I am pleased to support today’s final rule amending Part 36 and Part 37 of the CFTC’s regulations relating to swaps.  These amendments codify staff no-action letters in two areas: (1) package transactions and (2) error trades.

Before the 2008 financial crisis, swaps were executed bilaterally “over the counter,” rather than on a centralized exchange.  When crafting the Dodd-Frank Act in 2010, Congress faced a key decision: Should it require swaps to trade like futures, via a centralized exchange order book visible to the entire market of potential buyers and sellers?  Or should it retain the old bilateral, off-exchange trading practices?

This was a difficult decision.  After all, the crisis highlighted the need for more effective price discovery in our swaps markets.[1]  For more than a century, centralized exchanges have supported price discovery in futures products by providing a liquid, transparent market for buyers (longs) and sellers (shorts) to come together and transact.  On the other hand, swaps are not futures.  Many swaps products are executed only episodically through the negotiation of bespoke terms.  In the 1990s and 2000s, this was done primarily through brokers and dealers providing quotes to one another on the telephone or over email.  Hence, anonymous electronic trading via a central limit order book (CLOB) has not been viable for much of the swaps market.[2]  Even relatively standardized swaps are not typically as liquid as futures contracts and historically did not trade via the CLOB as futures do.

The Creation of SEFs

Ultimately, Congress sought a golden mean that would balance these competing concerns.  The Dodd-Frank Act gave birth to the concept of swap execution facilities (SEFs).  SEFs are platforms on which certain standardized swaps are required to trade.[3]  They resemble centralized exchanges, but have more flexibility in execution methods to accommodate the unique trading characteristics of swaps. In this regard, Congress took an evolutionary rather than a revolutionary approach, recognizing that mandating too much change too quickly could diminish rather than foster liquidity.

In implementing this portion of the Dodd-Frank Act, the CFTC required swaps that must be executed on a SEF (on-SEF) to trade via the CLOB or a request for quote to at least three SEF participants (Required Execution Methods or Required Methods).[4]  By contrast, swaps voluntarily traded on-SEF may be executed by any method the parties choose.[5]

The SEF regulatory regime has generally worked well.[6]  But rarely is statutory implementation perfect on the first attempt.  Some requirements are suitable for the swaps market as a whole but are not a good fit for particular types of transactions.  CFTC staff has addressed such issues through a series of no-action letters, many of which have been in place for over six years.  With the benefit of this experience, now is the time to begin codifying these no-action letters, with tweaks and refinements where needed.

Through today’s action, we continue to strive for the golden mean that strikes the optimal balance between the features of the old bilateral swaps world and those of the anonymous, exchange-traded futures model.  In short, we aim to facilitate a natural progression toward more standardized and liquid products with tighter spreads.  At the same time, we recognize that certain products that benefit the market do not lend themselves to the Required Execution Methods.

Package Transactions

A “package transaction” typically involves multiple component financial instruments, to be executed simultaneously (or nearly so), with each component transaction contingent on the others.  Pricing for certain components of the package is often based on the prices of other components.  Some components may hedge other components.  Executing these instruments in package form can improve execution pricing and efficiency, reduce execution costs, and mitigate execution risk, as compared with executing each instrument separately (known as “legging” into the transaction).

In layman’s terms, a package transaction is conceptually similar to booking a flight and hotel for an overnight trip.  Each booking’s utility is contingent on the other—making concurrent booking desirable—and there are often opportunities to improve cost and efficiency by bundling the bookings through a travel broker. As a practical matter, the derivatives market is no different.

The final rule approved by the Commission today address package transactions that include both (1) one or more swaps that are required to trade on-SEF pursuant to the Required Execution Methods, and (2) one or more instruments that are not.  The Required Execution Methods are suitable for swaps required to trade on-SEF, when such swaps are executed as standalone transactions.  But when these swaps are executed as part of a package, they often take on the trading characteristics of the less-liquid instruments in the package, thereby making it unfeasible to execute these swaps via the Required Methods.

This is a part of the market that is itself evolving.[7]  However, several types of package transactions would include swaps that must trade via the Required Methods under CFTC rules, but currently cannot do so as part of a package.  And it is not clear that they will be able to do so in the foreseeable future.  Accordingly, today’s final rule codifies the no-action relief allowing swap components of those packages to trade through any execution method, provided that the trade occurs on-SEF.[8]  I support this approach because it recognizes the progress made toward centralized exchange-type trading for swaps without forcing the market too far ahead of its natural evolutionary process.   In addition, we must work to ensure our rules reflect actual market practice and functioning.

Error Trades

The CFTC, in accordance with the Commodity Exchange Act, has long taken a principles-based regulatory approach to the futures markets.[9]  In granting the CFTC jurisdiction over swaps, the Dodd-Frank Act did not repudiate this principles-based tradition, but instead reinforced it.  Section 733 of the Act sets forth core principles for SEFs and expressly affords SEFs “reasonable discretion” in determining how to comply.[10]

In this spirit, the amendments set out a principles-based approach to addressing error trades.  They give SEFs the flexibility to determine the most suitable error trade rules for their markets and participants. At the same time, as I have said repeatedly, principles-based regulation is not a euphemism for “deregulation” or a “light-touch” approach.[11]  Accordingly, under our amendments a SEF must require its participants to inform it of error trades and correcting trades, so the SEF can maintain orderly markets and guard against false error claims.[12]

Conclusion

Today’s action is in keeping with my recent directive on the use of staff letters and guidance, in which I noted that they should supplement rulemakings, rather than themselves function as rules.[13]  CFTC staff has provided important relief over the last six years, but we cannot rely on staff no-action relief to bridge the gaps forever.  I expect these amendments will provide certainty and clarity to SEFs and their participants, thereby advancing our strategic objective of enhancing the regulatory experience for market participants at home and abroad.

Furthermore, I remain open to dialogue on further fine-tuning of our SEF rules, consistent with Congress’s mandate as well as the CFTC’s priorities and resources.  I therefore will support finalizing additional rules in the near term that have the backing of a broad-based consensus of market participants and stakeholders. Swaps markets will benefit most from evolution, not revolution.

I am voting for the final rule establishing procedures for granting registration exemptions to foreign derivatives clearing organizations (Exempt DCOs) to clear swaps for certain U.S. persons (Final Rule).  The Final Rule exercises the exemptive authority provided by Congress in the Commodity Exchange Act (CEA)[1] in a limited, pragmatic manner that will provide U.S. financial services firms that operate globally with access to foreign clearinghouses and cleared swaps in order to more effectively manage the risks arising from their global operations.

In July of last year, I dissented from the proposed exempt DCO rule, because it also would have permitted Exempt DCOs to clear for U.S. customers, but only through foreign intermediaries.  In doing so, the proposed rule would have subjected U.S. customer accounts to foreign bankruptcy and other regulations, promoted the use of foreign intermediaries at the expense of U.S. firms, and exceeded this agency’s limited exemptive authority.[2]  Enabling U.S. customers to clear swaps and amass large positions in non-U.S. markets in this manner would not only pose risks to those customers, but also could have presented systemic risks to the U.S. financial system.

In response to commenters who expressed similar objections, the Final Rule does not contain the concerning provisions.  Neither registered FCMs nor their foreign intermediary counterparts can clear for U.S. person customers.  With respect to clearing for U.S. persons, the Final Rule restricts clearing by an Exempt DCO to only U.S. firms that become clearing members of the Exempt DCO along with certain of their affiliates and persons associated with those firms in the manner identified in the definition of “proprietary account” in section 1.3 of our regulations.  In addition, registered FCMs, including U.S. firms, can also clear at exempt DCOs, but only for themselves and persons associated with the FCMs in the manner provided in the definition of “proprietary account.”  These sophisticated market participants are well equipped to assess the risks of clearing swaps under the foreign regime.  Furthermore, by requiring that they be members of the Exempt DCO (or clear through an affiliate that is a member), the Commission assures that such entities have taken affirmative actions to assess and accept those risks.  The margin funds and related obligations of these persons must also be segregated from customer funds held by registered FCMs thereby minimizing any impact on U.S. customers of the cleared positions at Exempt DCOs.  These limitations are a reasonable, practical approach to implementing the authority provided to the Commission to exempt certain foreign DCOs without adding uncertain risk into our system of fully registered DCOs and FCMs.

Furthermore, the Commission has, on an ad hoc basis, previously granted registration exemptions to four foreign clearinghouses limited to proprietary swap positions with effectively the same conditions and limitations as provided in the Final Rule.  The Final Rule will therefore maintain consistency with the existing exemptions.

The Final Rule also contains fairly detailed daily, quarterly, and annual reporting requirements, as well as special event notice requirements.  These requirements allow the Commission to monitor U.S. person clearing activity at the Exempt DCO on a daily basis and keep the Commission informed of any material changes to the regulatory and financial status of the Exempt DCO in its home jurisdiction.  While the Exempt DCOs will be able to operate under the compliance regime and oversight of its home country regulator, the CFTC can maintain limited, but up-to-date oversight of the activities that are relevant for U.S. market participants and that could have an impact on our financial system.

As noted above, the Final Rule does not permit registered FCMs to clear U.S. customer swaps at Exempt DCOs.  In the Commission’s initial 2018 proposal to establish a framework for Exempt DCOs, the Commission proposed this prohibition.  The Commission explained:

Section 4d(f)(1) of the CEA makes it unlawful for any person to accept money, securities, or property (i.e., funds) from a swaps customer to margin a swap cleared through a DCO unless the person is registered as an FCM.  Any swaps customer funds held by a DCO are also subject to the segregation requirements of section 4d(f)(2) of the CEA, and in order for a customer to receive protection under this regime, particularly in an insolvency context, its funds must be carried by an FCM, and deposited with a registered DCO.  Absent that chain of registration, the swaps customer’s funds may not be treated as customer property under the U.S. Bankruptcy Code and the Commission’s regulations.  Because of this, it has been the Commission’s policy to allow exempt DCOs to clear only proprietary positions of U.S. persons and FCMs.[3]

The Final Rule notes that the Commission may revisit the prohibition on U.S. customer clearing in the future.  While I agree with the outcome in the Final Rule as to customer clearing given the Commission’s interpretation of CEA Section 4d(f), if the above interpretation changes, whether by a change to the statute or by other appropriate means, I could support a further amendment of the Final Rule.  Any such change should place U.S. FCMs on an equal footing with their foreign counterparts when competing for U.S. customer clearing at Exempt DCOs.  In addition, such a change should not create an advantage for unregistered Exempt DCOs over registered DCOs who comply with all of our regulations.

Finally, I note that CEA Section 5b(h) provides for the registration exemption if the foreign DCO is subject to “comparable, comprehensive supervision and home country regulation.”  Under the Final Rule, to demonstrate comparability, the DCO must be subject to home country regulations that are consistent with, and the DCO must “observe in all material respects,” the “Principles for Financial Market Infrastructures”[4] (PFMIs) applicable to central counterparties.

Several commenters objected to this approach to comparability determinations on a number of grounds.  These commenters stated that the Commission should not substitute a commitment to adhere to the PFMIs for its own examination and assessment as to the comparability and comprehensiveness of the actual foreign regulations.  As the PFMIs are only general principles, even when the PFMIs are implemented, material differences may exist between the PFMI-compliant regime and the Commission’s DCO core principles and regulations.  Commenters further argued that Congress intended for the Commission to analyze comparability only by direct comparison to the CTFC’s laws and regulations.

Over the past two years, I have expressed concerns over the erosion of the Commission’s standards and role in finding comparability for various CFTC regulations.  The Commission’s approach has been increasingly deferential to other regulators, which has the potential to permit the importation of increased risks into the U.S. financial system.

In this regard, I too have some concerns about the use of the PFMIs as a standard for comparability.  However, for the purpose of granting DCO registration exemptions, I believe the approach taken in the Final Rule is reasonable.  I have consistently said that comparability determinations should involve a detailed examination of the other jurisdiction’s standards, but also should be outcomes based.  Regulators around the world take substantively different approaches to regulating DCOs, but that does not mean any one approach is necessarily better or worse than another as to its expected outcome.  The PFMIs tend to be more general in nature than the DCO core principles and regulations in the CEA and CFTC regulations.  However, regarding the general outcome of DCO regulation, the PFMIs–which the CFTC has contributed to and incorporated in regulation[5]–are consistent with our DCO core principles.  Furthermore, given the limited scope of the Final Rule in that it applies only to clearing of proprietary positions, using the PFMIs to find comparability is not unwarranted.  Finally, the Final Rule allows for the Commission to assess the extent to which the home country regulations are consistent with the PFMIs and the extent to which the applying DCO is observing the PFMIs.  As such, I believe the approach taken in the Final Rule is reasonable.

In conclusion, the Final Rule creates a limited, practical set of policies and procedures for granting exemptions from registration for foreign DCOs.  The Exempt DCOs can only clear swaps for U.S. persons who are proprietary traders and who are able to assess the specific risks of clearing at the Exempt DCO.  The U.S. customer accounts at registered FCMs will not be commingled with accounts used for Exempt DCO clearing.  Finally, U.S. FCMs are not put at a competitive disadvantage to their foreign counterparts.  For these reasons, I support the changes made to the proposed rule that result in an appropriate, codified approach to exempting foreign DCOs who meet appropriate standards.

I support today’s final rule to codify the CFTC’s existing practice of exempting non-U.S. derivatives clearing organizations (DCOs) from registration, pursuant to a provision of the Commodity Exchange Act that allows for U.S. swap market participants to access comparably regulated foreign DCOs.[1]  That provision authorizes the Commission to defer to its counterparts abroad, which I believe properly conserves the Commission’s resources and enables firms to avoid duplicative regulation, while providing U.S. market participants with greater choice.  I am proud that today’s final rule provides yet another example of the CFTC deferring to foreign regulators that provide comparable regulation and supervision.  During my tenure as a Commissioner, the CFTC has properly provided such deference in many areas, including swap dealer (SD) registration,[2] uncleared swap margin requirements,[3] swap execution facilities (SEFs),[4] registered DCOs, [5] and foreign futures.[6]  Like these other actions, today’s final rule holds exempt DCO to a high regulatory standard.  Under the final rule, a DCO is only eligible for an exemption if its home country regulator ensures the clearinghouse complies with rules consistent with the internationally accepted “Principles for Financial Market Infrastructures” (PFMIs) issued by CPMI-IOSCO.[7]  Moreover, the exempt DCO must regularly provide the CFTC with margin information concerning U.S. clearing members, among other key information.[8]

I note that under the final rule, an exempt DCO will only be authorized to clear the proprietary positions of its U.S. clearing members.  I had supported and still support the Commission’s 2019 proposal that would have expanded the exempt DCO framework to allow for U.S. customers, like asset managers and insurance companies, to clear at exempt DCOs directly to better manage and hedge their risk.[9]  I continue to believe that all participants meeting the Commodity Exchange Act’s definition of “eligible contract participant”[10] have the resources, sophistication, and incentives to adequately assess how customer protections provided by an exempt DCO may differ from protections established by CFTC regulations for registered DCOs.  The CFTC should provide these market participants with the choice befitting their status, not only as sophisticated market participants, but as complex international organizations who need access to foreign markets, products, and a choice of liquidity pools.  I hope the Commission will continue to consider the best way to expand the exempt DCO framework to allow for U.S. customer clearing.

We are voting to approve a rule proposed in 2018 that codifies existing staff guidance by which the CFTC exempts derivatives clearing organizations (DCOs) from registration for the clearing of swaps.[1]  Pursuant to that guidance, we have exempted four clearinghouses that we determined are subject to “comparable, comprehensive supervision and regulation” by the clearing organization’s home country regulator.[2]  Codifying this framework through a notice-and-comment rulemaking is, frankly, good government.  And doing so is in keeping with my recent directive on the use of staff letters and guidance, in which I noted that staff guidance and letters should supplement rulemakings, rather than themselves function as rules.[3]  This approach has many benefits, including providing increased transparency.  It also furthers our strategic objective of enhancing the regulatory experience for market participants at home and abroad.

This rulemaking is a modest first step.  As is the case in the existing staff guidance, the rule does not permit exempt DCOs to clear for U.S. customers, but rather only for proprietary swap transactions for U.S. clearing members and futures commission merchants (FCMs).  It reflects the CFTC’s continued efforts to foster cross-border cooperation and show deference to home country regulation that is deemed comparable to our own regulations.

In 2019, the Commission issued a supplemental proposal that would have gone further and permitted exempt DCOs to clear swaps for U.S. eligible contract participants (ECPs) through foreign intermediaries.[4]  I would have supported finalizing that proposal for two reasons.  First, the proposal would have provided greater flexibility and choice to our most sophisticated U.S. customers—ECPs—to access swaps cleared at non-U.S. clearinghouses.  This would have given these sophisticated counterparties access to foreign-currency denominated instruments traded overseas that would enable them to hedge their various risks on a global basis.  Second, exempting clearinghouses that do not pose a substantial risk to the U.S. financial system is consistent with principles of international comity.

Because we have not worked through all the issues raised by the 2019 supplemental proposal to the satisfaction of our Commission, today we are adopting only the 2018 proposal.  Nonetheless, I support continued discussion on whether to permit Exempt DCOs additionally to clear certain non-U.S.-dollar denominated swaps for U.S. customers who are ECPs, either directly through foreign intermediaries or through U.S. FCMs.  Although registration as a DCO—under either our traditional or recently-established alternative framework[5]—should be the preferred route for most non-U.S. clearinghouses, there are likely circumstances where U.S. customers would benefit from access to additional risk-mitigating instruments offered overseas.

I support today’s final rule that codifies through rulemaking two issues concerning swap execution facilities (SEFs) currently addressed in staff no-action letters.  I am pleased that this final rule will provide market participants with much needed regulatory certainty in the areas of “package transactions” (a series of related transactions sometimes including non-swap components) and the correction of erroneous trades.  With the benefit of six-plus years of implementation experience, and multiple extensions of each of these no-action letters, it is long overdue for the Commission to codify and clarify its policy on each of these important issues.

With regard to package transactions, the amendments recognize the need to provide flexible means of execution for swaps that are negotiated and executed concurrently with other components of a larger, integrated transaction.  This flexibility has proved workable since 2014.[1]  In codifying current permissible practices with regard to the resolution of erroneous trades, [2] the final rule similarly permits SEFs to allow market participants to execute offsetting or correcting trades through any method of execution offered by the SEF.  These amendments will facilitate the prompt identification and correction of error trades, thereby minimizing market participants’ exposure to market, credit, and operational risks.

I have long disagreed with the overly restrictive mandate on permissible SEF methods of execution.  While Dodd Frank’s amendments to the Commodity Exchange Act define a SEF as a trading system facilitating multiple-to-multiple trading activity “through any means of interstate commerce,”[3] the CFTC saw fit to only allow for two methods (RFQ and CLOB) to be used in connection with a swap subject to the trade execution requirement (“Required Transactions”).[4]  By dictating how Required Transactions are executed, the current regime forecloses any number of alternatives that could create liquidity on SEFs and better address the highly variable, bespoke nature of many swaps.  I believe the Commission should follow the law and further expand the allowed methods of execution for Required Transactions to any form that is truly multiple-to-multiple, which would allow SEFs to experiment with new means of execution tailored to the bespoke liquidity of a wide variety of critical risk management products.  Similarly, in the area of block trades, I recently expressed concern when the Commission raised the block size threshold, thereby reducing the population of swaps that can be negotiated through alternative means.[5]

Lastly, I hope the Commission promptly finalizes additional provisions of the SEF ruleset that the Commission has proposed revising.  These areas include making more practical the SEF financial resources requirement and codifying an exemption from the trade execution requirement for swaps between affiliated counterparties. Resolving these issues through final rules will promote the liquidity and transparency of SEFs.

I support today’s final rule to amend parts 36 and 37 of the Commission’s regulations relating to the execution of package transactions and correction of error trades on swap execution facilities (SEFs).  The final rule will further, in a flexible and cost-effective manner, the Congressional goal of promoting the trading of swaps on SEFs.

Beginning in 2014, the Commission issued a series of no-action letters specifying permissible methods of execution for certain package transactions, which enabled the agency to phase-in the application of the trade execution mandate for these transactions.  As market infrastructure has evolved, the Commission has allowed portions of the relief for some package transactions to expire, leaving a narrow set of these transactions that still may be implemented through flexible methods of execution.  Based on experience, the Commission has determined that flexible methods of execution are currently more appropriate for packages in which at least one of the components is (1) a swap not subject to the clearing requirement; (2) not a swap; or (3) a swap for which the CFTC does not have exclusive jurisdiction.  Requiring that the swap components of these transactions be traded through the required methods of execution (i.e., Order Book or Request-for-Quote to a minimum of 3 counterparties) could force market participants to break up the package into their individual components, which would increase transaction costs and risks, and thereby defeat the economic purpose and efficiency of the package transaction.  Commenters supported the rule as proposed.  It is therefore appropriate for the Commission to codify that flexible methods of execution may be used for the swap components of this limited set of package transactions.

The final rule also exempts from the trade execution requirement swap transactions that are components of “new issuance bond” package transactions, and amends part 37 to provide flexibility in the execution methods a SEF may offer counterparties to correct clerical or operational errors.  While providing additional flexibility for resolving error trades, the rule limits the number of instances in which such errors may be corrected, and preserves important protections to guard against abuse.  Notably, the Commission requires market participants to provide prompt notice to a SEF of an error trade, enabling the SEF to conduct real-time market monitoring and fulfill other self-regulatory obligations.  In addition, the rule makes clear that a SEF must maintain rules and procedures that are fair, transparent, incentivize timely resolution of an error trade, and allow for such resolution without disclosing the identity of counterparties to one another where the swaps trading is subject to the post-trade name give up prohibition.

Given the tailored nature of these amendments and the appropriate safeguards, I support this final rule.  I thank the staff of the Division of Market Oversight for their work on this rule and their helpful engagement with my office.

I am voting for the final rule codifying certain limited exemptions from the swap clearing requirement that currently exist through Commission guidance or staff no action relief.  The exemptions are consistent with longstanding Commission policies.  Analysis of available historical data shows that the number and notional amount of swaps that would be exempted are relatively limited and not likely to materially impact systemic risk.  Furthermore, the swaps exempted from clearing will be subject to uncleared swap margin requirements, if applicable, thereby mitigating the risks of not clearing these swaps.

The final rule codifies in rule text exemptions for swaps entered into by foreign central banks, sovereign entities at the national level, and certain international institutions that previously have been exempted from the clearing requirement through no action relief or guidance.  In this regard, the final rule represents a proper exercise of international comity in recognition of the governmental nature and non-speculative purposes of these sovereign entities and international institutions.

The final rule also provides clearing exemptions for certain interest rate swaps of community development financial institutions, subject to a number of significant limits, and for swaps entered into by bank or savings and loan holding companies that have no more than $10 billion in consolidated assets.  In each case, the exemption only applies if the swap is used to hedge or mitigate commercial risks.  Congress provided in Commodity Exchange Act section 2(h)(7)(C) for an exclusion from the clearing requirement for banks and savings associations with less than $10 billion in assets to the extent determined by the Commission.  It is appropriate to apply this exemption to the holding companies of these financial entities.

One commenter, Better Markets, expressed concern that the number of entities that will now have an exemption from the clearing requirement has grown over time, leading to the potential for greater risk, reduction in liquidity in cleared markets, and complexity in managing the exemptions.  As described in the preamble to the final rule, swap data repository data indicates that over the past several years the number and scope of swaps entered into by these institutions that will be included within the exemptions has been relatively limited.  Given this data, these concerns, today, do not outweigh the benefits of the final rule.  However, the Commission should periodically review the SDR data to reassess whether the clearing requirement exemptions are cumulatively having a material impact on the extent of swap clearing given the intent of the Dodd-Frank Act.  The Commission can then evaluate whether, on a going forward basis, any changes to the exemptions may be warranted.

I commend the staff of the Division of Clearing and Risk for this well developed and drafted final rule.  The clarity and completeness of the final release helps establish a sound basis for the Commission to approve the final rule.

I am pleased to support this final rule, which codifies existing relief from the Commission’s requirement that certain commonly traded interest rate swaps and credit default swaps be cleared following their execution.[1]  The new exemptions may be elected by several classes of counterparties that may enter into these swaps, namely:  sovereign nations; central banks; “international financial institutions” of which sovereign nations are members; bank holding companies, and savings and loan holding companies, whose assets total no more than $10 billion; and community development financial institutions recognized by the U.S. Treasury Department.  Today’s final rule notes that many of these entities have actually relied on existing relief, electing not to clear swaps that are generally subject to the clearing requirement.  I strongly support the policy of international “comity” described in the final rule, recognizing that sovereign nations and their instrumentalities should generally not be subject to the Commission’s regulations.  I trust that by issuing this rule, the United States, the Federal Reserve, and other U.S. government instrumentalities will receive the same treatment in foreign jurisdictions.