sufficient documentation that reasonably shows the
extent to which an expense is partially attributable to an
excludable expense;
(ii) Identify any pro-rated expense in the financial reports
that it submits to the Commission pursuant to Sec. 37.1306; and
(iii) Sufficiently explain why it pro-rated any expense. Common
allocation methodologies that can be used include actual use,
headcount, or square footage. A swap execution facility may provide
documentation, such as copies of service agreements, other legal
documents, firm policies, audit statements, or allocation
methodologies to support its determination to pro-rate an expense.
(3) Expenses allocated among affiliates. The Commission
recognizes that a swap execution facility may share certain expenses
with affiliated entities, such as parent entities or other
subsidiaries of the parent. For example, a swap execution facility
may share employees (including employees on secondment from an
affiliate) that perform similar tasks for the affiliated entities or
may share office space with its affiliated entities. Accordingly,
the Commission believes that it would be reasonable, for purposes of
calculating its projected operating costs, for a swap execution
facility to pro-rate any shared expense that the swap execution
facility pays for, but only to the extent that such shared expense
is actually attributable to the affiliate and for which the swap
execution facility is reimbursed. Similarly, a reasonable
calculation of a swap execution facility's projected operating costs
must include the pro-rated amount of any expense paid for by an
affiliated entity to the extent that the shared expense is
attributable to the swap execution facility. In order to pro-rate a
shared expense, the swap execution facility should:
(i) Maintain sufficient documentation that reasonably shows the
extent to which the shared expense is attributable to and paid for
by the swap execution facility and/or affiliated entity;
(ii) Identify any shared expense in the financial reports that
it submits to the Commission; and
(iii) Sufficiently explain why it pro-rated any shared expense.
A swap execution facility may provide documentation, such as copies
of service agreements, other legal documents, firm policies, audit
statements, or allocation methodologies, that reasonably shows how
expenses are attributable to, and paid for by, the swap execution
facility and/or its affiliated entities to support its determination
to pro-rate an expense.
Core Principle 14 of Section 5h of the Act--System Safeguards
The swap execution facility shall:
(A) Establish and maintain a program of risk analysis and
oversight to identify and minimize sources of operational risk,
through the development of appropriate controls and procedures, and
automated systems, that:
(1) Are reliable and secure; and
(2) Have adequate scalable capacity;
(B) Establish and maintain emergency procedures, backup
facilities, and a plan for disaster recovery that allow for:
(1) The timely recovery and resumption of operations; and
(2) The fulfillment of the responsibilities and obligations of
the swap execution facility; and
(C) Periodically conduct tests to verify that the backup
resources of the swap execution facility are sufficient to ensure
continued:
(1) Order processing and trade matching;
(2) Price reporting;
(3) Market surveillance; and
(4) Maintenance of a comprehensive and accurate audit trail.
(a) Guidance.
(1) Risk analysis and oversight program. In addressing the
categories of its risk analysis and oversight program, a swap
execution facility should follow generally accepted standards and
best practices with respect to the development, operation,
reliability, security, and capacity of automated systems.
(2) Testing. A swap execution facility's testing of its
automated systems and business continuity-disaster recovery
capabilities should be conducted by qualified, independent
professionals. Such qualified independent professionals may be
independent contractors or employees of the swap execution facility,
but should not be persons responsible for development or operation
of the systems or capabilities being tested.
(3) Coordination. To the extent practicable, a swap execution
facility should:
(i) Coordinate its business continuity-disaster recovery plan
with those of the market participants it depends upon to provide
liquidity, in a manner adequate to enable effective resumption of
activity in its markets following a disruption causing activation of
the swap execution facility's business continuity-disaster recovery
plan;
(ii) Initiate and coordinate periodic, synchronized testing of
its business continuity-disaster recovery plan with those of the
market participants it depends upon to provide liquidity; and
(iii) Ensure that its business continuity-disaster recovery plan
takes into account such plans of its telecommunications, power,
water, and other essential service providers.
(b) Acceptable Practices. [Reserved]
Core Principle 15 of Section 5h of the Act--Designation of Chief
Compliance Officer
(A) In general. Each swap execution facility shall designate an
individual to serve as a chief compliance officer.
(B) Duties. The chief compliance officer shall:
(1) Report directly to the board or to the senior officer of the
facility;
(2) Review compliance with the core principles in this
subsection;
(3) In consultation with the board of the facility, a body
performing a function similar to that of a board, or the senior
officer of the facility, resolve any conflicts of interest that may
arise;
(4) Be responsible for establishing and administering the
policies and procedures required to be established pursuant to this
section;
(5) Ensure compliance with the Act and the rules and regulations
issued under the Act, including rules prescribed by the Commission
pursuant to section 5h of the Act; and
(6) Establish procedures for the remediation of noncompliance
issues found during compliance office reviews, look backs, internal
or external audit findings, self-reported errors, or through
validated complaints.
(C) Requirements for procedures. In establishing procedures
under paragraph (B)(6) of this section, the chief compliance officer
shall design the procedures to establish the handling, management
response, remediation, retesting, and closing of noncompliance
issues.
(D) Annual reports.
(1) In general. In accordance with rules prescribed by the
Commission, the chief compliance officer shall annually prepare and
sign a report that contains a description of:
(i) The compliance of the swap execution facility with the Act;
and
(ii) The policies and procedures, including the code of ethics
and conflict of interest policies, of the swap execution facility.
(2) Requirements. The chief compliance officer shall:
(i) Submit each report described in clause (1) with the
appropriate financial report of the swap execution facility that is
required to be submitted to the Commission pursuant to section 5h of
the Act; and
(ii) Include in the report a certification that, under penalty
of law, the report is accurate and complete.
(a) Guidance. [Reserved]
(b) Acceptable Practices.
(1) Qualifications of chief compliance officer. In determining
whether the background and skills of a potential chief compliance
officer are appropriate for fulfilling the responsibilities of the
role of the chief compliance officer, the swap execution facility
has the discretion to base its determination on the totality of the
qualifications of the potential chief compliance officer, including,
but not limited to, compliance experience, related career
experience, training, and any other relevant factors to the
position. A swap execution facility should be especially vigilant
regarding potential conflicts of interest when appointing a chief
compliance officer.
Appendix C to Part 37--Demonstration of Compliance That a Swap Contract
Is Not Readily Susceptible to Manipulation
The swap execution facility shall permit trading only in swaps
that are not readily susceptible to manipulation.
(a) Guidance for cash-settled swaps.
(1) General provision. In general, a cash-settled swap contract
is an agreement to exchange a series of cash flows over a period of
time based on some reference price, which could be a single price,
such as an absolute level or a differential, or a price index
calculated based on multiple observations. Such a reference price
may be reported by the swap execution facility itself or by an
independent third party. When listing a swap
[[Page 62136]]
contract for trading, a swap execution facility shall ensure the
swap contract's compliance with Core Principle 3, focusing on the
reference price used to determine the exchanges of cash flows. A
swap execution facility should either (i) calculate its own
reference price, using suitable and well-established acceptable
methods; or (ii) carefully select a reliable third-party index.
(2) Reference price susceptibility to manipulation. A swap
execution facility must specify the reference price used for its
swap contract and determine that the reference price is not readily
susceptible to manipulation pursuant to SEF Core Principle 3.
Accordingly, any reference price that is used in establishing the
swap contract's cash settlement price should be assessed for its
reliability as an indicator of cash market values in the underlying
commercial market. Documentation demonstrating that the reference
price is a reliable indicator of market values and conditions and is
widely recognized by industry/market agents should be provided. Such
documentation may be in various forms, including carefully
documented interviews with principal market trading agents, pricing
experts, marketing agents, etc. Additionally, careful consideration
should be given to the potential for manipulation or distortion,
when using the reference price to establish the swap's cash
settlement price. The cash-settlement calculation should involve
appropriate computational procedures that eliminate or reduce the
impact of potentially unrepresentative data (i.e., outliers).
(i) Where a swap execution facility itself generates the
reference price, the swap execution facility should establish
calculation procedures that safeguard against potential attempts to
artificially influence the price. For example, if the reference
price is derived by the swap execution facility based on a survey of
cash market sources, then the swap execution facility should
maintain a list of such reputable sources with knowledge of the cash
market. In addition, the sample of sources polled should be
representative of the cash market, and the poll should be conducted
at a time when trading in the cash market is active and include the
most liquid markets.
(ii) Where an independent, private-sector third party calculates
the reference price, the swap execution facility should verify that
the third party utilizes business practices that minimize the
opportunity or incentive to manipulate the cash-settlement price
series. Such safeguards may include lock-downs, prohibitions against
derivatives trading by its employees, or public dissemination of the
names of sources and the price quotes they provide. Because a cash-
settled swap contract may create an incentive to manipulate or
artificially influence the underlying commercial market from which
the cash-settlement price is derived or to exert undue influence on
the cash-settlement computation in order to profit on a derivative
position in that commodity, a swap execution facility should,
whenever practicable, enter into an information-sharing agreement
with the third-party provider which would enable the swap execution
facility to better detect and prevent manipulative behavior. A swap
execution facility should also consider the need for a licensing
agreement that will ensure the swap execution facility's rights to
the use of the price series to settle the listed contract.
(3) Contract terms and conditions. An acceptable specification
of the terms and conditions of a cash-settled swap contract would
include, but may not be limited to, rules that address, as
appropriate, the following criteria and comply with the associated
standards:
(i) Commodity characteristics. The terms and conditions of a
cash-settled swap contract should describe or define all of the
economically significant characteristics or attributes of the
commodity underlying the contract.
(ii) Contract size and trading unit. For standardized swap
contracts, the contract size or size range should be clearly defined
and consistent with customary transactions in the cash market. A
swap execution facility may opt to set the swap contract size
smaller than that of standard cash market transactions. For non-
standardized swap contracts, a swap execution facility may allow the
contract size or size range to be negotiable.
(iii) Cash settlement procedure. A cash settlement price should
be an accurate and reliable indicator of prices in the underlying
cash market. A cash settlement price also should be acceptable to
commercial users of the cash-settled swap contract. A swap execution
facility should fully document that a settlement price is accurate,
reliable, widely regarded by industry/market participants. To the
extent possible, the cash settlement price series of the swap should
be based on reference prices that are publicly available on a timely
basis. A swap execution facility should make the cash settlement
price, as well as any other supporting information that is
appropriate for release to the public, available to the public when
cash settlement is conducted. If the cash settlement price is based
on reference prices that are obtained from non-public sources (e.g.,
cash market surveys conducted by the swap execution facility or by
third parties on behalf of the swap execution facility), then a swap
execution facility should make available to the public the cash
settlement price as well as any other supporting information that is
appropriate or feasible to make available to the public.
(iv) Minimum price fluctuation (minimum tick). For standardized
swap contracts, the minimum price increment (tick) should be set at
a level that is consistent with cash market transactions for the
underlying commodity. For non-standardized swap contracts, a swap
execution facility may choose to not specify a minimum price
increment (tick).
(v) Intraday market restrictions. A swap execution facility may
have intraday market restrictions that pause or halt trading in the
event of extraordinary price moves that may result in distorted
prices. If a swap execution facility adopts such restrictions, they
should not be unduly restrictive of trading. For swap contracts
based on security indexes, intraday price limits and trading halts
should be coordinated with circuit breakers of national security
exchanges.
(vi) Last trading day. If a swap execution facility chooses to
allow trading to occur through the determination of a settlement
price, then the swap execution facility should demonstrate that swap
trading would not distort the settlement price calculation. For
standardized swap contracts, specification of the last trading day
should take into consideration whether the volume of transactions
underlying the cash settlement price would be unduly limited by the
occurrence of holidays or traditional holiday periods in the cash
market. For non-standardized swap contracts, a swap execution
facility may allow the last trading day to be negotiable.
(b) Guidance for physically-settled swaps.
(1) General definition. A physically-settled swap contract is
any swap agreement, as defined in section 1a(47) of the Act, that
may result in physical settlement. Generally, these are agreements
where the primary intent is to transfer the financial risk
associated with the underlying commodity and not primarily to make
or take delivery of the commodity.
(2) Estimating deliverable supplies. A swap execution facility
should estimate the deliverable supply for which a swap contract is
not readily susceptible to manipulation. The estimate of deliverable
supply should be adequate to ensure that the swap contract is not
readily susceptible to price manipulation. In general, the term
``deliverable supply'' means the quantity of the commodity meeting
the swap contract's delivery specifications that reasonably can be
expected to be readily available to short traders and salable by
long traders at its market value in normal cash marketing channels
at the swap contract's delivery points during the specified delivery
period, barring abnormal movement in interstate commerce. For a non-
financial physically-settled swap contract, this estimate should
include all available supply that meets the swap contract's
specifications and can be delivered at prevailing market prices via
the delivery procedures set forth in the swap contract. Among this
eligible supply, the estimate of deliverable supply can consist of:
(i) Commercially available imports;
(ii) Product which is in storage at the delivery point(s)
specified in the swap contract; and
(iii) Product which is available for sale on a spot basis within
the marketing channels that normally are tributary to the delivery
point(s). Furthermore, an estimate of deliverable supply should
exclude quantities that at current price levels are not economically
obtainable or deliverable or were previously committed for long-term
agreements. The size of commodity supplies that are committed to
long-term agreements may be estimated by consulting with market
participants. However, if the estimated deliverable supply that is
committed for long-term agreements, or significant portion thereof,
can be demonstrated by the swap execution facility to be
consistently and regularly made available to the spot market for
shorts to acquire at prevailing economic values, then those
``available'' supplies committed for long-term contracts may be
included in the swap execution facility's estimate of deliverable
supply for that
[[Page 62137]]
commodity. To the extent possible and that data resources permit,
deliverable supply estimates should be constructed such that the
data reflect the market defined by the swap contract's terms and
conditions, and should be formulated, whenever possible, with
government or publicly available data. All deliverable supply
estimates should be fully defined, have all underlying assumptions
explicitly stated, and have documentation of all data/information
sources in order to permit estimate replication by Commission staff.
(iv) Accounting for variations in deliverable supplies. To
assure the availability of adequate deliverable supplies, a swap
contract's terms and conditions should assess adequately the
potential range of deliverable supplies and account for variations
in the patterns of production, consumption, and supply over a period
of at least three years. This assessment also should consider
seasonality, growth, and market concentration in the production/
consumption of the underlying cash commodity. Patterns of variations
in the deliverable supply are more apparent when deliverable supply
estimates are calculated on a monthly basis and when such monthly
estimates are provided for at least the most recent three years for
which data resources permit. For commodities with seasonal supply or
demand characteristics, the deliverable supply analysis should
include that period when potential supplies typically are at their
lowest levels. In addition, consideration should be given to the
relative roles of producers, merchants, and consumers in the
production, distribution, and consumption of the cash commodity and
whether the underlying commodity exhibits a domestic or
international export focus. Careful consideration also should be
given to the quality of the cash commodity, the movement or flow of
the cash commodity in normal commercial channels, and any external
factors or regulatory controls that could affect the price or supply
of the cash commodity.
(3) Contract terms and conditions. For a swap contract that is
settled by physical delivery, the terms and conditions of the
contract should conform to the most common commercial practices and
conditions in the cash market for the commodity underlying the swap
contract. The terms and conditions should be designed to avoid any
impediments to the delivery of the commodity so as to promote
convergence between the value of the swap contract and the cash
market value of the commodity at the expiration of the swap
contract. An acceptable specification of terms and conditions would
include, but may not be limited to, rules that address, as
appropriate, the following criteria and comply with the associated
standards:
(i) Quality standards. The terms and conditions of a swap
contract should describe or define all of the economically
significant characteristics or attributes of the commodity
underlying the contract. In particular, the quality standards should
be described or defined so that such standards reflect those used in
transactions in the commodity in normal cash marketing channels.
Documentation establishing that the quality standards of the swap
contract's underlying commodity comply with those accepted/
established by the industry, by government regulations, and/or by
relevant laws should also be submitted. For any particular swap
contract, the specific attributes that should be enumerated depend
upon the individual characteristics of the underlying commodity.
These may include, for example, the following items: Grade, quality,
purity, weight, class, origin, growth, issuer, originator, maturity
window, coupon rate, source, hours of trading, etc. If the terms of
the swap contract provide for the delivery of multiple qualities of
a specific attribute of the commodity having different cash market
values, then a ``par'' quality should be specified with price
differentials applicable to the ``non-par'' qualities that reflect
discounts or premiums commonly observed or expected to occur in the
cash market for that commodity.
(ii) Delivery points and facilities. Delivery point/area
specifications should provide for delivery at a single location or
at multiple locations where the underlying cash commodity is
normally transacted or stored and where there exists a viable cash
market(s). If multiple delivery points are specified and the value
of the commodity differs between these locations, a swap contract's
terms should include price differentials that reflect usual and
observed differences in value between the different delivery
locations. If the price relationships among the delivery points are
unstable and a swap execution facility chooses to adopt fixed
locational price differentials, such differentials should fall
within the range of commonly observed or expected commercial price
differences. In this regard, any price differentials should be
supported with cash price data for the delivery location(s) for a
period of three years. The price differential should be updated
periodically to reflect prevailing market conditions. The terms and
conditions of a swap contract also should specify, as appropriate,
any conditions the delivery facilities and/or delivery facility
operators should meet in order to be eligible for delivery.
Specification of any requirements for delivery facilities also
should consider the extent to which ownership of such facilities is
concentrated and whether the level of concentration would be
susceptible to manipulation of the swap contract's prices.
Physically-settled swap contracts also should specify appropriately
detailed delivery procedures that describe the responsibilities of
deliverers, receivers, and any required third parties in carrying
out the delivery process. Such responsibilities could include
allocation between buyer and seller of all associated costs such as
load-out, document preparation, sampling, grading, weighing,
storage, taxes, duties, fees, drayage, stevedoring, demurrage,
dispatch, etc. Required accreditation for third-parties also should
be detailed. These procedures should seek to minimize or eliminate
any impediments to making or taking delivery by both deliverers and
takers of delivery to help ensure convergence of the cash price and
swap price.
(iii) Delivery period and last trading day. An acceptable
specification of the delivery period would allow for sufficient time
for deliverers to acquire the deliverable commodity and make it
available for delivery, considering any restrictions or requirements
imposed by the swap execution facility. For standardized swap
contracts, specification of the last trading day for expiring swap
contracts should consider whether adequate time remains after the
last trading day to allow for delivery on the contract. For non-
standardized swap contracts, a swap execution facility may allow the
delivery period to be negotiable.
(iv) Contract size and trading unit. Generally, swap contract
sizes and trading units for standardized contracts should be
determined after a careful analysis of relevant cash market trading
practices, conditions, and deliverable supply estimates, so as to
ensure that the underlying commodity market and available supply
sources are able to support the contract sizes and trading units at
all times. For non-standardized swap contracts, a swap execution
facility may allow the contract sizes and trading units to be
negotiable.
(v) Delivery pack. The term ``delivery pack'' refers to the
specific cash market packaging standards (e.g., product may be
delivered in burlap or polyethylene bags stacked on wooden pallets)
or non-quality related standards regarding the composition of
commodity within a delivery unit (e.g., product must all be imported
from the same country or origin). An acceptable specification of the
delivery pack or composition of a swap contract's delivery unit
should reflect, to the extent possible, specifications commonly
applied to the commodity traded or transacted in the cash market.
(vi) Delivery instrument. An acceptable specification of the
delivery instrument (e.g., warehouse receipt, depository certificate
or receipt, shipping certificate, bill of lading, in-line transfer,
book transfer of securities, etc.) would provide for its conversion
into the cash commodity at a commercially-reasonable cost.
Transportation terms (e.g., FOB, CIF, freight prepaid to
destination) as well as any limits on storage or certificate daily
premium fees should be specified. These terms should reflect cash
market practices and the customary provision for allocating delivery
costs between buyer and seller.
(vii) Inspection provisions. Any inspection/certification
procedures for verifying compliance with quality requirements or any
other related delivery requirements (e.g., discounts relating to the
age of the commodity, etc.) should be specified in the swap
contract's rules. An acceptable specification of inspection
procedures would include the establishment of formal procedures that
are consistent with procedures used in the cash market. To the
extent that formal inspection procedures are not used in the cash
market, an acceptable specification would contain provisions that
assure accuracy in assessing the commodity, that are available at a
low cost, that do not pose an obstacle to delivery on the swap
contract and that are performed by a reputable, disinterested third
party or by qualified swap execution facility employees.
[[Page 62138]]
Inspection terms also should detail which party pays for the
service, particularly in light of the possibility of varying
inspection results.
(viii) Delivery months. Delivery months should be established
based on the risk management needs of commercial entities as well as
the availability of deliverable supplies in the specified months.
(ix) Minimum price fluctuation (minimum tick). For standardized
swap contracts, the minimum price increment (tick) should be set at
a level that is in line with cash market transactions for the
underlying commodity. For non-standardized swap contracts, a swap
execution facility may choose to not specify a minimum price
increment (tick).
(x) Maximum price fluctuation limits. A swap execution facility
may adopt price limits to (1) reduce or constrain price movements in
a trading day that may not be reflective of true market conditions
but might be caused by traders overreacting to news and (2) provide
a ``cooling-off'' period for swap market participants to respond to
bona fide changes in market supply and demand fundamentals that
would lead to large cash and swap price changes. If price limit
provisions are adopted, the limits should be set at levels that are
not overly restrictive in relation to price movements in the cash
market for the commodity underlying the swap contract.
(c) Guidance for options on swap contracts.
The Commission believes that, provided the underlying swap
complies with the relevant guidance in this Appendix C, any
specification of the following terms would be acceptable; the
primary requirement is that such terms be specified in an objective
manner in the option contract's rules:
(1) Exercise method;
(2) Exercise procedure;
(3) Strike price provisions;
(4) Automatic exercise provisions;
(5) Contract size;
(6) Option expiration and last trading day; and (vii) option
type and trading convention; and
(7) For non-standardized swap contracts, a swap execution
facility may allow these contract terms to be negotiable.
(d) Guidance for options on physicals contracts.
(1) Under the Commission's regulations, the term ``option on
physicals'' refers to option contracts that do not provide for
exercise into an underlying futures contract. Upon exercise, options
on physicals can be settled via physical delivery of the underlying
commodity or by a cash payment. Thus, options on physicals raise
many of the same issues associated with trading in other types of
swap contracts such as the adequacy of deliverable supplies or
acceptability of the cash settlement price series. In this regard,
an option that is cash settled based on the settlement price of a
futures contract or a swap contract would be considered an ``option
on physicals'' and the futures or swap settlement price would be
considered the cash price series.
(2) In view of the above, acceptable practices for the terms and
conditions of options on physicals contracts include, as
appropriate, those practices set forth above for physical-delivery
or cash-settled swap contracts plus the practices set forth for
options on swap contracts.
PART 38--DESIGNATED CONTRACT MARKETS
0
9. The authority citation for part 38 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376.
Sec. Sec. 38.11 and 38.12 [Removed and reserved]
0
10. Remove and reserve Sec. Sec. 38.11 and 38.12.
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
0
11. The authority citation for part 39 continues to read as follows:
Authority: 7 U.S.C. 2, 7a-1, and 12a; 12 U.S.C. 5464; 15 U.S.C.
8325.
0
12. In Sec. 39.12, revise paragraph (b)(7) to read as follows:
Sec. 39.12 Participant and product eligibility.
* * * * *
(b) * * *
(7) Time frame for clearing--(i) Coordination with markets and
clearing members. (A) Each derivatives clearing organization shall
coordinate with each designated contract market and swap execution
facility that lists for trading a product that is cleared by the
derivatives clearing organization in developing rules and procedures to
facilitate prompt, efficient, and accurate processing and routing of
all agreements, contracts, and transactions submitted to the
derivatives clearing organization for clearing.
(B) Each derivatives clearing organization shall coordinate with
each clearing member that is a futures commission merchant, swap
dealer, or major swap participant to establish systems that enable the
clearing member, or the derivatives clearing organization acting on its
behalf, to accept or reject each agreement, contract, or transaction
submitted to the derivatives clearing organization for clearing by or
for the clearing member or a customer of the clearing member as quickly
as would be technologically practicable if fully automated systems were
used.
(ii) Agreements, contracts, and transactions submitted for clearing
to a derivatives clearing organization. Each derivatives clearing
organization shall have rules that provide that the derivatives
clearing organization will accept or reject for clearing all
agreements, contracts, and transactions as quickly after submission to
the derivatives clearing organization as would be technologically
practicable if fully automated systems were used. The derivatives
clearing organization shall accept all agreements, contracts, and
transactions:
(A) For which the executing parties have clearing arrangements in
place with clearing members of the derivatives clearing organization;
(B) For which a derivatives clearing organization has been
identified as the intended clearinghouse; and
(C) That satisfy the criteria of the derivatives clearing
organization, including, but not limited to, applicable risk filters;
provided that such criteria are non-discriminatory across trading
venues and are applied as quickly as would be technologically
practicable if fully automated systems were used.
* * * * *
PART 43--REAL-TIME PUBLIC REPORTING
0
13. The authority citation for part 43 continues to read as follows:
Authority: 7 U.S.C. 2(a), 12a(5) and 24a, as amended by Pub. L.
111-203, 124 Stat. 1376 (2010).
0
14. Revise Sec. 43.2 to read as follows:
Sec. 43.2 Definitions.
As used in this part:
Act means the Commodity Exchange Act, as amended, 7 U.S.C. 1 et
seq.
Affirmation means the process by which parties to a swap verify
(orally, in writing, electronically or otherwise) that they agree on
the primary economic terms of a swap (but not necessarily all terms of
the swap). Affirmation may constitute ``execution'' of the swap or may
provide evidence of execution of the swap, but does not constitute
confirmation (or confirmation by affirmation) of the swap.
Appropriate minimum block size means the minimum notional or
principal amount for a category of swaps that qualifies a swap within
such category as a block trade or large notional off-facility swap.
As soon as technologically practicable means as soon as possible,
taking into consideration the prevalence, implementation and use of
technology by comparable market participants.
Asset class means a broad category of commodities including,
without limitation, any ``excluded commodity'' as defined in section
1a(19) of the Act, with common characteristics underlying a swap. The
asset classes include interest rate, foreign exchange, credit,
[[Page 62139]]
equity, other commodity and such other asset classes as may be
determined by the Commission.
Block trade means a publicly reportable swap transaction that:
(1) Involves a swap that is listed on a registered swap execution
facility or designated contract market;
(2) Is executed on a registered swap execution facility or occurs
away from a designated contract market's trading system or platform and
is executed pursuant to that designated contract market's rules;
(3) Has a notional or principal amount at or above the appropriate
minimum block size applicable to such swap; and
(4) Is reported subject to the rules and procedures of the
registered swap execution facility or designated contract market and
the rules described in this part, including the appropriate time delay
requirements set forth in Sec. 43.5.
Business day means the twenty-four hour day, on all days except
Saturdays, Sundays and legal holidays, in the location of the reporting
party or registered entity reporting data for the swap.
Business hours mean the consecutive hours of one or more
consecutive business days.
Cap size means, for each swap category, the maximum notional or
principal amount of a publicly reportable swap transaction that is
publicly disseminated.
Confirmation means the consummation (electronic or otherwise) of
legally binding documentation (electronic or otherwise) that
memorializes the agreement of the parties to all terms of a swap. A
confirmation shall be in writing (electronic or otherwise) and shall
legally supersede any previous agreement (electronic or otherwise)
relating to the swap.
Confirmation by affirmation means the process by which one party to
a swap acknowledges its assent to the complete swap terms submitted by
the other party to the swap. If the parties to a swap are using a
confirmation service vendor, complete swap terms may be submitted
electronically by a party to such vendor's platform and the other party
may affirm such terms on such platform.
Economically related means a direct or indirect reference to the
same commodity at the same delivery location or locations, or with the
same or a substantially similar cash market price series.
Embedded option means any right, but not an obligation, provided to
one party of a swap by the other party to the swap that provides the
party holding the option with the ability to change any one or more of
the economic terms of the swap as those terms previously were
established at confirmation (or were in effect on the start date).
Executed means the completion of the execution process.
Execution means an agreement by the parties (whether orally, in
writing, electronically, or otherwise) to the terms of a swap that
legally binds the parties to such swap terms under applicable law.
Execution occurs simultaneous with or immediately following the
affirmation of the swap.
Futures-related swap means a swap (as defined in section 1a(47) of
the Act and as further defined by the Commission in implementing
regulations) that is economically related to a futures contract.
Large notional off-facility swap means an off-facility swap that
has a notional or principal amount at or above the appropriate minimum
block size applicable to such publicly reportable swap transaction and
is not a block trade as defined in Sec. 43.2.
Major currencies mean the currencies, and the cross-rates between
the currencies, of Australia, Canada, Denmark, New Zealand, Norway,
South Africa, South Korea, Sweden, and Switzerland.
Non-major currencies mean all other currencies that are not super-
major currencies or major currencies.
Novation means the process by which a party to a swap transfers all
of its rights, liabilities, duties and obligations under the swap to a
new legal party other than the counterparty to the swap. The transferee
accepts all of the transferor's rights, liabilities, duties and
obligations under the swap. A novation is valid as long as the
transferor and the remaining party to the swap are given notice, and
the transferor, transferee and remaining party to the swap consent to
the transfer.
Off-facility swap means any publicly reportable swap transaction
that is not executed on or pursuant to the rules of a registered swap
execution facility or designated contract market.
Other commodity means any commodity that is not categorized in the
other asset classes as may be determined by the Commission.
Physical commodity swap means a swap in the other commodity asset
class that is based on a tangible commodity.
Public dissemination and publicly disseminate means to publish and
make available swap transaction and pricing data in a non-
discriminatory manner, through the internet or other electronic data
feed that is widely published and in machine-readable electronic
format.
Publicly reportable swap transaction means:
(1) Unless otherwise provided in this part--
(i) Any executed swap that is an arm's-length transaction between
two parties that results in a corresponding change in the market risk
position between the two parties; or
(ii) Any termination, assignment, novation, exchange, transfer,
amendment, conveyance, or extinguishing of rights or obligations of a
swap that changes the pricing of the swap.
(2) Examples of executed swaps that do not fall within the
definition of publicly reportable swap may include:
(i) Internal swaps between one-hundred percent owned subsidiaries
of the same parent entity; and
(ii) Portfolio compression exercises.
(3) These examples represent swaps that are not at arm's length and
thus are not publicly reportable swap transactions, notwithstanding
that they do result in a corresponding change in the market risk
position between two parties.
Real-time public reporting means the reporting of data relating to
a swap transaction, including price and volume, as soon as
technologically practicable after the time at which the swap
transaction has been executed.
Reference price means a floating price series (including
derivatives contract prices and cash market prices or price indices)
used by the parties to a swap or swaption to determine payments made,
exchanged or accrued under the terms of a swap contract.
Remaining party means a party to a swap that consents to a
transferor's transfer by novation of all of the transferor's rights,
liabilities, duties and obligations under such swap to a transferee.
Reporting party means the party to a swap with the duty to report a
publicly reportable swap transaction in accordance with this part and
section 2(a)(13)(F) of the Act.
Super-major currencies mean the currencies of the European Monetary
Union, Japan, the United Kingdom, and United States.
Swaps with composite reference prices mean swaps based on reference
prices that are composed of more than one reference price from more
than one swap category.
Transferee means a party to a swap that accepts, by way of
novation, all of a transferor's rights, liabilities, duties and
obligations under such swap with respect to a remaining party.
Transferor means a party to a swap that transfers, by way of
novation, all of
[[Page 62140]]
its rights, liabilities, duties and obligations under such swap, with
respect to a remaining party, to a transferee.
Trimmed data set means a data set that has had extraordinarily
large notional transactions removed by transforming the data into a
logarithm with a base of 10, computing the mean, and excluding
transactions that are beyond four standard deviations above the mean.
Unique product identifier means a unique identification of a
particular level of the taxonomy of the product in an asset class or
sub-asset class in question, as further described in Sec. 43.4(f) and
appendix A to this part. Such unique product identifier may combine the
information from one or more of the data fields described in appendix A
to this part.
Widely published means to publish and make available through
electronic means in a manner that is freely available and readily
accessible to the public.
Issued in Washington, DC, on November 6, 2018, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices To Swap Execution Facilities and Trade Execution
Requirement--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Giancarlo and Commissioners Quintenz,
Behnam, and Stump voted in the affirmative. Commissioner Berkovitz
voted in the negative.
Appendix 2--Statement of Chairman J. Christopher Giancarlo
I start by referencing an important White Paper written in 1970
by a young graduate student in economics at UC Berkeley. That White
Paper, entitled, ``Preliminary Design for an Electronic Market,''
written for the Pacific Commodity Exchange, was the world's first
written conceptualization of a fully electronic, for-profit futures
exchange.
The White Paper was written by Dr. Richard Sandor. That White
Paper has now been republished in a new book by Dr. Sandor.\1\ In
it, he recounts how his idea lay mostly dormant through the 1970s to
mid-1980s before being slowly developed, in fits and starts, first
in Europe in the 1990s and then in the United States in the 2000s.
His book notes that electronic execution of futures products with
continuous liquidity has become almost ubiquitous today, while other
exchange traded asset classes with more episodic liquidity, like
options and swaps, continue to trade by voice.
---------------------------------------------------------------------------
\1\ Sandor, Richard L., ``Electronic Trading & Blockchain:
Yesterday, Today and Tomorrow,'' 2018, World Scientific Publishing
Co. Pte. Ltd.
---------------------------------------------------------------------------
What I found fascinating in Dr. Sandor's recounting of this
five-decade long evolution from trading pits to electronic trading
of futures was the absence of any grand plan behind the
transformation. Instead, it was a series of incremental commercial
developments and technology innovations. At all times, the impetus
was the demands of market participants and the response of market
operators to reduce trading costs and transaction friction. At no
time, did government step in and say, ``Henceforth, all futures
trading shall be on electronic exchanges.'' Instead, market
evolution happened because a good idea was coupled with capable
technology and mutual commercial interest with enough time to catch
on and gain traction.
Before I joined the Commission, I spent a decade and a half at a
leading operator of swaps marketplaces. We launched many innovative
electronic platforms still in use today. Some of the platforms
caught right on with our customers, others did not. Yet, we designed
all of them to increase efficiency and reduce trading friction. It
was just that sometimes our competitors designed better or cheaper
ones or just simply got the timing right.
The point is that the design of trading platforms and the
evolution of market structure is best done by platform operators,
through trial and error, customer demand, commercial response and
technological innovation. Regulators will never be close enough to
the heartbeat of the markets, the spark of technology or the cost of
development to prescribe the optimal design of trading platforms or
business methods. Regulators can never know which trading methods
will work best in the full range of market conditions, from low to
extreme volatility.
Congress understood this. That is why Title VII of Dodd-Frank
permits Swap Execution Facilities (SEFs) to conduct their activities
through ``any means of interstate commerce,'' not ``such means that
may be chosen by regulators.''
Once regulators step in and dictate who serves who with what
type of service, we are picking winners and losers. We are simply
not authorized, nor are we competent, to act in this way. If we do,
the winners will invariably be those with the most persuasive voices
and best lobbyists.
Congress knew that swaps are not traded by retail participants,
but for sophisticated, institutional traders. Wall Street banks,
hedge funds, prop shops and large energy companies have the
wherewithal to demand the transaction services they need without
regulators holding their hands. And the platform operators are not
public utilities, but seasoned competitors. If there is money to be
made, trading efficiencies to be achieved, customers to be served or
costs to be saved, they will find them. If there is a better
mousetrap to be built, they will build it.
Unfortunately, the CFTC did not listen to Congress. Contrary to
provisions of Dodd-Frank that permit SEFs to operate by ``any means
of interstate commerce,'' the current SEF rules constrain swaps
trading to two methods of execution--request-for-quote or order
book. While swaps not subject to the trade execution mandate can
utilize other methods, SEFs must nevertheless provide an order book
for such permitted transactions. All other ``required'' transactions
have to be executed exclusively on one of those two options.
Further, the rules incorporate a number of practices from futures
markets that are antithetical to swaps trading, such as the 15
second ``cross'' and execution of block trades off platform.
Additionally, the SEF core principles are interpreted in ways that
are not conducive to environments in which swaps liquidity is formed
and price discovery is conducted.
One effect of this approach has been to incentivize the shift of
swaps price discovery and liquidity formation away from SEFs to
introducing brokers (or ``IBs''). SEFs have turned into booking
engines for trades formulated elsewhere, often on IBs. Yet, IBs are
not appropriate vehicles to formulate swaps transactions. The
intended purpose of IBs in the CFTC's regulatory framework is to
solicit orders for futures transactions, not swaps. Moving swaps
price discovery and liquidity formation away from SEFs to IBs is not
what Congress intended in Dodd-Frank. The goal was to have the
entire process of swaps liquidity formation, price discovery and
trade execution take place on licensed SEF platforms. IBs are not
subject to conduct and compliance requirements appropriate for swaps
trading. Their employees are not required to pass exams for
proficiency in serving institutional market participants in over-
the-counter swaps markets but they are for retail customers who are
prohibited from trading swaps.
Another effect of the current approach is the paucity of
platform innovation and new platform operators competing for market
share. The stagnation has allowed a few incumbents to consolidate
and dominate market share. According to one large swaps trader,
``the biggest disappointment of SEFs is that nothing has really
changed. I'm still trading the same way today as I was 10 years
ago.'' \2\ And, yet, the current rules were supposed to have caused
as much as a hundred firms to register as SEFs.\3\
---------------------------------------------------------------------------
\2\ Robert Mackenzie Smith, ``SEF reforms could distort new,
sounder benchmark rates,'' Risk.net, 19 Oct. 2016, at: https://www.risk.net/derivatives/6049931/sef-reforms-could-distort-new-sounder-benchmark-rates.
\3\ Christopher Doering & Roberta Rampton, ``US May See 100 New
Swaps Execution Entities: Broker,'' Reuters, Oct. 12, 2010, at:
https://www.reuters.com/article/us-financial-regulation-sefs/u-s-may-see-100-new-swap-execution-entities-broker-idUSTRE69B69020101012.
---------------------------------------------------------------------------
I have written a few white papers of my own. I have called for
revising our current restrictions on SEF activity and allowing
flexible methods of execution for swaps transactions using any means
of interstate commerce, exactly as Congress intended.\4\
---------------------------------------------------------------------------
\4\ Commissioner J. Christopher Giancarlo, Pro-Reform
Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-
Frank, Jan. 29, 2015, https://www.cftc.gov/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf; (``2015 SEF White
Paper''); and Swaps Regulation Version 2.0: An Assessment of the
Current Implementation of Reform and Proposals for Next Steps, April
26, 2018.
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[[Page 62141]]
Today's proposal does just that. It will allow SEFs to innovate
to meet customer demand and operate trading environments that are
more salutatory to the more episodic nature of swaps liquidity. At
the same time, it will make the ``made available for trading''
determination synonymous with the clearing determination to include
all swaps subject to the clearing requirement and listed by a SEF or
DCM. This is meant to bring the full range of liquidity formation,
price discovery and trade execution on SEFs for a broader range of
swaps products.
The promotion of swaps trading on SEFs brings ``daylight to the
marketplace'' by subjecting a much broader range of swaps products
to SEF record keeping, regulatory supervision and oversight, just as
Congress intended.
It is said that if CFTC mandates for minimum trading
functionality go away, so will the current degree of electronic
execution in the market. Sorry, but that is a na[iuml]ve concern.
Those electronic SEF platforms that are successful provide too much
competitive advantage and cost efficiency and sunk costs to be shut
down simply because they are no longer subject to a regulatory
mandate. No firm is going to give up electronic trading market share
and profitability and increase trading friction because regulation
suddenly becomes less prescriptive.
A word about ``impartial access,'' Dodd-Frank requires SEFs to
have rules to provide market participants with ``impartial access''
to the market and permits SEFs to establish rules regarding any
limitation on access.
``Impartial access'' means just that, ``impartial''. It does not
mean that SEFs must serve every type of market participant in an
all-to-all environment. If it did, then Congress would not have
allowed SEFs to establish rules for limitation of access.
The new proposal would establish what is meant by ``impartial
access''. The proposal will generally define ``impartial'' as
transparent, fair and non-discriminatory as applied to all similarly
situated market participants in a fair and non-discriminatory manner
based on objective, pre-established requirements.
Today's proposal would also enhance the professionalism of SEF
personnel who exercise discretion by adopting proficiency
requirements and conduct standards suitable for swaps. Furthermore,
the proposal adopts rule changes in a number of places where staff
has previously issued guidance or no-action relief from the current
rules, thereby increasing regulatory clarity and certainty.
We have approached today's proposal with the principle that the
CFTC engage its international counterparts with respect and due
consideration. The staff of the CFTC and I have made every effort to
ensure that non-U.S. authorities had the opportunity to review and
discuss the 2015 SEF White Paper that set out the concepts
underlying today's proposal. Based on that outreach, I see no reason
why today's proposal would be viewed as inconsistent with the
regulatory systems of other G20 jurisdictions. We certainly welcome
further dialogue with them. In fact, today's proposal is entirely
consistent with, and anticipated by, recent discussions with foreign
authorities about the CFTC's SEF regime, including the equivalence
agreement for swaps trading platforms with the European Commission
that EC Vice President Dombrovskis and I announced one year ago here
in this room. That agreement, which focused on an outcomes-based
approach toward EU equivalence and CFTC exemptions, was made by both
parties with full knowledge and understanding of the changes
advocated in the 2015 SEF White Paper and presented to us today.
Let me briefly address today's request for comment on the
practice of name give up in swaps markets. There are a range of
perspectives on this market practice. I have an open mind as to the
advisability of restrictions on the practice and what form a rule
would take, if at all. I look forward to comments and hearing more
about the current impact of this practice in the marketplace.
One final point: Today's proposal will invariably be slammed by
opponents of change as a ``rollback'' of Dodd-Frank. Any such
characterization would be disingenuous.
Those who examine my record know that I have been a consistent
supporter of the swaps reforms embodied in Title VII of the Dodd-
Frank Act. In fact, of the current five Commissioners, I may have
been the first to publicly state my support for Title VII.\5\ And, I
have not waivered since. Congress got Title VII right. There, I said
it again.
---------------------------------------------------------------------------
\5\ Wholesale Markets Brokers' Association, Americas, Commends
Historic US Financial legislation, Jul. 21 2010, available at:
https://www.lexissecuritiesmosaic.com/gateway/CFTC/Speech/01_WMBAA-Dodd-Frank-Law-press-release-final123.pdf.
---------------------------------------------------------------------------
My support for the Title VII reforms--swaps clearing, swap
dealer registration and requirements, trade reporting and regulated
swaps execution--is not based on academic theory or political
ideology. It is based on fifteen years of commercial experience.
Done right, the reforms are good for American markets.
So is today's proposal. It is not a rollback, but a policy
improvement, a step forward, to enhance swaps market health and
vitality that is true to Congressional intent and purpose. I trust
that market participants and interested parties will fairly consider
it with the good faith with which it is presented. I look forward to
a broad and active discussion.
In closing, I compliment the DMO staff for putting together a
balanced rule proposal and request for comment. I would like to
commend them for their many hours of hard work, the quality of the
written proposal and their thoughtfulness and engagement throughout.
You know, it is satisfying to see how an old White Paper, with
ample time and reflection, can become a formal proposal, an arrow
hitting its mark.
I look forward to the public's comments, healthy discussion, and
a final rule in 2019.
Appendix 3--Supporting Statement of Commissioner Brian D. Quintenz
I will vote in favor of issuing today's proposed rule and the
request for comment reforming the regulatory regime of swap
execution facilities (SEFs). The Chairman has shown great thought
leadership and transparency in consistently and fully articulating
his vision for swaps trading rules that would create a more
cohesive, liquid swap marketplace. Today's proposal represents a
significant step toward executing that vision. I look forward to
hearing from market participants about how these broad reforms will
work collectively to impact SEF trading dynamics and liquidity
formation. Mr. Chairman, I know this day has been a long time
coming, and I congratulate you and the Division of Market Oversight
for all of your and their tireless work on this proposed rule.
Appendix 4--Concurring Statement of Commissioner Rostin Behnam
Introduction
Today, the Commission votes to issue proposed rules that would
constitute an overhaul of the existing framework for swap execution
facilities (SEFs). Given the breadth and complexity of the proposed
rules before us, the process of public comment is particularly
important. I look forward to receiving input from market
participants and the public who would be impacted, in any way, by a
reworking of the SEF rules.
Background
As we consider the goals and therefore the direction of any SEF
reform, I think it is very important that we first review how we got
where we are today. Prior to the 2008 financial crisis, swaps were
largely exempt from regulation and traded exclusively over-the-
counter, rather than on a regulated exchange.\1\ Lack of
transparency in the over-the-counter swaps market contributed to the
financial crisis because both regulators and market participants
lacked the visibility necessary to identify and assess swaps market
exposures and counterparty relationships.\2\ In the aftermath of the
financial crisis, Congress enacted the Dodd-Frank Wall Street Reform
and Consumer Protection Act in 2010 (Dodd-Frank Act).\3\ The Dodd-
Frank Act largely incorporated the international financial reform
initiatives for over-the-counter derivatives laid out at the 2009
G20 Pittsburgh Summit aimed at improving transparency, mitigating
systemic
[[Page 62142]]
risk, and protecting against market abuse.\4\ Title VII of the Dodd-
Frank Act amended the Commodity Exchange Act (CEA or Act) to
establish a comprehensive new swaps regulatory framework that
includes the registration and oversight of a new registered entity--
SEFs. A key goal of Title VII of the Dodd-Frank Act is to bring
greater pre-trade and post-trade transparency to the swaps market.
The concept of transparency runs throughout Title VII--starting with
the title itself: The ``Wall Street Transparency and Accountability
Act of 2010.'' \5\
---------------------------------------------------------------------------
\1\ See Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (2000).
\2\ See The Financial Crisis Inquiry Commission, The Financial
Crisis Inquiry Report: Final Report of the National Commission on
the Causes of the Financial and Economic Crisis in the United States
(Official Government Edition), at 299, 352, 363-364, 386, 621 n. 56
(2011), available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
\3\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
\4\ G20, Leaders' Statement, The Pittsburgh Summit (Sept. 24-25,
2009) at 9, available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
\5\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, title VII, Section 701, 124 Stat. 1376
(2010).
---------------------------------------------------------------------------
As part of the Dodd-Frank effort to provide more transparency,
in 2013 the Commission adopted the part 37 rules in order to
implement a regulatory framework for SEFs.\6\ In so doing, the
Commission emphasized that ``[pre-trade] transparency lowers costs
for investors, consumers, and businesses; lowers the risks of the
swaps market to the economy; and enhances market integrity to
protect market participants and the public.'' \7\
---------------------------------------------------------------------------
\6\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476 (Jun. 4, 2013).
\7\ Id. at 33477.
---------------------------------------------------------------------------
The relatively young SEF framework has in many ways been a
success. There are currently 25 registered SEFs.\8\ Trading volume
on SEF has been steadily growing each year.\9\ The Commission's work
to promote swaps trading on SEFs has resulted in increased
liquidity, while adding pre-trade price transparency and
competition.\10\
---------------------------------------------------------------------------
\8\ See Trading Organizations--Swap Execution Facilities (SEF),
CFTC.gov, https://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities (last visited Nov. 4, 2018).
\9\ See FIA SEF Tracker, FIA.org, https://fia.org/node/1901/
(last visited Nov. 4, 2018).
\10\ See Bank of England Staff Working Paper No. 580,
Centralized Trading, Transparency and Interest Rate Swap Market
Liquidity: Evidence from the Implementation of the Dodd-Frank Act
(May 2018), pp. 2-4, 18-24, available at https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2018/centralized-trading-transparency-and-interest-rate-swap-market-liquidity-update.
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This is not to say that the SEF rules were perfect from the
start and would not benefit from some targeted changes. Most SEFs
operate under multiple no-action letters granted by the Division of
Market Oversight. While the purpose of this form of targeted relief
was often to smooth the implementation of the SEF framework,
codifying or eliminating the need for existing no-action relief
would provide market participants with greater legal certainty.
The current SEF rules have not brought as much trading onto SEFs
as intended or envisioned. We can improve upon that. Currently, the
Commission has a regulatory process for SEFs to demonstrate through
a multi-factor analysis that a swap has been made-available-to-
trade, or ``MAT,'' \11\ meaning that it is required to trade on a
SEF or DCM. The current process has resulted in relatively few MAT
determinations and, after an initial flurry of submissions for the
most standardized and liquid products, no further submissions have
been made. I believe that addressing the MAT process could bring
more activity on SEF, bringing pre-trade transparency to more
products without dismantling the aspects of the SEF rules that are
working currently.
---------------------------------------------------------------------------
\11\ See 17 CFR 37.10, 38.12.
---------------------------------------------------------------------------
Notice of Proposed Rulemaking (NPRM)
While I believe targeted reforms could bring more products onto
SEFs, increase transparency, and lower costs for market
participants, today's NPRM is far from targeted, and in some
instances may represent a regulatory overreach. I therefore have a
number of very serious concerns with the NPRM's approach and its
far-ranging alterations. First, the NPRM violates the clear language
of the Act, which states that one of the major goals of the SEF
regulatory regime is to promote pre-trade transparency in the swaps
market. As discussed below, the NPRM does exactly the opposite.
Second, in addition to reducing transparency, the proposed rule also
increases limitations on access to SEFs. The NPRM purports to
increase choice and flexibility for SEFs; however, it simultaneously
allows SEFs to limit choice and flexibility for market participants.
Third, as commenters and the Commission think about the NPRM, I
think it is also important to consider whether we would be creating
a new registration scheme that adds significant costs for market
participants, while failing to address the fixable issues that exist
in the market today.
Pre-Trade Transparency
Section 1a(50) of the Act defines a SEF as ``a trading system or
platform in which multiple participants have the ability to execute
or trade swaps by accepting bids and offers made by multiple
participants in the facility or system, through any means of
interstate commerce. . . .'' \12\ Section 5h(e) of the Act states
that ``[t]he goal of this section is to promote trading of swaps on
swap execution facilities and to promote pre-trade transparency in
the swaps market.'' \13\ The existing SEF rules establish two
methods of execution for required transactions: The central limit
order book (CLOB) and the Request for Quote (RFQ) system.\14\ These
methods were chosen specifically because they provide pre-trade
transparency.
---------------------------------------------------------------------------
\12\ 7 U.S.C. 1a(50).
\13\ 7 U.S.C. 7b-3(e).
\14\ See 17 CFR 37.9.
---------------------------------------------------------------------------
I am concerned that the NPRM goes too far by allowing,
literally, any means of execution. The NPRM's preamble states that
the approach ``should also promote pre-trade transparency in the
swaps market by allowing execution methods that maximize
participation and concentrate liquidity. . . .'' This simply cannot
be true. Absent a clear standard of what constitutes pre-trade
transparency, it is fairly easy to envision an execution method that
would not provide pre-trade transparency--one need look no further
than the over-the-counter system that preceded the financial crisis.
But this is more than a case of what the Commission should or should
not do. The statute is clear. The Commission must ``promote pre-
trade transparency in the swaps market.'' Today's NPRM would not do
that.
That is not to say that expanding methods of execution--in a
more limited and targeted way--is a bad idea or violates the Act.
There are likely other execution methods that fit within section
1a(50) and would promote pre-trade transparency. I look forward to
hearing from commenters as to what those methods might be, and
debating with my fellow Commissioners as to whether they are
appropriate within the confines of congressional intent and
ultimately the Act.
Made Available To Trade
As I mentioned earlier, the MAT process is seemingly broken. The
Commission stopped receiving MAT submissions after an initial set of
submissions for the most standardized and liquid swaps
contracts.\15\ The Commission has not received any MAT submissions
or made any MAT determinations since 2014.\16\ This is not what the
Commission envisioned in promulgating the Made Available to Trade
rule.\17\ The solution posited today is, in a sense, a simple,
elegant one. The NPRM states that the phrase ``makes the swap
available to trade'' in CEA section 2h(8) should be interpreted to
mean that ``once the clearing requirement applies to a swap, then
the trade execution requirement applies to that swap upon any single
SEF or DCM listing the swap for trading.'' This would take both the
SEF and the Commission out of the determination process.
---------------------------------------------------------------------------
\15\ See CFTC, Industry Oversight, Industry Filings, Swaps Made
Available to Trade Determination, https://sirt.cftc.gov/sirt/sirt.aspx?Topic=%20SwapsMadeAvailableToTradeDetermination.
\16\ Id.
\17\ See Process for a Designated Contract Market or Swap
Execution Facility To Make a Swap Available to Trade, Swap
Transaction Compliance and Implementation Schedule, and Trade
Execution Requirement Under the Commodity Exchange Act, 78 FR 33606
(Jun. 4, 2013).
---------------------------------------------------------------------------
My concern, however, is that there may be products that are more
appropriately traded off SEF. In addition, tying the trade execution
requirement to the clearing requirement could have unintended
consequences--it could actually discourage voluntary central
clearing.
I look forward to hearing from commenters regarding the
appropriate interpretation of the term ``made available to trade'',
including how to improve the existing process.
Impartial Access
One of the most troubling aspects of the NPRM is that it would
alter the Commission's interpretation of ``impartial access'' under
SEF Core Principle 2. Core Principle 2 of the Act requires SEFs to
establish and enforce participation rules that ``provide market
participants with impartial access to the market.'' \18\ Current
Commission regulation 37.202(a) states that a SEF ``shall provide
any eligible contract participant . . .
[[Page 62143]]
with impartial access to its market(s) and market services.''
(emphasis added). The Commission was clear in the preamble to the
existing rules that ``the purpose of the impartial access
requirement is to prevent a SEF's owners from using discriminatory
access requirements as a competitive tool'' against certain eligible
contract participants.\19\ The current rule provides that a SEF can
restrict access based on disciplinary history or financial or
operational soundness, if objective, pre-established criteria are
used. What a SEF cannot do is restrict access to certain types of
participants.
---------------------------------------------------------------------------
\18\ 7 U.S.C. 7b-3(f)(2).
\19\ Supra note 7 at 33508.
---------------------------------------------------------------------------
Today's NPRM would roll back this interpretation, leaving the
term ``impartial access'' an empty shell. The proposed rule would
``allow SEFs to serve different types of market participants or have
different access criteria for different execution methods.'' This is
exactly the type of discrimination that the ``impartial access''
provision in the Act was intended to prevent.
I believe that all market participants should have impartial
access to a SEF whose access criteria is applied in a fair and non-
discriminatory manner. Rather than erecting new barriers to
participation, we should focus on applying our existing regulations
as they are clearly written. It seems to me that impartial access
theoretically would go hand-in-hand with the proposed widening of
SEF execution methods. Instead, the Commission seems to be bending
over backwards to be impartial regarding SEFs' modes of execution,
while allowing the SEFs themselves to discriminate. This threatens
to take us back to the world as it was pre-Dodd-Frank and pre-
financial crisis, undermining some of the key successes of the
existing SEF regulatory regime regarding transparency and market
access.
Registration/Costs
I would like to turn for a minute to the potential costs to
market participants--and the Commission--from this proposed rule.
Currently, there are 25 registered SEFs.\20\ The Proposal will
drastically increase the number of SEFs--likely by multiples. In the
cost benefit considerations to the NPRM, the Commission estimates
that approximately 40-60 swaps broking entities, including
interdealer brokers, and one single-dealer aggregator platform would
need to register as a SEF. That is the universe that we know--the
market as we understand it to exist today. There could be more--
perhaps many more--entities that will fall under the expanded
registration requirements. Just as importantly, we do not know how
these new rules will incentivize SEFs--whether they will lead to
consolidation or myriad SEFs with myriad methods of execution.
---------------------------------------------------------------------------
\20\ See Trading Organizations--Swap Execution Facilities (SEF),
CFTC.gov, https://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities (last visited Nov. 4, 2018).
---------------------------------------------------------------------------
The new registration regime, and the many changes that come
along with it, will result in substantial costs all around: To both
existing SEFs and new SEF registrants, and to their participants. I
note with some concern that, while the preamble provides a laundry
list of what rule changes will result in costs, there is no effort
to quantify them. Operating or participating in a regulated market
comes with costs; but, these incremental costs are offset, in part,
by the benefits of having access to a transparent, safe market
ecosystem that demands accountability and punishes wrongdoers. I do
not mean to suggest anything else. However, as the Commission
proceeds with this NPRM, I am hopeful that the best, most cost
effective regulatory solutions will prevail as the Commission seeks
to improve and advance the health and vibrancy of the SEF
marketplace.
Comment Period
I also want to quickly raise a non-substantive concern, but one
that may greatly impact the substance of the NPRM. The comment
period for the proposal is only 75 days. As I have stated
previously, this rulemaking is complex and impacts a wide range of
market participants in fundamental ways. There are 105 numbered
questions for commenters in the NPRM's preamble, in addition to
general requests for comment. I think it is very important that we
give market participants time to carefully consider the proposed
rule and make reasoned comments. Recent proposed rules that raised
complex issues, like the capital rule and Reg AT, had 90 day comment
periods followed by extensions of at least an additional 60
days.\21\ The original part 37 notice of proposed rulemaking
ultimately had open comment periods totaling 90 days, and market
participants had 7 months between publication of the notice of
proposed rulemaking and the end of the final comment period.\22\
Today's NPRM deserves careful consideration, both from the public
and from the Commission, and I hope that the Commission will give
market participants the time they need to respond thoughtfully and
thoroughly.
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\21\ Capital Requirements of Swap Dealers and Major Swap
Participants, 81 FR 91252 (proposed Dec. 16, 2016), and Capital
Requirements of Swap Dealers and Major Swap Participants, 82 FR
13971 (March 16, 2017) (extending comment period an additional 60
days); Regulation Automated Trading, 80 FR 78824 (proposed Dec. 17,
2015), Regulation Automated Trading, 81 FR 85334 (proposed Nov. 25,
2016), and Regulation Automated Trading, 82 FR 8502 (Jan. 26, 2017).
\22\ Reopening and Extension of Comment Periods for Rulemakings
Implementing the Dodd-Frank Wall Street Reform and Consumer
Protection Act, 76 FR 25274 (May 4, 2011), available at https://www.gpo.gov/fdsys/pkg/FR-2011-05-04/pdf/2011-10884.pdf.
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Name Give Up Request for Comment
Before I conclude, I would like to turn briefly to the name
give-up request for comment that is before us as well, as it is
inextricably tied to the SEF NPRM. Post-trade name give-up also
relates to the issue of impartial access, which I discussed earlier.
While today's SEF NPRM reworks the SEF rules generally, the NPRM
does not address the long standing practice of disclosing the
identity of each swap counterparty to the other after a trade has
been matched anonymously. Instead, the Commission is voting to issue
a request for comment seeking public comment on the practice. While
I appreciate the desire to be measured and thoughtful on this issue,
I fear that not taking a view at this time in the proposal may
function as an endorsement of the status quo. The request for
comment puts name give-up on a slower track than the rest of the
rule. Any rule to address the issue will now be well behind the
process for the rest of the SEF rules.
Conclusion
As outlined above, I have numerous concerns about this NPRM,
both in terms of what the Commission should do as policy makers, and
in terms of what the Commission can do under the law. Congress was
clear in the Dodd-Frank Act--the Commission is tasked with bringing
greater pre-trade transparency to the swaps market. Today's NPRM not
only fails to advance pre-trade transparency, it actually undermines
pre-trade transparency that has been achieved through our existing
regulations. In addition to the few issues I raise today, the NPRM's
changes also demand thoughtful deliberation on equally important
issues related to cross-border implications, investigations, audit
trails, recordkeeping, and disciplinary hearings to name just a few.
As I read through the NPRM, I noticed a common thread that
naturally aims to shift the current part 37 regime to a less
prescriptive, and more principles based regime. The frequent weaving
of words into the text of the NPRM like, defer, flexible,
reasonable, and discretion stand as a clear declaration of where
this proposal's authors want it to go. I have long been a proponent
of sensible principles based regulation. I believe our markets, and
more importantly this agency, are strongly rooted in a principles
based regulatory regime. However, like the words of this NPRM, I
have woven my own thoughts on striking the right balance between
principles based and rules based regulation. Principles based
regulation certainly does not mean an absence of rules--or the
absence of supervision.
In remarks I delivered in February of this year, I stated, ``. .
. [w]hile I strongly oppose any roll backs of Dodd-Frank
initiatives, I believe a principles-based approach to implementation
can be suitable in certain instances. A principles-based approach
provides greater flexibility, but more importantly focuses on
thoughtful consideration, evaluation, and adoption of policies,
procedures, and practices as opposed to checking the box on a
predetermined, one-size-fits-all outcome. However, the best
principles-based rules in the world will not succeed absent: (1)
Clear guidance from regulators; (2) adequate means to measure and
ensure compliance; and (3) willingness to enforce compliance and
punish those who fail to ensure compliance with the rules.'' \23\
---------------------------------------------------------------------------
\23\ Rostin Behnam, Commissioner, U.S. Comm. Fut. Trading
Comm'n, Remarks of Rostin Behnam before FIA/SIFMA Asset Management
Group, Asset Management Derivatives Forum 2018, Dana Point,
California (Feb. 8, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam2.
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If the Commission was voting on a final rule today, my vote
would be no. However,
[[Page 62144]]
I fully recognize that our existing part 37 rules are not perfect.
Bringing more activity on SEF is a laudable goal, both from a policy
perspective and because Congress has tasked the Commission with
doing so. I will support today's proposed rule because I believe
that it is important that we hear from market participants regarding
what aspects of the NPRM will improve the regulatory framework for
SEFs, while staying within our responsibilities under the law.
Appendix 5--Dissenting Statement of Commissioner Dan M. Berkovitz
I. Summary of Dissenting Views
I respectfully dissent from the Commodity Futures Trading
Commission's (``CFTC'' or ``Commission'') notice of proposed
rulemaking regarding Swap Execution Facilities and Trade Execution
Requirement (the ``Proposal''). This Proposal would reduce
competition and diminish price transparency in the swaps market,
which will lead to higher costs for end users and increase systemic
risks.
The Proposal would abandon the commitments the United States
made at the G20 Summit in Pittsburgh in 2009 to trade standardized
swaps on exchanges or electronic trading platforms and is contrary
to Congressional direction in the Dodd-Frank Act and the Commodity
Exchange Act (``CEA'') reflecting those commitments. It would
retreat from the progress made by the Commission and the financial
industry in implementing those reforms.
The Proposal would reduce competition by cementing the oligopoly
of the largest bank dealers as the main source of liquidity and
pricing in the swaps markets. It would diminish transparency by
removing the requirement that highly liquid swaps be traded through
competitive methods of trading. By reducing competition and
diminishing price transparency, the Proposal would increase systemic
risks and lead to higher swaps prices for commercial and financial
end-users. Ultimately, the millions of Americans who indirectly
participate in the swaps market through their investments in
retirement accounts, pension plans, home mortgages, and mutual funds
will pay that higher cost. Finally, the Proposal would provide SEFs
with too much discretion to set their own rules and in so doing,
weaken regulatory oversight and enforcement capabilities.
II. Major Flaws in the Proposal
The evidence is clear that the Dodd-Frank reforms, including the
Commission's swap execution regulations, have led to more
competition, greater liquidity, more electronic trading, better
price transparency, and lower prices for swaps that are required to
be traded on regulated platforms. Numerous academic studies and
reports by market consultants have documented these benefits.\1\ The
Proposal ignores this evidence and analysis.
---------------------------------------------------------------------------
\1\ See infra section II.
---------------------------------------------------------------------------
The Proposal would jettison the regulatory foundation for the
way swap execution facilities (``SEFs'') currently operate. It would
delete the requirement that swaps that are subject to the trade
execution mandate (``Required Transactions'') be traded either on
Order Book or by a request for quote from at least three market
participants (``RFQ-3''). This would undermine the Congressional
directive in the Dodd-Frank Act that for Required Transactions, a
SEF provide multiple participants with ``the ability to execute or
trade swaps by accepting bids and offers made by multiple
participants in the facility or system.'' \2\ Consequently, the
Proposal would lead to less price transparency and less competition.
---------------------------------------------------------------------------
\2\ 7 U.S.C. 1a(50).
---------------------------------------------------------------------------
The Proposal also would gut the impartial access requirement in
the Dodd-Frank Act. The statute requires SEFs to establish rules
that ``provide market participants with impartial access to the
market.'' \3\ Authorizing discrimination based on the type of entity
will permit the largest bank-dealers to establish and maintain
exclusive pools of liquidity for themselves. By denying other market
participants access to the most favorable prices in the dealer-to-
dealer market, bank dealers can prevent others from cost-effectively
competing with them for customers. Eliminating competition will
result in higher prices for customers. Permitting large banks and
dealers to discriminate in this manner is inconsistent with sound
economic principles underpinning competitive markets and the CEA's
impartial access requirement.
---------------------------------------------------------------------------
\3\ 7 U.S.C. 7b-3(f)(2)(B)(i).
---------------------------------------------------------------------------
In pursuit of the goal of ``flexibility'' for SEF markets, the
Proposal deletes, reverses, or waters down many key trading, access,
and compliance requirements for SEFs. The wide latitude that would
be granted to SEFs as to how swaps may be traded, who may trade
them, the oversight of the marketplace, and the conduct of the
brokers looks very much like the ``light-touch'' approach to
regulation that was discredited by the financial crisis.
Seven years ago, as the Commission was formulating the current
regulations, very little data was available on swap trading and
pricing. But now, after six years of experience with those
regulations, we have an extensive amount of data, collected by SEFs
and swap data repositories. The Commission should base its
regulatory decisions on this data and the studies and literature
that have analyzed this data and demonstrated the benefits of the
current swap trading requirements.
Unfortunately, the Proposal does not consider the available data
and market studies that demonstrate the current RFQ-3 system is
working well to provide highly competitive prices and low
transaction costs. For example, the Proposal ignores the following
studies and conclusions:
CFTC economists' study (2018).\4\ This study, conducted
by four CFTC economists, concluded: ``Judged from our evidence, SEF-
traded index CDS market seems to be working well after Dodd-Frank--
dealers' response rates are high, the vast majority of customer
orders result in trades, and customers' transaction costs are low.''
\5\ With respect to the most liquid CDS index swaps, the CFTC
economists found that ``the average transaction cost is
statistically and economically close to zero.'' \6\
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\4\ Lynn Riggs (CFTC), Esen Onur (CFTC), David Reiffen (CFTC) &
Haoxiang Zhu (MIT, NBER, and CFTC), Swap Trading after Dodd-Frank:
Evidence from Index CDS (Jan. 26, 2018) (``CFTC Economist Study'').
\5\ Id. at 50.
\6\ Id. at 43.
---------------------------------------------------------------------------
Bank of England Staff Working Paper (2018).\7\ This
Bank of England paper concluded that the CFTC's trade execution
mandate, including the RFQ-3 requirement, has led to a ``sharp
increase in competition between swap dealers'' in dealer-to-customer
transactions for interest rate swaps subject to the mandate.\8\ The
study concluded that this competition had led to ``a substantial
reduction in execution costs,'' amounting ``to daily savings in
execution costs of as much as $3-$6 million for end-users of USD
swaps.'' \9\
---------------------------------------------------------------------------
\7\ Evangelos Benos, Richard Payne & Michalis Vasios,
Centralized trading, transparency and interest rate swap market
liquidity: Evidence from the implementation of the Dodd-Frank Act,
Bank of England Staff Working Paper No. 580 (May 2018) (``Bank of
England Study'').
\8\ Id. at 31.
\9\ Id. The authors explain that during this period these EUR-
mandated swaps were not traded on SEFs due to the fragmentation of
the EUR swaps market. Id. at 28.
---------------------------------------------------------------------------
Study of ``Market Structure and Transaction Costs of
Index CDSs'' (2017).\10\ This study found that prices customers
obtained in the dealer-to-customer market through the RFQ system
often were better than the prices that were available on the
interdealer Order Book.\11\ ``[O]ur results show that the current
market structure delivers very low transaction costs. . . .\12\
---------------------------------------------------------------------------
\10\ Pierre Collin-Dufresne, Benjamin Junge & Anders B. Trolle,
Market Structure and Transaction Costs of Index CDSs (Sept. 12,
2017) (``Collin-Dufresne, Junge, and Trolle Study'').
\11\ Id. at 38.
\12\ Id. at 6.
---------------------------------------------------------------------------
The Proposal conjectures that novel ``flexible methods of
execution'' will benefit the trading of all swaps. The Proposal,
however, does not identify any trading methodology that can provide
lower costs than the RFQ-3 method as applied to interest rate swaps
and index CDS subject to the current trade execution mandate. In
discarding the trading requirements for Required Transactions to
bring more swaps onto SEFs, the Proposal throws the baby out with
the bathwater.
Today, a small number of large dealers provide liquidity to the
swaps market. Five very large banks were party to over 60 percent of
interest rate swap transactions.\13\ Liquidity in highly
standardized swaps is fragmented between a dealer-to-dealer market
and a dealer-to-customer market. There are no non-dealers in the
dealer-to-dealer market. This high degree of reliance on a few large
bank dealers to supply liquidity to all swaps market participants
presents systemic risks as well as other types of risk that arise in
highly concentrated markets.
---------------------------------------------------------------------------
\13\ Quantifying Interest Rate Swap Order Book Liquidity,
Greenwich Associates, Q1 2016 (``Greenwich Report''), at 8.
---------------------------------------------------------------------------
One of the fundamental purposes of the CEA is to ``promote
responsible innovation
[[Page 62145]]
and fair competition among boards of trade, other markets and market
participants.'' \14\ It is the CFTC's mission, and incumbent upon
this agency in carrying out that mission, to ensure that there is
fair competition among all market participants. This means ensuring
no market participant or limited group of participants has excessive
market power. Market structure and price competition should develop
in the interest of all market participants, rather than in the
interest of just a few of the largest banks. The Commission should
strive to remove the existing barriers to broader participation and
fair competition in the swaps markets. In my view, the Proposal
seeks to perpetuate existing barriers.
---------------------------------------------------------------------------
\14\ 7 U.S.C. 5(b).
---------------------------------------------------------------------------
III. Targeted Reforms To Consider
The current system is not perfect; there are flaws that should
be addressed. But the evidence is clear that the current system has
provided substantial benefits over the unregulated system that
existed prior to the financial crisis and the Dodd-Frank reforms.
The Proposal would return the swaps market to the dealer-dominated,
trade-however-you-want system heavily reliant on voice brokers that
existed prior to the financial crisis. At the G20 Summit in
Pittsburgh in 2009, the United States made an international
commitment to move away from the dealer-dominated, voice-brokered
approach and Congress expressly rejected the dealer-dominated,
flexible approach when it adopted the Dodd-Frank Act.
My sense from working with and talking to swap market
participants is that many do not see a need for a major overhaul of
the swaps regulatory framework. The benefits of the current system
are due not just to the regulations, but also are the result of
major efforts and investments by market participants and operators
of SEFs in electronic trading technology and personnel. Many market
participants do not want to deal with another round of costs and
uncertainties that wholesale regulatory changes will generate. They
believe the current system is working, despite its flaws. They
prefer that we consider more targeted reforms to address specific
issues with the current system, rather than scrap the current system
entirely. They do not want to face the possibility that the
Commission will continue to engage in a repetitive cycle of de-
regulation and re-regulation.
Rather than completely rewrite the SEF regulatory structure, and
turn our back on the progress made in transparency and competition,
I favor a more limited, data-based approach to build on our progress
and improve upon the current structure. This could be accomplished
by removing some of the unnecessary barriers to greater
participation on SEFs. Banks and other swap dealers play a critical
role in providing liquidity. We need them to participate. However, a
highly concentrated dealer oligopoly is not a prerequisite for
sufficient liquidity. We should seek ways to bring in more sources
of liquidity and competition. Robust competition leads to healthier
markets and improves the overall welfare of all market participants.
I support the goal of bringing more types of swaps onto the SEF
trading environment. I could support a more narrow approach to
achieve this goal that does not undermine the progress that has been
made to date.
I am not persuaded that we should continue to have two separate
pools of liquidity in the swaps market for all types of swaps,
regardless of liquidity characteristics--one in which the dealers
trade amongst themselves, and another in which the dealers trade
with customers. Perhaps we should look for ways to consolidate
rather than separate the swaps markets.
Specifically, I support considering the following regulatory
measures to improve competition in the swaps market:
Abolish Name Give-Up. The Commission should prohibit
the practice of name give-up for cleared swaps. On many platforms
that provide anonymous trading, the identity of a counterparty is
provided to the dealer after the completion of a trade. Name give-up
is a major deterrent to non-dealers seeking to participate on
dealer-only platforms as it provides the dealers with valuable
information about a counterparty's positions. Name give-up is a
relic of the pre-Dodd-Frank era when most swaps were not cleared and
the identity of the counterparty was necessary to manage credit
risks.
Expand Floor Trader registration. The Commission should
amend the floor trader provision in the swap dealer definition to
remove overly restrictive conditions. This would permit a wider
range of proprietary traders to provide liquidity and compete with
large bank dealers on price.
Revise capital requirements. The Commission should work
with the prudential regulators to ensure that capital requirements
do not unduly restrict the availability of clearing services by
futures commission merchants (``FCMs''). The current capital
requirements have had the unintended consequences of discouraging
FCMs from providing additional clearing services to the cleared
swaps market.
Enable average pricing. The Commission should work with
market participants and facilities to enable buy-side firms to
obtain average pricing for buy-side swap trades. Although average
pricing is available for futures, it currently is not available for
swaps, which limits the direct participation of buy-side asset
managers on SEFs.
We should explore these and other ways to increase competition
in the swaps market rather than retreat from the progress that has
been made. What follows is a more detailed explanation of how the
current regulatory system has improved the swaps market and how the
Proposal would undermine those improvements.
IV. Specific Concerns With the Proposal
The Proposal raises the following specific concerns:
Less competition
Less transparency
Higher prices for end-users
Diminished CFTC supervision and enforcement abilities
A. Less Competition, Less Transparency, and Higher Prices
The first three concerns--higher prices, less competition, and
less transparency--arise from the repeal of two critical and inter-
related provisions of the current regulations.
Elimination of Order Book/RFQ-3. The Dodd-Frank Act sets forth a
Rule of Construction that the goal of the SEF regulations is ``to
promote the trading of swaps on swap execution facilities and to
promote pre-trade price transparency in the swaps market.'' \15\ A
key requirement facilitating the statutory goal of pre-trade price
transparency is that all Required Transactions must be traded by
Order Book or RFQ-3.\16\ Under RFQ-3, a customer must request quotes
from at least three dealers prior to entering into a transaction. In
this manner, dealers must compete on price.
---------------------------------------------------------------------------
\15\ 7 U.S.C. 7b-3(e).
\16\ 17 CFR 37.9. In the 2013 rulemaking adopting the current
SEF regulations, the Commission explained the rationale for this
requirement: ``[T]he Commission believes that an RFQ System, as
defined in Sec. 37.9, operating in conjunction with a SEF's minimum
trading functionality (i.e., Order Book) is consistent with the SEF
definition and promotes the goals provided in [CEA Section 5h(e), 7
U.S.C. 7b-3(e)], which are to: (1) Promote the trading of swaps on
SEFs and (2) promote pre-trade price transparency in the swaps
market. The Commission notes that the RFQ System definition requires
SEFs to provide market participants the ability to access multiple
market participants, but not necessarily the entire market, in
conformance with the SEF definition.'' Core Principles and Other
Requirements for Swap Execution Facilities (``2013 SEF
Rulemaking''), 78 FR 33476, 33496 (June 4, 2013).
---------------------------------------------------------------------------
The Proposal would delete the Order Book/RFQ-3 requirement, even
for swaps already traded on SEFs and subject to the trade execution
requirement. Instead, the Proposal states that ``a SEF may utilize
`any means of interstate commerce' for purposes of execution and
communication, including, but not limited to, the mail, internet,
email and telephone.'' \17\
---------------------------------------------------------------------------
\17\ Notice of proposed rulemaking, Swap Execution Facilities
and Trade Execution Requirement (``Proposal''), section IV.I.4.b.
---------------------------------------------------------------------------
Authorizing discrimination; eviscerating impartial access. Next,
the Proposal flips on its head the impartial access requirement. CEA
section 5h(f)(2)(B)(i) requires a SEF to ``provide market
participants with impartial access to the market.'' \18\ Under
existing Commission Regulation 37.202, which implements this
statutory provision, any SEF criteria governing access must be
``impartial, transparent, and applied in a fair and non-
discriminatory manner.'' \19\ In the 2013 SEF rulemaking, the
Commission explicitly rejected a proposed interpretation that would
permit SEFs to discriminate against types of market participants.
``[T]he Commission believes that the impartial access requirement of
Core Principle 2 does not allow a SEF to limit access to its trading
systems or platforms to certain types of [eligible contract
participants (``ECPs'')] or [independent software vendors
(``ISVs'')] as requested by some commenters. The Commission notes
that the rule states
[[Page 62146]]
`impartial' criteria and not `selective' criteria as recommended by
some commenters.'' \20\
---------------------------------------------------------------------------
\18\ 7 U.S.C. 7b-3(f)(2)(B)(i).
\19\ 17 CFR 37.202(a)(1).
\20\ 2013 SEF Rulemaking, 78 FR at 33508. The Commission also
stated that ``the purpose of the impartial access requirements is to
prevent a SEF's owners or operators from using discriminatory access
requirements as a competitive tool against certain ECPs or ISVs.''
Id.
---------------------------------------------------------------------------
The Proposal would replace this critical requirement and allow
each SEF to establish exclusionary criteria determining what types
of market participants are ``similarly situated market
participants'' that are allowed to trade on the SEF (let's call this
what it is, the ``Discriminatory Access Provision''). This approach
flips the statutory ``impartial access'' requirement on its head by
empowering SEFs to build limited liquidity pools for a select few
market participants such as the dealers seeking to hedge with each
other.
Under the Discriminatory Access Provision, it is reasonable to
expect that the large bank swap dealers would encourage
discriminatory SEF participation criteria such that only large bank
swap dealers would be ``similarly situated market participants''
able to participate in dealer-to-dealer liquidity pools. Proprietary
trading firms and smaller dealers provide competition to the large
banks in pricing swaps, and are one major reason customers are able
to obtain favorable prices through the current RFQ process. If
discrimination is permitted, these other types of firms would not be
able to use the dealer-to-dealer market to effectively hedge or
offset trades with customers, and therefore would not be able to
compete with the large bank swap dealers in the dealer-to-customer
market. In this manner, the Discriminatory Access Provision would
result in a significant loss of competition in the dealer-to-
customer market, which ultimately would result in higher prices for
end users.\21\
---------------------------------------------------------------------------
\21\ It is unclear under the Proposal what happens to market
participants subject to the SEF trading requirements who are not
given access to a SEF because of the Discriminatory Access
Provision.
---------------------------------------------------------------------------
If the current trade execution requirement is repealed, dealers
also could establish single-dealer platforms and call them SEFs to
siphon liquidity away from the RFQ platforms. The dealers wield
significant market power in the swaps market. Five dealers currently
account for nearly two-thirds of the interest rate swap market,
which is the largest swap product category.\22\ Although SEFs that
currently offer RFQ-3 functionality might continue to do so even if
the requirement is repealed, once the customers are no longer
required to use that functionality, the dealers could undermine the
effectiveness of the RFQ process by offering incentives to trade on
single-dealer platforms or voice-brokered SEFs. This outcome would
reduce liquidity for the RFQ platforms. In the long run, draining
liquidity from RFQ-3 platforms to single-dealer or voice-brokered
systems will result in less direct competition between dealers, less
transparency, and higher costs for customers.\23\
---------------------------------------------------------------------------
\22\ Greenwich Report at 8. One market participant has commented
on the ability of the dealers to determine market structure through
the exercise of their market power:
``There is no commercial explanation for having a market that is
not open to a lot more people. It just doesn't make any sense. But
the ability of people to enforce change outside the incumbent
dealers is very limited,'' says the expert. ``The part that
frustrates me more than anything is pretending that the leverage of
the incumbent dealers over this market isn't real. When I hear
people talk about the natural market evolution, I would contend that
progress has been 100% prevented to date.''
Robert Mackenzie Smith, US swap trading overhaul may reinforce
market split, users warn, Risk.net, Mar. 21, 2018, https://www.risk.net/derivatives/5440516/us-swap-trading-overhaul-may-reinforce-market-split-users-warn.
\23\ In the equities market, the forced transition away from a
market centered around multiple dealers improved prices
substantially. See, e.g., Michael J. Barclay, William G. Christie,
Jeffrey H. Harris, Eugene Kandel & Paul H. Schultz, The Effects of
Market Reform on the Trading Costs and Depths of Nasdaq Stocks,
Journal of Finance, Vol. 54, Issue 1, at 1-2 (1999) (``Our results
indicate that quoted and effective spreads fell dramatically without
adversely affecting market quality.'').
---------------------------------------------------------------------------
The Proposal asserts that all-to-all markets are ``inimical'' to
``fundamental'' swaps trading features.\24\ The Proposal also states
that ``market participants have rarely used Order Books to trade
swaps on SEFs,'' and that ``this low level of swaps trading on Order
Books is attributable to an Order Book's inability to support the
broad and diverse range of products traded in the swaps market that
trade episodically, rather than on a continuous basis.'' \25\
Following a brief discussion of why the Order Book is unsuitable for
some swaps, the Proposal states that the Order Book should be
eliminated for all swaps: ``[B]ased in part on its experience, the
Commission proposes to eliminate the minimum trading functionality
requirement and the regulatory Order Book definition.'' \26\
---------------------------------------------------------------------------
\24\ Proposal at section VII.A.1.a.
\25\ Id. at section IV.C.2.
\26\ Id.
---------------------------------------------------------------------------
Similarly, the Proposal eliminates the RFQ requirement because
it states that this method of execution may be unsuitable for some
additional types of swaps that are currently traded off SEF. ``[T]he
Commission believes that [Order Book and RFQ-3] would not be
suitable for the broad swath of the swaps market that would become
newly subject to the trade execution requirement.'' \27\
---------------------------------------------------------------------------
\27\ Proposal at section IV.I.4.b.
---------------------------------------------------------------------------
This reasoning is flawed. From the proposition that an Order
Book may be unsuitable for some episodically traded swaps, it does
not follow that an Order Book is unsuitable for all swaps, even
highly liquid ones. Nor does it follow from the proposition that the
RFQ process may be unsuitable for some swaps that it should be
removed for all swaps. Yet this flawed logic appears to be the
rationale for the elimination of both the Order Book and RFQ-3
functionality requirements, even for highly liquid standardized
swaps.\28\
---------------------------------------------------------------------------
\28\ In the Cost-Benefit Considerations, the Proposal
acknowledges that ``the overall amount of pre-trade price
transparency in swap transactions currently subject to the trade
execution requirement may decline if the Order Book and RFQ-to-3
requirement[s are] eliminated. This potential reduction in pre-trade
price transparency could reduce the liquidity of certain swaps
trading on SEFs and increase the overall trading costs.'' Proposal
at section XXIII.C.
---------------------------------------------------------------------------
RFQ-3 has improved competition and lowered trading costs.
Empirical evidence demonstrates that the Order Book/RFQ-3 and
impartial access requirements for standardized, highly liquid
cleared swaps have increased competition and transparency and
brought low trading costs to swap markets. The Bank of England Study
found that the RFQ-3 requirement significantly improved liquidity
for U.S. dollar interest rate swaps, which reduced swap execution
costs for end-users by an estimated $3 to $6 million per day
relative to Euro swaps, which were not traded pursuant to the trade
execution mandate.\29\
---------------------------------------------------------------------------
\29\ Bank of England Study at 31. As discussed further below,
the Proposal appears to consider liquidity solely in terms of total
volume of trades. The Bank of England Study measures liquidity using
various price dispersion measures complemented by a price impact
measure and a bid-ask spread. See id. at 4. This measure of
liquidity better assesses how liquidity affects efficient execution,
pricing, and timing of trading.
---------------------------------------------------------------------------
The Bank of England Study also assessed the impact of the SEF
trading mandate on dealer market power.\30\ The study found that,
prior to the SEF trading mandate, 28 percent of customers for U.S.
and Euro interest rate swaps that became subject to the mandate
dealt with only a single dealer, and over 50 percent of customers
dealt with three or fewer dealers.\31\ After the SEF trading
requirements went into effect, those percentages dropped to 8
percent and 20 percent, respectively.\32\ The study states that
``[w]ith the improvements in pre-trade transparency, customer search
costs have fallen and it has become easier for customers to trade
with the dealer showing the best price.'' \33\
---------------------------------------------------------------------------
\30\ Id. at section 5.
\31\ Id. at 26.
\32\ Id.
\33\ Id.
---------------------------------------------------------------------------
Other studies have found similar results. Collin-Dufresne,
Junge, and Trolle compared the prices on the Order Books used in the
interdealer market with the prices generated in the dealer-to-
customer market through the RFQ system. The authors found that
prices customers obtained in the dealer-to-customer market through
the RFQ system often were better than the prices that were available
on the interdealer Order Book.\34\
---------------------------------------------------------------------------
\34\ Collin-Dufresne, Junge, and Trolle Study at 38.
---------------------------------------------------------------------------
Economists in the CFTC's Office of Chief Economist examined data
regarding the customer trading of index CDS on the Bloomberg and
Tradeweb SEFs, which are the leading SEFs for dealer-to-customer
trading.\35\ The CFTC economists found that very little customer
trading occurred on the Central Limit Order Book (``Clob'') of
either facility, but rather that most of the trading occurred either
by RFQ or by request-for-streaming (``RFS'').\36\ Focusing on
customer
[[Page 62147]]
trading through the RFQ mechanism, the CFTC economists found that,
on average, a customer requests quotes from 4.1 dealers and gets
back 3.6 responses.\37\
---------------------------------------------------------------------------
\35\ The study reports that, according to the SEF Tracker, at
the time of the study, Bloomberg held a market share of 71% and
Tradeweb held a market share of 13.6%. CFTC Economist Study at 2.
\36\ Under RFS, customers ask multiple dealers to send
indicative quotes in a continuous manner, and can respond to one of
them by proposing to trade at the dealers' quote.
\37\ Id. at 17. The study also found that customers are more
likely to request quotes from dealers with whom they have a clearing
or pre-existing trading relationship, although customers realize
small actual price benefits from requesting quotes from relationship
dealers. Id. at 5.
---------------------------------------------------------------------------
The CFTC economists concluded that the current regulatory
structure is working well: ``Judged from our evidence, SEF-traded
index CDS market seems to be working well after Dodd-Frank--dealers'
response rates are high, the vast majority of customer orders result
in trades and customers' transaction costs are low.'' \38\
Specifically, the CFTC economists found that transaction costs were
low for index CDS contracts:
---------------------------------------------------------------------------
\38\ Id. at 50.
The transaction costs of on-the-run CDX.NA.IG and iTraxx Europe
have a mean around 0.2 bps and a standard deviation of 1.4 bps, so
the average transaction cost is statistically and economically close
to zero. For on-the-run CDX.NA.HY and iTraxx Crossover, the average
costs are larger, at about 0.5 and 1.1 bps, but again not
significant compared to their standard deviations of about 2.6 and
3.5 bps. The first off-the-run contracts have comparable average
transaction costs but a much higher standard deviation due to the
relatively few number of trades in these contracts.\39\
---------------------------------------------------------------------------
\39\ Id. at 43.
Market participants have expressed similar concerns about
removing the Order Book/RFQ-3 and impartial access requirements. One
senior executive at a trading firm recently stated that the SEF
regulations have helped halve the bid-offer spread in US dollar
swaps and increased price competition. ``My fear is we take too big
a step back from having the competitive pricing in the market,'' he
said. ``It is still a dealer-controlled market and if the biggest
dealers simply say: `Great, I don't have to put a competitive price
on the screen anymore, and if someone wants my most competitive
price then you've got to pick up the phone again,' I don't want to
take that step backwards.'' \40\
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\40\ Robert Mackenzie Smith, Sef reforms could distort new,
sounder benchmark rates, Risk.net, Oct. 19, 2018, https://www.risk.net/derivatives/6049931/sef-reforms-could-distort-new-sounder-benchmark-rates (remarks of Stephen Berger, Managing
Director, Government and Regulatory Policy, Citadel).
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Similarly, the CEO of one SEF cautioned, ``[o]ne of the risks of
this concept of `any means of interstate commerce' is you have
benchmarks and fixings that rely on better liquidity coming in from
liquid Clobs. You wouldn't want to go backwards in that respect.''
\41\
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\41\ Id. (remarks of Scott Fitzpatrick, Chief Executive Officer,
Tradition SEF).
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In 2016, Greenwich Associates reported that ``the buy side feels
the executions they are receiving under the current paradigm are
sufficient, if not excellent.'' \42\ Greenwich Associates noted
that, for many asset managers, sending a request for quote to three
market participants and selecting the best-priced response (no
matter how many respond) ``has long been considered an appropriate
approach to achieving best execution.'' \43\
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\42\ Greenwich Report at 7.
\43\ Id. at 11.
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The Proposal does not reference any of these findings or views
of market participants. In contrast to these data-based empirical
studies regarding the benefits of the current regulatory system, the
Proposal speculates--without any evidentiary support--that the
``flexibility'' afforded by the elimination of the Order Book/RFQ-3
requirement may provide various benefits. For example, the Proposal
asserts ``SEFs would have broader latitude to innovate and develop
new and different methods of execution tailored to their markets.''
\44\ The Proposal further opines that these new, flexible methods
``could be more efficient,'' ``may lead to reduced costs and
increased transparency,'' and ``may provide opportunities for new
entrants in the SEF market.'' \45\
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\44\ Proposal at section XXIII.C.4.b(1) (emphasis added).
\45\ Id.
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However, the Proposal provides no factual basis for any of these
hypothetical benefits. In light of the very low execution costs that
have been documented for interest rate and index CDS swaps traded
through RFQ-3, it is difficult to understand why RFQ-3 should be
eliminated, at least for the swaps to which it currently applies.
Effect of expanded trading mandate on liquidity. The overriding
rationale for the Proposal is to attract greater liquidity formation
to SEFs. The Proposal seeks to accomplish this goal by expanding the
SEF trading requirement to include all mandatorily cleared swaps for
which SEF trading exists, with several exceptions. Although the
Proposal would expand the trade execution mandate in this manner, it
also would eliminate the Order Book/RFQ-3 requirements and provide
effectively unlimited flexibility as to the trading methods for all
swaps subject to the expanded trading mandate. The Proposal broadly
asserts, without providing any evidentiary support, that the
expanded trading mandate will improve liquidity and pre-trade price
transparency and reduce market fragmentation.
In asserting that the expanded execution mandate will increase
on-SEF liquidity, the Proposal appears to measure liquidity solely
in terms of volume. But volume does not equal liquidity. It is not
apparent how simply moving this volume from off SEF to being traded
within a SEF will have any effect on other traditional measures of
liquidity, such as cost of transaction or price dispersion. Indeed,
the only difference is that the swaps would be traded on SEF, but by
the same people and using the same methods that they now use to
trade them off SEF. It is not apparent how this would lead to any
greater price transparency or lower costs.
How many and what types of swaps would be brought onto SEFs
under the expanded trading mandate? The Proposal presents little
data to answer this question. One approach would be to assume that
all swap transactions that are currently subject to clearing would
become subject to the expanded trading mandate under the Proposal.
This amount may be significantly larger than the actual result
because many swaps subject to clearing may not be easily traded on
SEF. But by comparing this amount to the amount of swaps currently
traded on SEF, we can estimate an upper bound on the incremental
increase in on-SEF trading resulting from the Proposal.
The Proposal notes that an estimated 57% of the notional amount
of interest rate swaps are being traded on SEF, and that 85% are
subject to the clearing requirement. Accordingly, an upper bound of
about 28% of interest rate swaps could be moved on SEF under the
Proposal.\46\ This estimate is consistent with a recent estimate
provided by Clarus that approximately two-thirds of the fixed/float
USD interest rate swap market is traded on SEF.\47\ Examining the
one-third of interest rate swaps that are being traded off SEF,
Clarus found that ``[g]enerally speaking, everything off-SEF is
bespoke.'' \48\
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\46\ Using the same method, available data from ISDA indicates
that only about 4-5% of index CDS that are currently subject to
mandatory clearing are not currently traded on SEF. See SwapsInfo
Full Year 2017 and Fourth Quarter 2017 Review, ISDA, at 13-14 (Feb.
2018).
\47\ What is Left Off-SEF, Clarus Financial Technology (Mar. 16,
2016), https://www.clarusft.com/what-is-left-off-sef/.
\48\ Id.
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Again, it is not apparent how moving the trading of bespoke
swaps from being traded by introducing brokers (``IBs'') outside a
SEF to being traded by swap trading specialists inside a SEF will
have any effect on the prices of those bespoke swaps. It is even
less apparent how the trading of these bespoke swaps within a SEF
will have any impact upon the trading of the highly liquid
standardized swaps already being traded within a SEF under the RFQ-3
methodology. In fact, eliminating RFQ-3 for those liquid swaps could
raise the prices for those swaps, and in turn may also negatively
impact pricing for less liquid swaps, because most interest rate
swaps--including bespoke swaps--are priced in part on a standard
rate curve developed from prices for liquid swaps at various point
along the curve.
Other impacts from excessive flexibility and discretion. The
Proposal establishes an overly flexible approach that allows each
SEF to self-determine how it will operate in almost every respect.
Among other areas, a SEF would use discretion (a word used over 150
times in the Proposal) to tailor policies and procedures regarding
trading procedures and rules, access, pre-execution communication,
personnel oversight and ethics training, SEF compliance
requirements, trading surveillance, error trade policies, record
keeping, trade documentation, internal investigations and
enforcement, setting fees, financial resource requirements, and
supervision of third party services. Most of these changes would
loosen current regulatory requirements.
Documentation of executed swaps would no longer be required at
the time of execution, but as soon as technologically
[[Page 62148]]
possible. The Proposal acknowledges that creating flexibility for
execution methods and trading technology makes simultaneous
documentation ``impracticable.'' \49\ In other words, moving away
from electronic trading back to telephones will delay the time
within which counterparties receive full confirmation of price and
terms, preventing precision in the time of pricing, creating a
higher likelihood of errors, and leading to less pre-trade price
transparency.
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\49\ Proposal at section IV.F.2.b.
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Many of the changes in the Proposal would allow the SEF to
exercise discretion in brokering trades and establishing rules to
facilitate broking away from electronic platforms. The Proposal
explains that one of the reasons for granting the SEF greater
discretion is to allow voice-broking to occur directly within the
SEF.
Traditional introducing broking, by its nature, is slower and
less transparent at establishing prices as compared to electronic
trading. As a broker calls around to multiple dealers for prices,
the broker might make trade adjustments over time and prices from
one call to the next may change. As time passes, prices may become
stale, even within seconds. Dealers and other liquidity providers
will add a cushion to the spread to account for this delay. This
means that as the length of time increases between when a quote is
first received and when the trade is executed and the price is
reported, spreads become wider and pricing becomes less transparent.
For certain trades, such as block trades, timing delays in price
transparency might be appropriate for reasons related to the unique
nature of each trade. However, we should not be adopting regulations
that would degrade the current level of transparency for liquid
swaps that are being efficiently traded using an Order Book or RFQ
system.
Similarly, the Proposal would allow extensive pre-trade
negotiation for all swaps so long as the SEF defines it into the
SEF's trading rules. Pre-trade negotiation may be appropriate for
certain bespoke or large sized swaps. However, to create flexibility
in SEF trading methods, the Proposal would allow SEFs to include
pre-trade negotiations for any and all types of swaps including
standardized swaps currently traded electronically. However, the
Proposal would allow SEFs to include pre-trade negotiations for more
liquid, standardized swaps for which pre-trade price transparency is
better achieved through electronic trading, as explained in the
studies discussed above.
In addition, the Proposal would allow SEF trading specialists,
when acting as brokers, to exercise discretion in sharing different
market information with different market participants. The Proposal
acknowledges that this ``trading discretion exercised by SEF trading
specialists may affect the manner in which market participants are
treated on a facility.'' \50\ The Proposal suggests that this is
somehow ``consistent with impartial access'' because it facilitates
more trading. More likely, this greater degree of sanctioned
discretion--the extent of which is largely left up to the SEFs to
determine--would lead to unfair treatment of different market
participants and less pre-trade price transparency because SEF
trading specialists can decide who gets what information pre-trade.
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\50\ Proposal at section VII.A.1.a(1)(iii).
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The statements above should not be interpreted as critical of
intermediary broking services. These services provide important
options for trading and pricing certain types of swaps, such as
bespoke swaps, package trades, and block sizes. Rather, my concern
is that these important services and the professionals who provide
them may become less regulated, and that they will become
intermediaries for transactions that are required to be traded
electronically.
B. Diminished Oversight and Enforcement
I am also concerned that this Proposal waters down the robust,
and uniform, standards of conduct and supervision to which it
currently holds SEFs, IBs, associated persons (``APs'') of IBs, and
other market participants. This could lead to SEFs reducing their
focus on compliance, require the Commission to take on an enhanced
oversight role, and constrain the Commission's ability to
investigate and prosecute abusive trade practices involving SEFs.
As previously discussed, this Proposal grants extensive
discretion to SEFs to create rules governing their operations and
does away with some of the specific compliance and recordkeeping
obligations currently required by the regulations governing SEFs,
set forth in Part 37 of the Commission's Regulations.\51\ The
Proposal suggests that providing SEFs with greater flexibility to
tailor their compliance and oversight programs will mitigate
compliance challenges that SEFs have encountered in implementing
part 37, yet fails to describe in any detail those challenges.\52\
On the other hand, we know that our current system of oversight
provides market participants and regulatory authorities with uniform
and descriptive standards of conduct and compliance procedures.
Enumerating these standards (1) prevents a race to the bottom, in
which market participants pare back their policies and procedures to
the bare minimum, and (2) provides the registrant and the Commission
with the tools they need to successfully enforce compliance with
those standards.
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\51\ 17 CFR part 37.
\52\ Proposal at section I.C.
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As an example, the Proposal would remove the requirement set
forth in Regulation 37.203(c) that a SEF establish and maintain
sufficient compliance staff and resources to (i) conduct specific
monitoring, including audit trail reviews, trade practice and market
surveillance, and real-time market monitoring; (ii) address unusual
market or trading events; and (iii) complete investigations in a
timely manner. Rather, the Proposal would only require that the SEF
establish and maintain sufficient compliance staff and resources to
ensure that it can fulfill its self-regulatory obligations under the
CEA and Commission Regulations. Without specific requirements on
what compliance resources are needed, each SEF will be free to
determine what level of resources is sufficient for such a broad
mandate. In essence, the SEF need not map its compliance resources
to specific compliance tasks. Additionally, experience has shown
that conducting oversight and examinations of the sufficiency of a
registrant's compliance resources is more difficult to undertake on
a standard and fair basis across registrants when each one has a
different view of what resources will meet the generalized
requirement.
As another example, the Proposal eliminates the specific
requirements that a SEF establish an annual audit trail review and
related enforcement program, and retain certain categories of
documents currently required by Regulation 37.205. The Proposal
assumes, however that ``SEFs would continue to fulfill their
information collection burdens in a manner similar to the status
quo.'' \53\ If the expectation is that SEFs will continue to comply
with the current requirements, then why is it necessary to remove or
weaken them? Many still view the compliance function as a cost
center. It is unrealistic to assume that we can remove many of the
specific conduct and recordkeeping obligations and expect that
market participants will continue to comply, when competitive market
pressures will drive the allocation of resources elsewhere.
Moreover, market participants have dedicated significant resources
to developing these compliance policies and systems, and changing
them without sufficient justification does not make practical sense.
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\53\ Proposal at section XXIII.B.1.f.
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As a final example, the Proposal removes some of the specific
requirements in Regulation 37.204 for oversight of third-party
regulatory services. SEFs would no longer be required to conduct
regular meetings with, and periodic reviews of, service providers or
provide records of such oversight to the Commission. Instead, SEFs
are given broad latitude to determine the necessary processes to
supervise these providers. When registrants delegate critical
functions to third-party providers, it is imperative that the
registrant maintain diligent supervision over the provider's
handling of these functions.\54\ In my view, the Proposal does not
provide satisfactory reasons for removing these unambiguous
requirements, considering that doing so could hamper the
Commission's ability hold SEFs accountable for supervising third-
party providers.
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\54\ See, e.g., In re AMP Global Clearing LLC, CFTC No. 18-10,
2018 WL 898755 (Feb. 12, 2018) (consent order) (charging registrant
with failing to supervise diligently its information technology
provider's implementation of registrant's information systems
security program); In re Tillage Commodities, LLC, No. 17-27, 2017
WL 4386853 (Sept. 28, 2017) (consent order) (charging registrant
with failing to supervise diligently its fund administrator's
operation of the registrant's bank account containing participant
funds).
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Equally concerning is the sweeping change the Proposal makes to
the way in which SEFs and their employees and agents will be
registered, and in turn, the Commission's oversight of their
conduct. Under the current system, swaps broking entities that meet
the definition of an IB must be registered with
[[Page 62149]]
the Commission as such. The individuals who are involved in
soliciting or accepting orders at IBs, or involved in supervising
such individuals, must register as APs of IBs. As NFA members, IBs
and APs are not only subject to the applicable Commission
Regulations, but are also subject to uniform rules governing swaps
brokering, trade practices, reporting, minimum financial
requirements, proficiency testing, training standards, and
supervision. In addition, NFA monitors IBs' swaps broking activity
and compliance with all applicable statutes and rules. In
furtherance of that responsibility, NFA conducts periodic
examinations of swap IB member firms and has the ability to
discipline IBs and APs where appropriate.
Under the Proposal, which limits the activity that can be
conducted off SEF, IBs will need to register with the Commission as
SEFs to continue to broker swaps transactions. Given that the
majority of IBs engaging in swap transactions on SEF are affiliated
with SEFs, it is likely that many of these entities, or their
employees, will merge into or join the affiliated SEF. We can also
expect to see the formation of new SEFs, which presumably would not
be required to register as IBs.\55\ SEFs and SEF employees would be
free to withdraw their IB and AP registrations and memberships with
NFA, leaving a regulatory vacuum with no self-regulatory
organization oversight. Already strained Commission resources
inevitably would need to fill that void.
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\55\ The Proposal is not clear on whether an existing IB that
now must register as a SEF, but continues to primarily conduct phone
broking and other IB-related activities, and continues to meet the
IB definition, would need to be dually registered.
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Further, the Proposal creates an entirely new category of
persons: The SEF trading specialist. As proposed, SEF trading
specialists will perform ``core functions'' that facilitate swaps
trading and execution, including negotiating trade terms, arranging
bids and offers, and discussing market color with market
participants, or directly supervising a person who engages in such
functions. In fact, the Proposal notes that broadening the SEF
registration and trade execution requirements would increase the
level of discretion that these SEF employees and agents would
exercise in connection with swaps trading. However, despite these
key, customer-facing functions, SEF trading specialists would not be
required to register with the Commission.
For this reason, I am also concerned that the Proposal would
weaken the supervisory function within the SEF. Regulation 166.3
imposes a duty on all Commission registrants who act in a
supervisory capacity, including APs, to diligently supervise the
activities of employees and agents relating to their business as a
Commission registrant.\56\ However, if the SEF is not registered as
an IB, and its employees are thereby not registered as APs, the SEF
employees themselves will have no duty to supervise under Regulation
166.3. The Proposal imposes a separate duty on SEFs to supervise the
activities of its SEF trading specialists ``in the facilitation of
trading and execution on the swap execution facility.'' \57\
Critically, however, that duty runs only to the SEF as an entity and
not to its employees, including the SEF trading specialists. As a
result, SEF trading specialists or other SEF employees with
supervisory duties cannot be held individually liable for failure to
supervise under any Commission regulation if they are not duly
registered as APs of IBs. Individual accountability is an important
tool in incentivizing corporate responsibility and I think it must
be preserved.
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\56\ 17 CFR 166.3.
\57\ Proposal at section VI.A.3.f. Unlike Regulation 166.3,
which applies to all activities relating to a registrant's business,
the language ``in facilitation of trading and execution on the swap
execution facility'' is susceptible to various interpretations and
could considerably narrow the conduct that is required to be
supervised.
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Finally, in at least one instance, the flexibility afforded to
SEFs to establish a code of conduct for their SEF trading
specialists is in direct conflict with the supervision rules
applicable to all registrants under Regulation 166.3. The Proposal
states that a SEF's Code of Conduct ``may provide'' that, among
other things, a SEF trading specialist ``not engage in fraudulent,
manipulate, or disruptive conduct.'' \58\ However, Regulation 166.3
requires that Commission registrants establish and maintain
meaningful procedures for detecting and deterring fraud and other
prohibited conduct by their employees and agents.\59\ This could
create another potential gap in our supervisory structure that could
weaken the Commission's enforcement capabilities.
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\58\ Id. at section VI.A.3.e (emphasis added).
\59\ See, e.g., CFTC v. Sidoti, 178 F.3d 1132, 1137 (11th Cir.
1999); Sansom Refining Co. v. Drexel Burnham Lambert, Inc., CFTC No.
82-R448, 1990 WL 10830742 (Feb. 16, 1990) (registrant has ``a duty
to develop procedures for the `detection and deterrence of possible
wrongdoing by its agents.' ''). Moreover, various provisions of the
CEA and Commission Regulations prohibit fraudulent and manipulative
conduct, so adequate supervision necessarily dictates that entities
and supervisors monitor for this conduct. See, e.g., 7 U.S.C. 6b, 9.
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V. Conclusion
This Proposal is a fundamental overhaul of the SEF regulatory
regime. The changes create a trading system that is so flexible that
all swaps traded on SEFs--including the most liquid--could be traded
the same way they were before the Dodd-Frank reforms were adopted.
The Proposal would allow the largest dealers to establish separate
dealer-to-dealer liquidity pools through exclusionary access
criteria. Competition would be reduced and price transparency
diminished. This is not what Congress intended when it passed the
Dodd-Frank Act.
I am open to appropriate, targeted amendments to the
regulations, several of which I have suggested above. However,
empirical studies have shown that the existing SEF regulations have
made great progress in achieving the statutory goals of promoting
on-SEF trading and pre-trade price transparency. With respect to the
swaps markets that are working and providing low costs to the buy
side and end users, we should live by the adage, ``if it ain't
broke, don't fix it.''
[FR Doc. 2018-24642 Filed 11-29-18; 8:45 am]
BILLING CODE 6351-01-P
