CFTC Unveils Proposed New Oversight Regime For Swap-Trading Platforms

U.S. regulators unveiled a proposed new oversight regime for the trading of swaps on Thursday that aims to shed light on how those financial instruments are priced and could lead to major changes in the industry.

The proposal by the Commodity Futures Trading Commission would implement a key provision in the Dodd-Frank financial law that seeks to promote pretrade price transparency for swaps, derivatives often used by companies to mitigate risks such as interest-rate changes. If the agency votes to propose it, it will be issued for public comment. A second vote is needed to implement the rule.

The law requires that standard swap contracts traded between major players such as banks to be executed on trading platforms. The swaps can be traded on a traditional futures exchange like those run by CME Group Inc. (CME). But the law also provides for an alternative kind of platform known as a swap execution facility, or SEF. These platforms are meant to be used by institutional investors to help match buyers and sellers.

Numerous companies that offer swap trading today, from Tradeweb to the interdealer brokerage firm ICAP, are all planning to apply for "SEF" status. Some of these firms offer a "request for quote" trading model that lets a customer request a price with the click of a mouse to get quotes from several dealers. Others use a mix of the computer and the telephone to help broker deals.

Many of the companies have urged the CFTC not to define a SEF too much like a traditional exchange, which has an "open order book" model that publicly lists bids and offers. SEFs should be treated differently, they have said, because swaps are generally less frequently traded than futures contracts and a certain degree of anonymity is required to ensure that liquidity in the swap market is preserved.

To address these concerns, the CFTC on Thursday proposed allowing SEFs to offer three different kinds of trading models that can only be used in certain cases. But it's possible the industry may see the CFTC's proposal as too strict--especially because it would force at least some companies to change how they do business.

If a swap is traded 10 times a day or more, it would need to be traded on a SEF model that most closely resembles an exchange and has a central order book open to all market players.

If a swap doesn't have sufficient trading volume and isn't an overly large trade, then it could be executed on a second kind of SEF model that offers a so-called "transparent request for quote system." This system would be different from what some companies have in place today, a CFTC staffer told reporters late Wednesday. While some firms now only allow customers to submit quote requests to a handful of dealers, this new model of trading wouldn't let them limit how many companies can see the quote.

The CFTC's proposed rules also create a third kind of SEF category that can be used to execute illiquid swaps, swaps not covered by the CFTC's clearing and trading rules, or block trades--large trades executed away from the public marketplace. This kind of SEF would allow for voice-brokering or for the use of a limited request-for-quote model in which only a small group of market participants see the quote.

The rules unveiled Thursday also lay out various other requirements for an SEF to operate, including registration rules and 15 core principles they must follow.

Under the rules, these trading platforms would need to abide by certain financial and resource requirements, surveillance obligations, and other standards. Since there are already running swap trading platforms, the CFTC would offer temporary relief allowing them to continue operating their business while the agency reviews their application to become a SEF.

In addition to unveiling proposed new rules for SEFs on Thursday, the CFTC also laid out various other proposed governance requirements for SEFs as well as futures exchanges and clearinghouses. These rules would require derivatives clearing and trading companies to report to the CFTC if their boards reject recommendations from their risk or regulatory oversight committees. Exchanges and clearinghouses would also have to enforce minimum fitness standards for their directors.

-By Sarah N. Lynch, Dow Jones Newswires; 202-862-6634; sarah.lynch@dowjones.com

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