May 16, 2013
Thank you Mr. Chairman. This is a momentous day for the Commission and market participants because we are finalizing long-awaited trade execution rules, and also for me personally because this is likely the last time I will participate in an open meeting to consider Dodd-Frank rules. It has been an incredible learning experience for me over the past three years, and although I think the Commission would have reached different conclusions on many of the foundational rules if we would have been consulted earlier in the process, I really appreciate all the time the staff has dedicated to this very challenging and often times overwhelming task we have been given.
Today we are considering rules on Swap Execution Facilities (SEFs), minimum block sizes for swaps, the process for making a swap available to trade under Section 2(h)(8) of the Commodity Exchange Act (Act), and guidance on how we will interpret the disruptive trading practices authority contained in Section 4c(a)(5). That is a lot of ground to cover, so my comments will be brief.
With respect to setting block sizes, I have acknowledged in the past the difficulty of establishing appropriate minimum thresholds. The goal is to promote transparency as much as possible without reducing liquidity in the various markets. The Commission cannot achieve this goal without appropriate data. When we proposed the block rules I applauded the team’s efforts to analyze the data that was available at the time in the interest rate and credit default swap asset classes, but noted that the team had access to only three months’ worth of data from 2010. Regrettably, we are relying on the same stale data to support the final rule. We are also finalizing the 67% notional amount formula, which, as I observed at the proposal stage would allow for only the largest 6% of all interest rate and credit default swaps to be executed as blocks, and we are applying the 67% formula across all asset classes. This approach, in my view, ignores Congress’ mandate that we take into account the impact of public disclosure on liquidity when setting block sizes. These are not one-size-fits-all markets, and we should not be adopting a one-size-fits-all approach. I appreciate that we will initially use a 50% notional amount formula in order to phase in the impact of the minimum block sizes, but the rules provide for an automatic adjustment to the 67% formula after one year no matter what the data may show at that time. Minimum block sizes should be driven by the most current objective data available, not an automatic across-the-board formula based on stale data.
My objections to the made available for trading rules also remain the same. A few minor revisions have been incorporated into the final rules, but, as proposed, the final rules provide that Designated Contract Markets (DCMs) and SEFs, rather than the Commission, will make the determination of when a swap has been made available to trade (MAT determination) by considering a list of factors that fail to contain any objective standards. Although we claim we will review certifications or requests for approval to determine whether a swap is “suitable” for the mandatory execution requirements, in fact, our hands are tied. Unless a MAT determination is inconsistent with the Act or our regulations, we must approve it, or deem it approved. But, because neither the Act nor the final rules contain any objective requirements that a swap must meet for a MAT determination to be valid, it is difficult to envision how we could ever find such a determination to be inconsistent with the Act or regulations. This approach allows a single SEF or DCM to bind the entire marketplace to a trade execution requirement as long as the swap must be cleared, even if liquidity is lacking. This is overly broad, potentially inconsistent with foreign regulations, and just plain bad policy. I suppose we are crossing our fingers and hoping that SEFs and DCMs will be reasonable when they make their MAT submissions and submit only highly liquid products that are truly suitable for the mandatory execution requirements, but I would not count on it.
My comments on the disruptive trading practices guidance relate to my hope that the guidance has clarified how we intend to apply this authority in our enforcement actions. Guidance should be helpful and not create more questions than it answers. While we have made some improvements in the final guidance, I think we could have been more helpful in some areas.
With regard to the SEF rulemaking, although a lot of noise has been made in the press about the request-for-quote (RFQ) number, I have a number of other concerns with the SEF final rules. As with many of our rules, we have gone beyond Congressional intent by imposing requirements not called for by the statute—the order book and RFQ requirements, to name just a few. Nothing in the statute mandates these minimum trade functionalities. We made them up. This puts us out of sync with the SEC and, I suspect, with foreign regulators when they finalize their rules. I am glad that we have lowered the RFQ requirement from five to two initially, but, as with the block rules, the SEF final rules provide for an automatic bump up to three after one year for all contracts that must be cleared, no matter what the data shows. We should base any decision to increase the RFQ requirements on objective data. There is no reason not to. We have taken a very narrow interpretation of what the statute allows and incorporated it into these final rules. I believe we will regret this restrictive approach because it may cause the U.S. to lose this business to foreign jurisdictions that do not stifle illiquid contracts in this way. I also have questions about why we have refused to contemplate a framework that would allow for exempt SEFs and exempt DCOs, which are clearly included in the statute. Although both concepts are mentioned in the preamble, we fail to give any commitment to develop a process for determining this exempt status.
I want to thank the entire Commission staff as well as my colleagues for their kindness and respect and wish them well as they continue their public service.
Last Updated: May 16, 2013