Market Participants Line Up Against Rule 1001

By Larry Thompson

Originally published on Tabb Forum 

While the debate over the Chicago Mercantile Exchange’s proposed Rule 1001 has, in some cases, been mischaracterized as a battle between the CME and DTCC, nothing could be further from the truth. The reality is that this is a battle between CME and a wide cross section of financial market participants, industry associations and interested third parties that do not want their freedom to choose how to report their swaps transactions blocked by regulatory fiat.

In fact, more than a dozen comment letters opposing the proposed rule were filed with the Commodity Futures Trading Commission (CFTC) last month, including by groups representing corporate end users that represent the bulk of domestic energy production and natural gas supply; traditional investment managers representing a significant portion of retirement savings and pension funds for U.S. workers; and multiple financial services trade groups. As evidenced by these comment letters, proposed Rule 1001 would decrease transparency for investors and regulators; increase complexity, costs and risk for financial institutions; and undermine core principles of the Dodd-Frank Act.

While market participants have varying reasons for choosing a swap data repository (SDR), the common denominator is their desire to choose where they report data.

Unfortunately, the proposed rule would allow CME (and potentially other DCOs) to inappropriately bundle SDR and clearing services. This is problematic because it would effectively allow CME to dictate to market participants where their swaps data is sent – a concern that a coalition of energy end users addressed in their comment letter, stating, “[M]arket participants who are reporting parties must have the ability to direct data related to their transactions to any swap data repository regardless of where the transactions are executed or cleared.”

If the CFTC approves the proposed rule and injects itself into market decisions, it would be compromising choice in the SDR market rather than allowing competition, market forces and innovation to determine how swaps counterparties choose an SDR, as was clearly envisioned by Dodd-Frank.                      

Deutsche Bank highlighted this concern in its comment letter to the CFTC, arguing that: “[T]he Proposed Rule would effectively eliminate reporting counterparties’ choice of SDR in contravention of Commission Regulations and related guidance, statutory principles of fair and open access to clearing services and regulatory prohibitions on anticompetitive practices by DCOs and SDRs.”

Market participants have expressed concern about where their swaps data is stored and accessed by regulators – not to mention that they are frustrated by the added complexity and costs that the CME’s proposed rule would have on the reporting process. The proposal would not only alter well-established rules promulgated by the Commission to date, it also would disrupt the significant preparations already made by market participants to report to their preferred SDR.

As The International Swaps and Derivatives Association (ISDA) explained in its comment letter, “[M]arket participants have made considerable investments in building and testing connectivity to their chosen SDRs not just to comply with reporting obligations but also to enhance their ability to manage other processes, including internal risk management and responding to ad hoc queries from multiple regulators in a timely and efficient manner.”

Industry trade groups have raised concern regarding the impact of the proposed rule on fragmentation and regulatory oversight. This point was reinforced by The Association of Institutional Investors (AII), which argued that: “CME’s Proposed Rule 1001 … undermines the goals of the Dodd-Frank Act by reducing the ability of regulators to view consolidated positions and patterns of abusive trading. It also undermines the ability of the buy-side to effectively manage risk through monitoring data reported to SDRs.”

The Wholesale Market Brokers’ Association, Americas (WMBAA) cautioned that: “CME’s proposed approach would violate the Part 45 Rules, fragment swap transaction data, and frustrate the Commission’s efforts to record the entirety of one swap in a single location.”

Market participants remain rightly concerned about the anti-competitive ramifications of Rule 1001. A coalition of energy end users said: “A competitive SDR reporting process … lowers the cost of reporting for counterparties and fosters efficient interfaces for end users[.]” The letter continues: “It is critical that reporting alternatives compete on a level playing field and that reporting swap data is not so costly or burdensome that liquidity is harmed or end users are discouraged from participating in the market. Competition among SDRs is the best way to avoid these problems while ensuring that regulators receive accurate market data.”

The WMBAA also stated in its comment letter that the proposed rule is inconsistent with the competitive landscape envisioned by Dodd-Frank because it promotes the bundling of regulatory services and “set[s] the  . . .  precedent for the combining of DCO and mandated [swap data repository] services as ‘one stop shopping’ in OTC markets.” The WMBAA expressed concern that: “[T]he logical expansion of this market structure would be to permit the combination of trade clearing services and trade execution services,” which would “seriously disadvantage  . . .  trade execution platforms without affiliated clearing houses” and “further [reduce] market competition.”

While regulators and investors rely on the integrity, timeliness and accuracy of market data, the proposed rule would increase the likelihood for misreporting and misunderstanding reported data. As a result, additional risk would be introduced to an already complicated system. In its comment letter, J.P. Morgan Chase & Co. highlighted concern regarding risk: “Anticompetitive tying arrangements such as CME’s proposed Rule 1001 would likely increase operational and systemic risk.”

When you strip the rhetoric away, the debate over proposed Rule 1001 is really a choice between empowering CME to dictate decisions on behalf of market participants and properly implementing the objectives of Dodd-Frank to enhance transparency and mitigate risk to ensure the safety and soundness of the capital markets. All investors and regulators have a stake in the outcome. But don’t take our word for it – listen to what market participants are saying.