February 23, 2012
On December 7, 2010, the Commission proposed a rule that attempted to: establish minimum block sizes for large notional off-facility swaps and block trades; and institute measures to protect the identities of parties to swap transactions.1 Unfortunately, that proposal was fundamentally flawed and received numerous critical comments from market participants. Recognizing that the proposal was beyond repair, the Commission wisely chose to withdraw the proposal and began anew. I commend my fellow commissioners and staff for having the wherewithal to admit error and to develop a new proposal. Unfortunately, the new draft, while a modification of the block formula, still fails to establish a realistic proposal that utilizes asset-specific data to develop reasonable block standards, rather than a one-size-fits-all solution.
Today, pursuant to section 727 of the Dodd-Frank Act, the Commission is putting forward a re-proposal (“Re-proposal”) that would establish methodologies for setting minimum block sizes for various swap categories.2 In establishing minimum block sizes, the Commission is required to take into account whether public disclosure of swap transaction and pricing data will materially reduce market liquidity.3 Further, the Re-proposal, under part 43 of the Commission’s regulations, creates a protocol to prevent the public disclosure of the identities, business transactions, and market positions of swap market participants.4 While the Re-proposal is an improvement over the 2010 proposal, it still suffers from defects. Though I appreciate that the proposal seeks commenters’ input, this alone cannot justify issuing the Re-proposal in this form. I would like to highlight two major concerns with the Re-Proposal.
First, I am troubled that the Commission has not attempted meaningful quantification of the costs of its many rulemakings, which deprives the public of transparency into their impact, in direct contradiction of two Executive Orders.5 I am concerned with the Commission’s contention that cost-benefit analysis is only required for those aspects of a proposed rule where the Commission exercises its discretionary authority, rather than the rule in its entirety. Contrary to Office of Management and Budget (“OMB”) guidance found in Circular A-4,6 the Commission refuses to establish the baseline for comparison of the costs and benefits of regulatory proposals by incorporating all of the costs of the statutorily-mandated rulemaking.
I am pleased that the Re-proposal has asked a number of questions to assess the real costs of this proposal and hope that market participants will avail themselves of the opportunity to submit data to assist the Commission in evaluating all of the costs and benefits of the Re-proposal. But even if the Commission receives informative comments about costs, it appears likely that the Commission will still limit its cost-benefit analysis to discretionary items and not quantify the costs of any congressionally-mandated provisions. The cumulative consequences of Congressional and Commission regulatory requirements impose significant costs on our markets and market participants, yet the Commission’s unsound approach understates the true impact of our rules. I firmly believe that the Commission has an obligation to quantify the full impact that our rules will have on our economy and to balance the regulatory objectives of the Dodd-Frank Act with economic growth.
Second, though the Re-proposal takes a more nuanced approach to setting minimum block sizes than the 2010 proposal, I am concerned that we still fail to differentiate among asset classes in setting minimum block sizes. In the post-initial period, the minimum block sizes in all asset classes will be set at sixty-seven percent of the notional value of trades.7 While this may make sense for certain trades within an asset class, the use of a one-size-fits-all approach cannot be the best that we can do. Even more problematic is the fact that this notional threshold is based solely on a substantive analysis of only three months of credit and interest data from 2010. While I recognize there are limitations to the data available to the Commission, using such an inapt data set containing such a small and stale amount of data to set minimum block sizes is very troubling, especially given that this threshold is applied to all five diverse asset classes. The Commission will soon have access to large amounts of reliable market data and we should scrutinize that data to find the proper point at which to set the minimum block sizes. We must recognize that we cannot rely on data that the Commission does not collect or employ mismatched data sets—an apples-to-oranges comparison—when trying to fine-tune appropriate block sizes. It is unwise to arbitrarily set the minimum block size threshold at sixty-seven percent for all asset classes. Each of these asset classes has distinct characteristics and trading styles which warrant a reasoned approach based on actual, reliable data. A more precise calibration of minimum block sizes in each asset class will ensure that liquidity is protected while increasing transparency and encouraging on-exchange trading. The Commission needs to adopt a more robust and analytically sound approach than simply placing block sizes at the same level for every asset class at sixty-seven percent of notional value.
Going forward, it is important that this rule also be developed in coordination with the Designated Contract Market Core Principals and proposal for the establishment of Swap Execution Facility rules in order to ensure the block rules are consistent with the new trade execution standards, including the use of reliable transaction data.
I look forward to reviewing the comments from market participants and hope they will provide their own analysis of the block rules and the impact the various options will have on liquidity. I want to ensure this proposal complies with Congressional intent to improve market transparency and real time reporting, while protecting liquidity and the identities of market participants. This rule must also comply with OMB Circular A-4 in developing a realistic cost/benefit analysis.
1 See Real-Time Public Reporting of Swap Transaction Data,75 FR 76,139, Dec. 7, 2010, as corrected in Real-Time Public Reporting of Swap Transaction Data Correction, 75 FR 76,930, Dec. 10, 2010.
2 See CEA Sections 2(a)(13)(E)(ii) and (iii).
3 See CEA Section 2(a)(13)(E)(iv).
4 See CEA Sections 2(a)(13)(E)(i) and 2(a)(13)(C)(iii).
5 See Exec. Order No. 13,563, 76 Fed. Reg. 3821 (Jan. 21, 2011); Exec. Order No. 13,579, 76 Fed. Reg. 41,587 (July 14, 2011).
6 OMB Circular A-4 , available at http://www.whitehouse.gov/sites/default/files/omb/assets/regulatory_matters_pdf/a-4.pdf
7 For the interest rate and credit asset classes—the only asset classes for which the Commission has market data— sixty-seven percent of notional value translates into approximately ninety-four percent of trades. Thus, the fact that ninety-three percent of trades will not be eligible for block treatment is only a slight improvement from the ninety-five percent threshold in the December 2010 proposal; and does not provide any guidance on where to set the threshold for other asset classes.
Last Updated: February 23, 2012