UPDATE 2-CFTC plan sheds light on delays for block trades

Thu Feb 23, 2012 2:59pm EST

* CFTC passes block trade proposal by 3-2 vote

* Sommers, O'Malia question usefulness of data in proposal

* Agency to hold roundtable to boost customer protection

By Christopher Doering

WASHINGTON, Feb 23 (Reuters) - The U.S. futures regulator on Thursday approved a measure that provides more insight on when dealers can delay reporting large over the counter swap transactions with sensitive price and size information to the public.

However, Republican commissioners at the Commodity Futures Trading Commission warned that poor quality data used in the proposed new rule was "troubling" and could serve to undermine efforts by the agency to boost swaps transparency.

The CFTC proposal, which passed along party lines by a 3-2 vote, establishes at what level block trades are big enough to qualify for a longer reporting delay. The agency measure will define and categorize block sizes for five asset classes, including interest rate and credit swaps.

"If we go too far in, for example, setting block levels too low, we will possibly not promote (swap execution facilities)swaps trading," said Bart Chilton, a CFTC commissioner.

"On the other hand, if we set the block level too high, then we risk impairing the ability of participants to effectively utilize the markets at all," he said.

End users entering into a trade do so with a dealer, who then hedges that risk. In most cases there is sufficient liquidly to offset the risk, but in block trades or those where there may not be enough liquidity, it can take more time to complete.

Block trades are large deals negotiated off an exchange's trading facility and posted later. Voice brokering is often used for these transactions.

Major swap dealers, such as Goldman Sachs, argue they need sufficient time to hedge the price risk of their over-the-counter swaps in other markets, such as futures, before reporting the trade, or risk the market moving against them. Without sufficient time, end users could face higher prices to conduct the trade.

The CFTC proposed the threshold for block sizes in all asset classes to be set at 67 percent of the notional value of swaps for each category, meaning that about a third of that dollar amount would be subjected to the new block rules.

Still, the one-third could actually represent a small number of large transactions. In this case, CFTC estimated 6 percent of interest rate swaps and 6 percent of credit swaps would be classified as block trades.

The CFTC is expected to post later on Thursday the initial level at which transactions, using data included in the proposed rule, would be classified as a block trade and subjected to a delay. For example, CFTC said for a U.S. 5-10 year interest rate swap the threshold would be $290 million and for NYMEX light sweet crude it would be 100,000 barrels.

The CFTC also is considering whether to use a 50 percent notional amount calculation.

Initially, the CFTC proposal would set the block threshold size for each group, which would be effective for at least a year. Registered swap data repositories would collect data on the asset classes that the CFTC would use to establish new block sizes for each swap category.

The appropriate minimum block sizes would be updated no less than once a year, the agency said.

Scott O'Malia and Jill Sommers, the agency's two Republican commissioners, criticized the one-size-fits-all approach and questioned whether the agency could effectively set block sizes using antiquated credit and interest data collected during a three-month window in 2010.

"While I recognize there are limitations to the data available to the Commission, using such an inapt data set containing such a small and stale amount of data to set minimum block sizes is very troubling," said O'Malia.

Sommers warned without "robust data" the CFTC "could severely harm liquidity" at a time where it is seeking to bring more swaps on to SEFs.

The final real-time reporting rule passed by the CFTC in December provided temporary measures such as interim caps on the reporting of notional and principal amounts until the regulator established appropriate minimum block sizes.

Until the new block rule is in place, the CFTC said all trades will be reported post transaction to a repository with a time delay, as if they were a block.

The CFTC also on Thursday approved by a 3-2 vote a final rule establishing reporting, recordkeeping and daily trading record requirements for swap dealers and major swap particpants.

Among their requirements, the final rule requires swap dealers and major swap participants to establish measures to monitor for and prevent violations of position limits set by the CFTC, exchanges or a swap execution facility.

The rules are part of the new regulatory framework to boost oversight for the previously opaque $700 trillion over-the-counter derivatives market required under the 2010 Dodd-Frank law.

Meanwhile, the futures regulator will hold a two-day roundtable on Feb. 29 and March 1 to consider changes to protect customer collateral following the collapse of MF Global.

Gary Gensler, the CFTC's chairman, said the meeting will consider changes, including looking at alternative custodial arrangements for segregated funds, enhanced customer protections and transparency provisions for futures commission merchants.

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