In the past several days, there has been news of the forging of a long-awaited compromise among the commissioners at the Commodity Futures Trading Commission (CFTC). The potential deal, which will be discussed at a meeting next Thursday, relates to the rules governing swap execution facilities (SEFs). SEFs are the new swap trading venues created by Dodd-Frank. The CFTC's proposal was perceived by many to be unworkable.
Even if the CFTC successfully crafts a better final set of rules for SEFs, SEFs may not attract much business. Last month, Bloomberg--a would-be SEF operator--sued the CFTC over a Dodd-Frank rule that Bloomberg alleges will create a competitive disadvantage for SEFs. The challenged rule relates to margin, which is money that a clearinghouse collects to protect itself from the risks associated with the swaps and futures that it clears. In determining how much margin to collect, a clearinghouse considers, among other factors, how long it would take to liquidate the particular swap or future. Bloomberg is arguing that the CFTC violated its requirements under the Administrative Procedure Act and its statutory obligations to conduct benefit-cost analysis. At issue is a directive that clearinghouses use a 5-day minimum liquidation time for financial swaps and only a 1-day minimum for other types of swaps and futures. As a consequence, margin requirements for financial swaps will be higher than for comparable futures.
The distinction matters, because market participants, who quite naturally prefer to make smaller margin payments, will favor futures--which do not trade on SEFs--to swaps. That spells trouble for SEFs. Futures that are effective substitutes for swaps are already cropping up, although margin differences are not the only reason for this trend.
The signals coming out of the CFTC regarding a potentially revamped SEF rule are positive, but the SEF battles will continue. As discussed in an earlier post, Dodd-Frank has set up some fierce competitive battles, into which the CFTC and courts are being dragged because of the CFTC's failure to follow sound rulemaking procedures.