The Commodity Futures Trading Commission faces a conundrum that impedes its
ability to create an efficient and cost effective solution to establish a
comprehensive data-set of interest rate swaps.
The lawsuit that CME has recently
brought against the CFTC highlights the issues facing a regulator to implement
an often poorly drafted statute. It also
highlights the disruption to the existing futures industry as it seeks to enter
and compete in the swap market. Before
describing the Catch 22, a review of the issues in CME v. CFTC is useful.
The Commission has determined that CME, as a registered Derivatives Clearing
Organization, or “DCO,” is obligated to report all swap data, including
proprietary customer information, to a third party Swap Data Repository, or
“SDR,” most likely the DTCC. Of all the
parties to compel the CME to report to, DTCC is among the most sensitive
competitive possibilities as DTCC currently competes directly with the CME on
interest rate futures clearing.
The CFTC is preparing to oversee a newly regulated world of swap
transactions for which it has little technical infrastructure already
established. In theory, having all swap
data aggregated through a single SDR could alleviate the cost, development
effort, and “time to market” for the Commission to employ a system to aggregate
data across many SDRs and DCOs in order to view the positions and exposures of
swap entities in a single location and format.
Section 20a(c)(4)(a) of the Commodity Exchange Act (Act) , 7 USC § 24a
(c)(4)(a) - Swap Data Repositories - explicitly allows the Commission the power
to require SDRs to send swap data, including proprietary data, to a central
SDR:
“A swap data repository shall—
(4) (A)
provide direct electronic access to the Commission (or any designee of the
Commission, including another registered entity);”
In governing the data requirements of SDRs, Section 20a of the Act
broadly empowers the Commission to establish data standards for SDRs’ public
price and transaction dissemination as well as for collection and retrieval of
proprietary data.
CME is contesting the Commission’s authority to require it as a DCO to
follow the Commission’s directives. The
suit makes two main claims: (1) the Commission’s
regulation requiring CME to report non-public swap data to an SDR violates the Commodity
Exchange Act by requiring a DCO to perform actions that are outside the
statute’s allowable area of regulatory authority; and (2) the Commission failed to perform a sufficient
cost-benefit analysis even if the regulation is otherwise permissible.
The CME’s Complaint highlights the various and clear distinctions in the
CEA governing the duties of a DCO with respect to sharing transaction data for
cleared swaps with SDRs. Specifically,
the CME draws a bright line between providing price and basic reporting
information to an SDR for contemporaneous public reporting (a market data
function) versus providing detailed information of proprietary client
information, such as name, counterparty, clearing firm, account designation,
etc. As paragraph 70 of the Complaint
states,
“CEA Section
5b(k) unambiguously requires DCOs to make nonpublic regulatory reporting of
cleared swap data available to the CFTC.
Section 5b(k) does not mention SDRs.”
As the CME points out in its Complaint, it has outstanding with the
Commission an application to be designated as an SDR. However, the Commission has not approved the
CME’s application, and has so far indicated that without changes to the CME’s proposed
operating rules as an SDR it is not inclined to give its approval.
It appears that the Commission’s most straightforward solution to the
claims leveled in the lawsuit would be to grant the CME its application to be
an SDR, and then use the powers given to the Commission under Section 20a
a(c)(4)(a) of the Act to require the CME as an SDR, and not as a DCO, to report
swap data to a designee. In the case of
interest rate swaps presumably that designee would be the DTCC. Of course, even if CME were designated as an
SDR it might still litigate to avoid sharing proprietary information with a
competitor.
However, litigating as an SDR, and not as a DCO, would appear to considerably
weaken the CME’s arguments. First, Dodd
Frank grants the Commission clear statutory authority to require “SDR to SDR”
reporting, but does not grant the CFTC specific authority to require “DCO to
SDR” reporting of proprietary swap data.
The CME’s “cost-benefit” argument
would also be weaker. Unlike the recent federal
court ruling against the Commission (ISDA v. CFTC) on position limits - where
the court found an unambiguous requirement in Dodd Frank to justify the
imposition of position limit regulations on hard data - in this instance, Dodd
Frank does not appear to make a similar fact-finding condition a prerequisite of
regulation. In addition, the Commission presumably
could make a clear showing of the heavy impact on its own costs, as well as
causing delay to implement a core statutory purpose of Dodd Frank, should it
not designate interest rate swap reporting to a central depository.
The CME’s lawsuit describes a standoff between it and the CFTC over the
issue of the Commission’s view of the competitive requirements of Dodd Frank as
they pertain to the CME’s application for designation. According to the CME’s Complaint:
“57. The FAQ
also makes clear that a DCO cannot require, through agreement or otherwise,
market participants to select the DCO’s SDR or an affiliated SDR: “Market
participants may choose to use a. . . DCO’s SDR for reporting swap
transactions, but a.. . DCO as part of its offering of trading or clearing
services cannot require that market participants use its affiliated or
‘captive’ SDR for reporting.”
58. CFTC staff
has taken the position that CME must amend its SDR application to show
compliance with the FAQ before staff will recommend approving the application.
This piece is not intending to pass judgment on the merits of the
Commission’s position with respect to the CME’s application to be an SDR. However, while Dodd Frank requires the
Commission to take steps to not promote anticompetitive conduct, the statute
also circumscribes the authority of the Commission to compel sharing of proprietary swap data other
than between registered SDRs.
The Commission’s Catch 22, it appears, is to approve the CME’s SDR
application, notwithstanding its competitiveness issues (which of course might
prompt other lawsuits from other parties), or to limit its ability to create an
efficient, cost-effective mechanism to centralize interest rate swap data –
which is critical to the success of its Dodd Frank mandate to understand,
monitor and regulate swap exposure.
Will the CME amend its SDR application to satisfy the Commission’s
concerns while its lawsuit is pending and likely to be successful? Will the CFTC justify approving an SDR
application that it believes is problematic in order to quickly get the
technology solution to implement a rational method of interest rate swap data
collection?
As I said: a conundrum.
Meanwhile swap dealers that cover all sorts of asset classes get to deal with figuring out integration with a bunch of 3rd party APIs, and in this case the CME is vapor ware so there is no endpoint for a ton of data...
ReplyDeleteThe real-life operational issues must be a nightmare.
DeleteActually it looks like DTCC should be able to accept data across all asset classes, unfortunately someone put some eggs in the CME basket and left them there. Time to switch gears it seems.
Deleteoh look at that, no-relief action blamed on Sandy. Well, whatever it takes I spose
ReplyDeleteA careful selection of available market instruments must done to arrive at the best curve possible.
ReplyDelete