CFTC's Massad 'Hopeful' for Cross-Border Clearing Equivalence, Intends to Extend Relief for Package Trades

Addressing attendees of the 3rd Annual OTC Derivatives Conference in London on September 29th, CFTC Chairman Timothy Massad discussed the progress made so far in reducing the systemic risk that amplified the damage resulting from the financial crisis. Acknowledging that there is still much work to do be done, Massad outlined some of his agency’s biggest achievements and discussed areas where he hoped to see progress soon.

Following are some highlights from his speech.

Strength of clearinghouses

While Massad considers central clearing to be “one of the great innovations of the financial system,” he says it is not an answer to all problems. He believes the focus needs to remain on ensuring the strength of clearinghouses to further reduce risk. To ensure proper risk management, he said, the CFTC performs a daily review of clearing members and traders, examining margin models, stress and back testing, and compliance procedures. By emphasizing transparency, Massad believes all clearinghouses can properly manage risk.

Cross-border equivalence

While the European Union (E.U.) has granted regulatory equivalence to numerous other jurisdictions, like those Australia, Mexico, Canada, and several in Asia, it has not done so for U.S. clearinghouses.  The sticking points are differences in margin methodologies. Massad emphasizes the general result of the margining process and notes that, according to international criteria, U.S. margining is just as thorough. He notes the need for continued negotiation and appears hopeful for progress from the review being undertaken by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) that might lead to recognition from the E.U.

Leverage ratio and collateral fixes proposed

Massad was explicit in his endorsement of the supplementary leverage ratio (SLR) for banks, though he does think that bank capital requirements need to be tweaked.  Specifically, Massad proposed that cash collateral collected by banks to cover initial losses on trade in the event of a default can avoid being treated as an additional exposure under the leverage ratio if the bank meets certain conditions.  Among those conditions: banks would need to agree to give up any investment income or interest that the make on clients’ collateral.

Margin for uncleared swaps

Though central clearing for swaps is becoming standard, there will always be some swaps that should not and will not fall under a clearing mandate. The CFTC’s proposal requires swap dealers to post and collect margin for uncleared swaps with other dealers and with some counterparties. At the same time, it exempts some specific end-users. Massad notes that he is working with both banking and international regulators to harmonize margin rules. He believes that once rules are finalized, potentially at the end of 2015, the agency will reintroduce rules for capital requirements for swap dealers and significant market players.

Swap data reporting

Massad proposed a fix to the swap data reporting process designed to reduce reporting costs and improve the quality of swap data.  Citing an example of where the current system can be unnecessarily cumbersome, Massad shared the following scenario:

“Here’s an example of a problem: If a swap is transacted on a SEF, it is reported to an SDR. If that ‘alpha’ swap is then cleared, the so-called ‘beta’ and ‘gamma’ swaps that are created as a result are also reported. But those two new swaps might be reported to a different SDR, and there might not be any record of the termination of the original alpha swap.”

Under the new proposal, which the CFTC plans to explain in detail later this year, Massad said his focus was on clarifying reporting obligations and ensuring accurate valuations of swaps so trades can be traced from execution through clearing.

 SEF trading

Massad also highlighted ISDA and Clarus Financial data, which show that the majority of interest rate swaps and credit default swaps are now trading on SEFs. He noted that there are still several rules that need to be fine-tuned to improve SEF trading.  The areas the agency is still examining are package trades, for which Massad announced his intent to extend no-action relief through late 2016, and the “made available to trade” – or MAT – determination process.  Massad said the CFTC is “considering” playing an expanded role in identifying which products are MAT’d on SEFs following suggestions from several market participants.

To read his speech in full, please click here.