External Meetings: Meeting with Bloomberg on pending SEF rule

Bloomberg came and discussed topics relating to the SEF rule that include, broadly, the futurization of swaps.  They emphasized that there should be parity between the swaps markets and the futures markets, including in matters such as margin, aggregation up to $8 billion, and block trading, so that there should not be more expensive transactions for end-users.  Tailored products can be done more cheaply on swaps than with multiple futures, in the abstract, but regulatory rules might make some swaps activity more expensive. 

Bloomberg stated that they were reflecting legitimate market concerns of some swap customers, emphasizing that their clients are evenly split between  buy- and sell-side participants.  Certain regulatory decisions could eliminate swaps and deprive end-users from the best price for hedging their risks.  They recognize that some futurization is natural, and contemplated by Dodd-Frank, but emphasized that there are many swaps – cleared products – that have equal liquidity and equal risk profile to futures and so should be treated similarly for regulatory purposes.

On margins, Bloomberg emphasized that the CFTC had authority to adjust margins and should do so for the cleared SEF world.  They emphasized that such relief should come before the March 11th clearing mandate.  If end-users are forced to a product that is a futures on swaps, and cleared swaps are not competitive as an economic alternative, large-scale futures entities might engage in anti-competitive behavior in the adjustment of margin.

Bloomberg raised the issue of the difficulty of new innovation in the cleared swaps space because the SEF rules are, by comparison with the futures world, proscriptive.  The differentials in cost of compliance and the trading protocols on swaps risks forcing everything into futures on swaps or into the uncleared OTC space.  Banks may trade swaps largely abroad, especially international banks, with US banks trading out of international affiliates.  The chain of effects won’t be immediate after the clearing mandate, but after two years, the drain on the domestic cleared swaps space of liquidity may be hard to fix.  There are real-world domestic impacts from overly prescriptive rules for the cleared swaps space, including higher mortgage costs from lower access to cleared swaps.  A prohibitively expensive cleared swaps market could also limit companies’ ability to raise money, causing a relative restriction generally in credit. In short, Bloomberg raised concerns that it says it is hearing from its customers that, in effect, the proposed SEF rule, in combination with some other rulemakings, may inadvertently be changing market structure more than the Commission may have intended.

Bloomberg offered possible solutions to various facets of its articulated concerns.   The commission could equalize real-time reporting between the cleared swaps and futures spaces.  Margin, Bloomberg said, should be tied to the liquidity of the contract, and if the liquidity is equal, then there shouldn’t be dramatic differences in margin.  It advocated that the Commission should, if it wished to stay with a more proscriptive approach to swaps, be equally proscriptive in its approach to futures on swaps.  It also observed that the Commission could avail itself more of the interim final rule process, so that adjustments could be made after the Commission finalized rules such as the proposed SEF rule.  Bloomberg emphasized that it is hearing from both the buy and sell side on this use of the futurization of swaps.   On block trades, Bloomberg stated there was no requirement in Dodd-Frank that the Commission itself had to specifically set block sizes.  It could let SEFs set the blocks by product, and look at the matter asset class by asset class.
XIII. SEF Registration,General,
CFTC Staff
Salman Banaei, Nancy Doyle, Omid Harraf
Chris Iacovella and Gregory Babyak (government relations, Bloomberg) and Nathan Jenner and George Baker (fixed income trading, Bloomberg)