What Revisions did the CFTC Propose and WHY?
The CFTC proposed revisions to swaps processing & reporting (Section 21 of the CEA (Commodity Exchange Act). Given the goal of D-F is to make the swaps market transparent & liquid, we need to apply a certain number of identifiers to keep transactions straight. Also, these ID’s can be used to automated processes such as trade reporting and cash accrual.
A liquid market, by definition requires the Primary Economic Terms (PET) of the transaction to be reported to a central repository (in derivatives land they’re called Swaps Data Repositories or SDR). They are the aggregator of price discovery, transparency, depth & liquidity.
While price discovery is easy for new at-market swaps. Previously opened swap contracts held on counterparty books have to make some change to confluence to eliminate fragmentation with regard to continuation pricing.
Most swap dealers agree on rates for At market swaps during the trading day, so there’s very little deviation while market is open. Where an institution marked their yield curves, how they calculate their OIS curve & market volatility will impact consistency amongst swap dealers.
The advantage of having consistent pricing for all open contracts and all players, is the ability to be fungible among different clients, Clearinghouses (DCO, CCP).
The CFTC proposed revisisions hopes to eliminate mismatches in mark-to-markets as noted by problems zeroing out amongst different clearinghouses. Differences in repricing, collateral collection, etc. results in fragmentation across the trade process value chain. The result is a series of open contracts, which is fine. But it does not make a continuously trading, liquid market.
Further, the revisions should diminish (in part) the fragmentation that has resulted in repricing Cleared and Bilateral derivatives because of so many SEF’s and CCP’s now in business.
Revisions Will Ease confluence of Cleared and Uncleared Swaps
To make cleared and uncleared swaps easy to reprice once they’re submitted to a CCP, we need to design a workflow. The workflow will contain new terms such as:
The Original Swap (the uncleared swaps, from pre-dodd-frank)
All open swaps expected to be submitted into a DCO (designated Clearing organization) are called the “Original Swap”. These Bespoke contracts will not submitted to a clearinghouse, documentation, rules for repricing and collateral levels are close to cleared derivatives.
The rule includes bespoke swaps to be submitted to a DCO resulting in 100% transparency and consistent continuation pricing for Interest Rate Swaps. Those swaps which cannot be placed in the clearinhouse will be identified in a consistent manner for submissiong ot trade reporting, repricing and cash accruals.
The Clearing Swap(s): All Original Swaps will be converted to “Cleared Swaps” and submitted into a DCO. Thereafter the Original Swap is extinguished.
The swaps both now face the Clearinghouse. Both counterparties will post initial margin This operates much like our futures markets
The Proposed Rules would remove existing confirmation data reporting requirements for NEW swaps that will be submitted to the clearinghouse upon execution.
Under the CFTC’s Proposed Revisions, SEFs/DCMs and reporting counterparties would continue to be required to report primary economic terms (“PET”) data as part of their creation data reporting.
A New Role For a Derivative Clearinghouse Orgs. (DCO)
The Proposal clarifies the DCO’s obligation to provide continuation data including the obligation to report terminations to the Swap Derivative Repository (SDR) to which the swap was originally reported.
Further the proposal asks for clarification of DCO’s obligation to report data providing for the linking of swaps involved in a cleared swap transaction
The Designated Clearing Organization (DCO) is proposed to create, transmit and use UNIQUE SWAP IDENTIFiERS (USI) for swaps with a DCO as a counterparty or were created pursuant to their rules.
The DCO will be the reporting counterparty for swaps that have a DCO as a counterparty or were created pursuant to their rules.
The Proposed Rules provide that for swaps executed on a Swap Execution Facility (SEF or Designated Contract Market (DCM) that SEF/DCM would be obligated to choose the Swap Data Repository that the swap creation data is reported. All other execution forms would choose their SDR.
The DCO would be required to report both PET and confirmation data for “clearing swaps” as part of its creation data reporting obligations. Requiring an additional set of confirmation data reporting for a terminated “original swap,” in addition to PET data, would be unnecessary and provide little benefit
This short blog should give swap players a sense for the work ahead in deciding where you should transfer you open swap contracts,if you need to transfer them at all.
I’ve noticed a lot of new Terminology lately,, so here’s a quick glossary of terms on collateral, and the new swaps value chain.
DCO: Designated Clearing Origination: given permission to operate as a clearing organization by the SEC-CFTC combined Derivatives regulator
DCM Designated Contract Market
PET Primary Economic Terms: pay/receive fixed; quantity; periodicity of cash flows
SEF Swap Execution Facility: Electronic means of executing swaps transactions, hopefully has STP through middle office, with reportage to management
SDR Swap Data Repository: The organization aggregating all swaps transaction ans information. This is similar to the Commitment of Traders report in Futures.
LEI Legal Entity Identifier: TBA A Legal Entity Identifier (LEI) is a unique ID for a single corporate entity.
USI Unique Swap Identifier: For now, USI’s will Identify those swaps remaining outside of the clearinghouse.
Summary & Resources
These changes are exepected to be put into practice within a short time. So the markets (globally) can be more transparent to all users as well as dealers.