PUBLIC STATEMENTS & REMARKS

Joint Statement of Chairman Heath Tarbert, Commissioner Rostin Behnam, and Commissioner Dan Berkovitz in Support of Proposed Rule Restricting Post-Trade Name Give-Up

December 18, 2019

It is a hallmark of American exchange-style trading systems that the buyer and seller of a given financial instrument have no reason to know—and do not know—the identity of one another.[1]  Trading anonymity can be viewed as a great equalizer, leveling the playing field for counterparties of all sizes and types by allowing traders to enter and exit the market without exposing their trading positions and strategies.[2]  As a result, markets with pre- and post-trade anonymity are generally not only fairer, but also feature greater liquidity and greater competition between market participants.[3]

Before the adoption of central clearing for standardized swaps, post-trade disclosure of counterparty identities was the norm in swaps markets because of the need to manage counterparty credit risk.  For example, Party A would ask its broker to enter into a five-year interest rate swap to exchange a fixed payment for a floating rate.  The broker would find (often through another broker) Party B, who would be willing to take the other side of the swap. Post-trade, the identities of Party A and B would be revealed to one another.  A five-year bilateral relationship would thus ensue, wherein both parties would need to monitor their counterparty’s respective ability to make good on their obligations. But times have now changed.

The Dodd-Frank Act has encouraged—and in some instances required—centralized clearing for classes of swaps that are sufficiently standardized and liquid to be cleared through a central counterparty, i.e., a derivatives clearinghouse.[4]  As is the case for exchange-listed products, a cleared swap no longer exposes the respective parties to the risk of non-performance.  Rather than Party A and Party B being obligated to one another under the terms of the swap, the clearinghouse steps in between the parties to the trade and takes on the counterparty credit risk of both sides.[5]  Consequently, anonymous trading is now possible for large swaths of the U.S. swaps markets.

Yet a number of swap execution facilities (“SEFs”) still retain a vestige of the old bilateral over-the-counter markets, even for transactions that are centrally cleared: the practice of “post-trade name give-up.”  That is, the SEF will provide the identity of each swap counterparty to the other after a trade has been executed anonymously.  Given the advent of clearing, many have reasonably questioned the policy rationale for post-trade name give-up for cleared swaps, and still others have gone further, criticizing the practice as anticompetitive and an obstacle to broad and diverse participation on SEFs.

We support today’s proposed rule (“Proposal”) to prohibit post-trade name give-up for swaps that are executed anonymously via a SEF and intended to be cleared.[6]  We believe that the Proposal serves two key objectives of the Commission’s governing statute: (1) promoting swaps trading on SEFs[7] and (2) promoting fair competition among market participants, including through impartial access to a SEF’s trading platform.[8]  The Proposal could also help attract a diverse set of additional market participants who have been deterred from trading on these platforms by the practice of post-trade name give-up, but remain interested in bringing liquidity and competition to SEFs if there is a level playing field.

The Proposal is in large part based upon responses to the Commission’s November 2018 request for comment on post-trade name give-up.[9]  A large majority of commenters saw no sufficient justification for the practice with respect to cleared swaps, given the absence of counterparty credit risk attending such swaps.[10]  These commenters acknowledged arguments that dealers use the practice to allocate capital to preferred customers as part of an overall cross-marketing strategy.  However, they either did not find this rationale legitimate or believed that it does not justify potential harms resulting from name give-up.[11]

Commenters identified several such harms.  A principal concern was the risk of information leakage allowing counterparties to glean a SEF participant’s trading positions and strategies.[12]  Commenters also expressed concern that disclosure of counterparty identities could run counter to the “impartial access” requirement for SEFs.  Under this view, SEF participants can (and purportedly do) use name give-up to discriminate against counterparties whose trading practices they believe are harmful.[13]  A large majority of commenters stated that the concerns discussed above have inhibited buy-side participation on SEFs employing name give-up.[14]  In their view, prohibiting the practice would enhance liquidity on SEFs. Empirical studies on the effects of post-trade anonymity—in U.S. securities markets and in a wide range of foreign financial markets—bolster this view.[15]

We note that one response to the request for comment argued that post-trade anonymity could prompt dealers to withdraw from SEFs.  The comment expressed concerns that the prohibition could on net reduce liquidity on SEFs.[16]  Yet we have seen predictions of a drought in liquidity time and time again with respect to swaps regulatory reform.  For example, it was used to oppose the clearing requirement of the Dodd-Frank Act and the Commission’s 2013 SEF trading rules.[17]  Such predictions have not proven accurate thus far.[18]

Thus, to be persuaded that the Proposal would have net liquidity-reducing effects, we will need convincing evidence.  While we remain open to all commenters’ viewpoints, we currently believe that SEF trading that starts anonymous should remain anonymous.  This belief is consistent with the Commission’s past views regarding a swap that is executed anonymously on a SEF.[19]  Demonstrating otherwise will require more than hypothetical scenarios or anecdotal statements.

We look forward to reviewing comments on the Proposal and working with all external stakeholders to address this issue in a way that enhances SEF liquidity, ensures impartial access, and promotes increased and fair competition.[20]

 

[1] See, e.g., Peter A. McKay, CME and CBOT to Close Loophole, Wall St. J. (Apr. 15, 2006) (“When stocks are traded on public exchanges, investors generally don’t know who they are buying from or selling to. On futures exchanges, most investors expect the same thing when trading electronically.”).

[2] See, e.g., Peter Madigan, CFTC to Test Role of Anonymity in SEF Order Book Flop, Risk (Nov. 21, 2014) (noting arguments that anonymity creates a more egalitarian market); Managed Funds Association (“MFA”), Position Paper: Why Eliminating Post-Trade Name Disclosure Will Improve the Swaps Market 8 (Mar. 31, 2015) (arguing that “markets should remain anonymous to create a level playing field for all participants”); CFTC Market Risk Advisory Committee, Panel Discussion: Market’s Response to the Introduction of SEFs 139 (Apr. 2, 2015) (“MRAC Meeting Transcript”) (noting buy-side reticence to use SEF order books with name give-up because of potential uncontrolled information leakage); see also Testimony of Stephen Berger, Citadel LLC, Before the Subcomm. on Commodity Exchanges, Energy, & Credit of the H. Comm. on Ag., Hearing to Review the Impact of G-20 Clearing and Trade Execution Requirements (June 14, 2016) (testifying on behalf of MFA) (asserting that lack of post-trade anonymity “creates an uneven playing field and impairs competition”).  

[3] See, e.g., MRAC Meeting Transcript, supra note 2, at 154 (explaining that anonymous order books have facilitated liquidity and diverse participation in markets for other instruments, such as equities and futures); S. Freiderich & R. Payne, Trading Anonymity and Order Anticipation, 21 Journal of Financial Markets 1-24 (2014) (finding that post-trade anonymity improved market liquidity, particularly for small stocks and stocks with concentrated trading, which may be more analogous to swaps); T.G. Meling, Anonymous Trading in Equities (2018 working paper) (also finding that post-trade anonymity improved market liquidity); P. J Dennis & P. Sandas, Does Trading Anonymously Enhance Liquidity? (2019 working paper) (same); A. Hachmeister & D. Schiereck, Dancing in the Dark: Post-Trade Anonymity, Liquidity, and Informed Trading, 34 Review of Quantitative Finance and Accounting 145-177 (2010) (same); J. Linnainmaa & G. Saar, Lack of Anonymity and the Inference from Order Flow, 25 Review of Financial Studies 1,414-1,456 (2012) (same).

[4] Commodity Exchange Act (“CEA”) § 2(h)(8), 7 U.S.C. § 2(h)(8); see also Committee on Capital Markets Regulation, The Global Financial Crisis: A Plan for Regulatory Reform iii (May 2009), https://www.capmktsreg.org/wp-content/uploads/2018/10/The-Global-FInancial-Crisis-A-Plan-for-Regulatory-Reform.pdf (“If clearinghouses were to clear CDS contracts and other standardized derivatives, like foreign exchange and interest rate swaps, systemic risk could be substantially reduced by more netting, centralized information on the exposures of counterparties, and the collectivization of losses.”).

[5] See Robert S. Steigerwald, Federal Reserve Bank of Chicago, Central Counterparty Clearing, in Understanding Derivatives: Markets and Infrastructure (2013) (explaining that through novation, the original contract is replaced by two contracts, with the central counterparty becoming buyer to the seller and seller to the buyer).

[6] Of note, the proposed prohibition would not apply to trading protocols that involve pre-trade counterparty disclosure, such as a typical request-for-quote process.

[7] CEA § 5h(e), 7 U.S.C. § 7b-3(e).

[8] CEA § 3(b), 7 U.S.C. § 5(b) (listing fair competition among market participants as a goal of the CEA); CEA §5h(f)(2)(B)(i) (requiring a SEF to establish and enforce rules to provide participants impartial access to the market).

[9] CFTC Request for Comment on Post-Trade Name Give-Up on Swap Execution Facilities, 83 Fed. Reg. 61,571, 61,572 (Nov. 30, 2018).

[10] See, e.g., Investment Company Institute (“ICI”) Letter at 3; FHLBanks Letter at 2; Futures Industry Association Principal Traders Group (“FIA PTG”) Letter at 1; MFA Letter at 2; SIFMA AMG Letter at 14; Vanguard Letter at 2; Better Markets Letter at 2, 66. This seems particularly to be the case in light of pre-trade credit check and straight-through processing requirements that minimize the time between trade execution and acceptance for clearing.

[11] E.g., ICI Letter at 3; MFA Letter at 3; SIFMA AMG Letter at 14.

[12] E.g., FHLBanks Letter at 3; ICI Letter at 3-4; MFA Letter at 4; Vanguard Letter at 10.

[13] E.g., FIA PTG Letter at 1; ICI Letter at 3; MFA Letter at 4.

[14] E.g., ICI Letter at 3-4; MFA Letter at 4; SIFMA AMG Letter at 15; see also MRAC Meeting Transcript, supra note 2 (multiple panelists and committee members arguing that name give-up impairs buy-side SEF participation).

[15] See supra note 3. We note that at least one study of a U.S. securities trading platform found that post-trade anonymity had no impact on the quality of price quotes on the platform. K. Benhami, Liquidity Providers’ Valuation of Anonymity: The Nasdaq Market Makers Evidence (2006 working paper). Another study on the South Korea Exchange found that post-trade disclosure of the order flow of major brokers to the entire market improved liquidity. T. P. Pham et al., Intra-day Revelation of Counterparty Identity in the World’s Best-Lit Market (2016 working paper). On balance, however, the liquidity and other benefits of anonymous trading in financial markets appear well established.

[16] See Securities Industry & Financial Markets Ass’n (“SIFMA”) Letter at 1, 3-4. We also note the argument that post-trade anonymity allows participants to “game” the market. Under this scenario, a buy-side customer may undercut prices from dealers by posting aggressive orders to a dealer-to-dealer SEF’s order book, then soliciting dealers through a request for quote on a dealer-to-client SEF in the hope that the dealers will provide more favorable quotes based on the order book pricing. See, e.g., Request for Comment, 83 Fed. Reg. at 61,572; Tom Osborn, How to Game a SEF: Banks Fear Arrival of Arbitrageurs, Risk (Mar. 19, 2014); Madigan, supra note 2. We urge commenters to submit any evidence or indicia that such gaming is in fact occurring in other fully anonymous markets or would occur on SEFs if the proposed prohibition were implemented. We preliminarily believe that such conduct could constitute a disruptive trading practice or market manipulation prohibited by the CEA and potentially also subject to SEF disciplinary action. Such conduct may be best addressed by regulatory or self-regulatory authorities as appropriate, rather than via SEF participant “self-help” effectuated via name give-up.

[17] See, e.g., International Swaps & Derivatives Ass’n (“ISDA”), Swap Execution Facilities: Can They Improve the Structure of OTC Derivatives Markets? 14-15 (Mar. 2011) (arguing that proposed SEF rules would reduce liquidity); SIFMA, SIFMA Strongly Disagrees with CFTC’s Final SEF Rules (May 29, 2013) (same); Terry Flanagan, Wholesale Brokers Criticize CFTC, Markets Media (Oct. 3, 2011) (same).

[18] See, e.g., Lynn Riggs et al., CFTC, Swap Trading after Dodd-Frank: Evidence from Index CDS, at 6, 52 (Aug. 17, 2019) (finding that SEF-traded index credit default swap markets are working relatively well following the Dodd-Frank reforms, though there is always room for improvement); Evangelos Benos, Richard Payne, & Michalis Vasios, Centralized Trading, Transparency, and Interest Rate Swap Market Liquidity: Evidence from the Implementation of the Dodd-Frank Act, Bank of England Staff Working Paper No. 580, at 31 (May 2018) (finding liquidity improvement for swaps subject to the SEF trading mandate); ISDA Comment Letter on 2018 SEF Proposed Rule, at 2 (“Certain aspects of the current swaps trading framework work well, and there have been some enhancements in market functioning, including improved liquidity and pre- and post-trade price transparency.”); ISDA, SwapsInfo (Sept. 30, 2019) (finding that SEF-traded credit derivatives represented 78.4% of total traded notional and 79.7% of trade count, and SEF-traded interest rate derivatives represented 55.4% of total traded notional and 60.9% of trade count).

[19] Swap Data Repositories—Access to SDR Data by Market Participants, 79 Fed. Reg. 16,673 (Mar. 26, 2014).

[20] Our thanks to the staff of the Commission’s Division of Market Oversight (“DMO”), Office of the General Counsel, and Office of the Chief Economist who drafted and reviewed this proposal, particularly Aleko Stamoulis and Vince McGonagle of DMO.