Speaking at the Tabb Forum conference in New York last week, CFTC Commissioner Scott D, O’Malia addressed two topics that have been generating lots of buzz in the industry: the “futurization” of swaps and the long-awaited final rules for SEFs.
As we reported last week, there has been a great deal of speculation in the press about the futurization of the OTC swaps market. The prevailing logic has been that OTC swaps will follow a similar path to energy swaps, eventually migrating to futures contracts to dodge onerous regulations. O’Malia set out to quickly diffuse the idea that a move to futures would skirt regulation, suggesting that, ultimately, the derivatives market will be driven by risk management needs and cost:
“Some have even opined that the shift to futures is a move to a less regulated environment. While I disagree with the characterization that the futures market is less regulated, I couldn't agree more with the argument that the futures market is well understood and that its rules are clear and provide market participants with regulatory certainty. In comparison, the swaps rules are vague, poorly understood, and now riddled with temporary exemptions and no-action relief – in other words, a confounding mess that only an outside counsel could love."
However, the current state of affairs is not necessarily the end of the story. The transition to futures in the energy market has been facilitated by the exchanges establishing extremely low threshold sizes for block trades in the futures contracts. These thresholds are unlikely to stay at these levels. The question is: if they are raised, what impact will this have on traders?
"[…] With the election behind us, we can lower the rhetoric and look objectively at the relationship between the markets and the products. We must look at both U.S. markets and foreign markets to understand the costs and regulatory incentives embedded in their rules. We must always be thinking about risk management. We must also refrain from jumping to conclusions as we haven’t yet completely defined the costs associated with over-the-counter trades."
On the topic of finalizing SEF rules, O’Malia said he expects his agency to take a final vote within two weeks:
“It appears the SEF final rules may be voted on by the Commission as early as mid-February. That’s right in time for Valentine’s Day, and nothing says “Valentine, I care” like a SEF final rulemaking.”
As to the specifics of those rules, O’Malia shared a four-part checklist for the final SEF rule, which he said was developed to address the concerns of asset managers and dealers that the agency’s proposed SEF rules from January 2011 did not provide the necessary flexibility for less liquid swaps to be executed on the SEF platforms. He said the final rules must meet the following four criteria:
- Allow for flexible methods of execution including request for quote systems (RFQs) and limited voice-based systems.
- Do not copy the rules for designated contract markets (DCMs).
- Adhere to and explain the statute, or risk litigation and delay.
- Develop a clear pathway for timely approval of temporary SEF licenses.
To read Commissioner O’Malia’s full key note speech, click here.