Two financial industry heavyweights -- the CME Group and the
Depository Trust & Clearing Corp. -- are in a war over the seemingly
mundane topic of derivatives data storage. While the subject matter sounds
unremarkable, the fight shows the difficulty the CFTC faces in bringing
competition to the swaps markets when a less competitive model from the listed
futures world offers a better regulatory tool. The collision between the
Dodd-Frank model of “open access” swaps markets and “closed access” futures
markets presents a stark choice for regulators: Enhance market competition or
regulate the derivatives markets in the best way possible.
Although Title VII of Dodd-Frank specifically directs that the
trading and clearing of swaps be done in an “open access,” or fully competitive
model, Congress and the CFTC have also chosen time and again to retain a
“closed access” model for listed futures, and they have done so with a complete
understanding of the limits their choices place on competition. Dodd-Frank did
not specifically extend the “open access” provisions to Swaps Data Repository
(SDR) services, and it did not condition or limit a “closed access” market
participant from using its futures-related assets to build a successful “open
access” market to trade or clear swaps. As such, CME is assertively seeking to
take advantage of the benefits its traditional marketplace can bring to its
success in the swaps markets.
DTCC characterizes that assertiveness as impermissible anticompetitive
behavior, in effect imprinting the “closed” practices from the futures world
onto the new “open access” market structure for swaps. DTCC, in its letter to
the CFTC opposing the CME’s proposed Rule 1001 -- which ties the choice of
using CME’s Swaps Data Repository to the decision to use CME’s clearinghouse
for a swaps trade -- dramatically describes its position as protecting “the
integrity of the Dodd-Frank Wall Street Reform and Consumer Protection Act’s
(‘Dodd-Frank Act’) primary objectives.”
The dispute over data storage raises a number of questions about
whether non-competitive practices long associated with the futures industry can
also become a feature of the OTC derivatives space as well. The answer seems to
be yes, as traditional restrictions on anti-competitive business practices meet
a complex new market structure. Given a wide-ranging statutory scheme such as
Title VII of Dodd-Frank, which is enforced by a fully empowered regulator --
the CFTC -- the regulator will decide competition issues in light of how they
impact the regulation of the markets and the safety of the investing public.
Competition concerns will not stand on their own in a black-and-white
determination of whether a new practice will be allowed in the absence of a
statutory mandate.
In the interest rate space, CME will likely clear the large
majority of swaps due to the benefits its customers will receive from margining
their swaps alongside CME’s pool of listed futures. Language in the proposed
rule, which requires approval by the CFTC, gives a customer discretion to ask
the CME to forward the same proprietary swap information to another SDR; but
the rule is silent about whether a customer that requests its data be moved
will incur extra costs in doing so, and thus be deterred from asking.
In the murky waters around competition in the derivatives space,
the CFTC faces two questions in deciding on Rule 1001: (1) Can the CFTC better
regulate the markets where most data -- at least for interest rate futures and
swaps -- is retained by a single entity, in this case the CME? And (2), can
CME’s cost structure be designed to protect users of its clearing services from
being disadvantaged by using the data sharing arrangement called for by Rule
1001?
Competition among SDRs is subordinated in Dodd-Frank to regulatory
interests. In the case of SDR regulation, Dodd-Frank empowers the CFTC to
fashion rules as it sees fit to meet its regulatory burden. The statute even
empowers the Commission to force any or all SDRs to report their data into a
centralized SDR, should that help it better regulate the markets (7 USC §24a(a)(c)(4)(a)).
It is almost inconceivable that the Commission would not be better off in
fulfilling its regulatory duties with a more concentrated deposit of swaps data
than a more dispersed one, especially given the weak customer concerns in
maintaining robust competition in data storage.
Unfortunately for DTCC’s position, the anti-competitive issues that
it raises are not particularly strong in the SDR context. DTCC’s argument over
data storage is a fight between competitors and their allies over issues that
have little, if any, bearing on the well-being of customers in the derivatives
markets. Derivative customers have no commercial interest in where their data
is stored for review by the CFTC, other than how much storage will cost at any
particular SDR. In contrast, customers have strong interests in choosing one
SEF over another, or one DCO over another, because execution and clearing
services are integral components of what makes a trade successful or not.
As to the issue of cost -- which is the only customer interest at
stake in this decision -- the CFTC could easily mitigate such concerns in order
to obtain a better regulatory result by conditioning Rule 1001 on the CME
waiving any fee it charges for SDR services, including transfer of data, to a
customer requesting a transfer. (To glimpse the type of power that regulators
have in controlling fees to maintain a “fair and orderly” market, consider the
SEC’s imposition of a fee cap of 30¢ on exchange fees in securities markets.)
DTCC has direct experience from its recent past in a conflict
between competitive concerns and regulatory interests. In the situation in
mind, DTCC (through its subsidiary FICC) received SEC approval to partner
exclusively with a single exchange to offer collateral reductions for that
exchange’s futures contracts when offset by U.S. Treasury Securities held in
DTCC’s utility clearing business. The SEC allowed DTCC to move forward because
it saw a regulatory benefit, notwithstanding the anticompetitive issues. (ELX,
of which I was then CEO, vigorously opposed DTCC’s proposed rules in that
venture). Regulatory interests -- even when not compelling -- can overcome
competitive concerns where markets are subject to a regulatory agency’s
oversight under broad statutory powers, as is the case with swaps regulation.
The CFTC, like the SEC,has the same opportunity to evaluate this case on the
merits of what is best for the market -- more aggregation of data in fewer
SDRs, or more fragmented availability of data in more SDRs.
In its role as the market regulator, the CFTC’s main focus will be
on whether Rule 1001 will enhance its ability to act upon trade and position
information for the benefit of the public. DTCC’s anti-competitive concerns are
indeed substantive, but they will not be evaluated in a vacuum. Rather, they
will be decided, and likely disposed of, in light of regulatory interests, the
relative lack of customer harm, as well as moving the pace of Dodd-Frank
regulation forward in a sensible and effective way.
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