November 18, 2015
I compliment the CFTC’s DSIO staff for today’s issuance of the preliminary staff report (Report) regarding which market participants should be regulated as swap dealers under the CFTC rule regime.
The Report is important for at least three reasons:
First, the Report confirms that the current and contemplated de minimis thresholds set by the Commission in 2012 are completely arbitrary. There is no policy basis whatsoever for the current threshold of $8 billion and no policy basis for lowering it to $3 billion. The Report provides no reason to believe that the threshold has anything to do with optimizing the safety, soundness, liquidity or vibrancy of U.S. swaps markets. The Report makes clear that $8 billion and $3 billion are just made up numbers.
Second, because the Report is so reliant on assumptions, it sheds very little light on the amount of swap dealing activity being conducted today in the marketplace. This is due to a fundamental shortcoming in the swap data repository data available for analysis – namely, it does not include fields indicating whether a transaction was entered into for dealing purposes. Given this baseline flaw, staff made a number of assumptions that may or may not be valid in an attempt to draw conclusions from the data.
Third, the Report shows that a drop in the swap dealer registration threshold from $8 billion to $3 billion would capture a significant number of market participants causing them to either register as swap dealers or reduce services to the marketplace. Yet, while expanding the CFTC’s reach over potentially more market participants, the lower threshold would not have an appreciable impact on coverage of the marketplace as measured by notional amount, transactions or unique counterparties. Thus, the drop in threshold would create unnecessary burdens for non-financial companies that engage in relatively small levels of swap dealing to manage business risk for themselves and their customers. Undoubtedly, it would have the effect of causing many non-financial companies to curtail or terminate risk-hedging activities with their customers, limiting risk-management options for end-users and ultimately consolidating marketplace risk in only a few large swap dealers. Such risk consolidation runs counter to the goal of the Dodd-Frank Act to reduce systemic risk in the marketplace.
The Report is preliminary in nature. It provides no recommendations to the Commission in advance of the de minimis threshold lowering to $3 billion automatically in December 2017 without a Commission vote. However, as I have said before, requiring that the Commission vote before a major shift in its regulations takes effect is a basic tenet of proper administrative law. In light of the incomplete data cited in the Report, I believe a vote to consider other alternatives to the automatic lowering of the de minimis threshold via a new rulemaking is absolutely necessary.
The issuance of this report is a reminder that the CFTC botched the policy analysis in 2012 when it implemented its current swap dealer registration de minimis rules. Dodd-Frank’s remedy for swap dealer counterparty risk is to move more swaps from bilateral to central counterparty clearing, not to make it more burdensome to transact cleared swaps. With the clearing mandate in place, the CFTC should only count a dealer’s remaining uncleared swaps towards the de minimis threshold for swap dealer registration and avoid imposing the ancillary costs and expense of CFTC regulatory compliance on cleared swaps activity.
In a future de minimis rulemaking, I would advocate for an exclusion from counting cleared swaps towards the registration threshold. As the Report recognizes, once a swap is cleared, the swap between the counterparties is extinguished and risk mitigation is performed by the clearing organization. If the true goal of Dodd-Frank is to reduce systemic risk, counting cleared swaps towards the registration threshold is of questionable value. Rather, counting only the level of uncleared swaps between two unrelated counterparties is the intellectually honest manner of proceeding. The Report appropriately asks for comment on this issue, and I encourage market participants to weigh in.
Last Updated: November 18, 2015