WASHINGTON The U.S. futures regulator on Thursday outlined long-awaited exemptions for firms using derivatives to hedge risk, but delayed plans for swap trading platforms amid growing opposition from some commissioners.
The rules -- eagerly awaited by companies like Exelon and Ford that do not want to be forced to clear their swaps trades, causing them to post billions of dollars in margin -- grant an exemption if one side of the trade is a non-financial entity, and can prove the deal is not speculative.
But, in yet another sign that regulators are conflicted on how best to limit systemic risk in the swaps market, the two Republican commissioners on the five-member Commodity Futures Trading Commission voted against releasing the rules for public comment, saying more clarity was needed.
"I am flummoxed as to why we are failing to fully address the issue of excluding small banks, farm credit institutions and credit unions from the definition of financial entity," CFTC Commissioner Scott O'Malia said at the public meeting.
O'Malia and Jill Sommers, both Republicans, have voted several times against releasing proposals, echoing industry calls for greater caution and further study on the impact of the CFTC's effort to implement the Dodd-Frank bill, which requires much tougher rules for the $600 trillion over-the-counter swaps market.
Republican concerns may have also forced the CFTC to postpone by one week plans to define what kind of trading platform will qualify as a swap execution facility, or SEF, the specially designated venues where most swaps will be required to trade in order to limit risk and increase transparency.
CFTC Chairman Gary Gensler said the original plans -- which proposed SEFs adopt a central limit order book for any product that trades more than 10 times a day, or a transparent request-for-quote system -- may change.
"We're human," Gensler said at a public agency meeting.
The delay further underscores the tight deadline the agency is under, and different views by the agency's five commissioners as to what Congress intended.
Gensler also said the regulator intends to propose on December 16 a long-awaited and hotly debated plan to limit speculative positions held by commodity traders.
END-USERS EXEMPT IF...
Gensler was quick to point out that, if a company, fund or entity took a position to speculate, that transaction would not qualify for the end-user exception.
The new law also allows "end-users" such as manufacturers that use swaps to hedge "commercial risk" to be exempt from mandatory clearing requirements. Supporters contend this will keep costs lower by letting firms retain capital that otherwise would be used to post margin to cover cleared trades.
The CFTC said end-users could be exempt if at least one party to the swap transaction is not a financial entity, information is provided on how the firm meets its financial obligations associated with entering into non-cleared swaps, and the swap is being used to hedge or mitigate commercial risk.
Hedging or mitigating commercial risk would be determined by analyzing the facts and circumstances at the time the swap is entered into, and taking into account the person's overall hedging and risk mitigation strategies. It would not include any swap position held for speculation, investing or trading.
An end-user would inform the CFTC it's using the exemption, and provide information including the methods used to mitigate counterparty credit risk in the absence of clearing, the identity of the end user, whether an affiliate or financial entity is involved, and other information about the swap.
The CFTC said it was seeking public comment to help it determine if small banks should be granted a clearing exemption. That puzzled commissioners O'Malia and Sommers.
"I fear that by delaying ... going final with a process for exemption may have a lot of unintended consequences," Sommers said. O'Malia agreed, saying, "All we are going to do today, after almost five months with this language, is punt it."
The Dodd-Frank bill prohibits most financial entities from receiving an exemption.
MORE TRANSPARENT SEFs NEXT WEEK
CFTC commissioners had been expected to decide on Thursday whether to propose rules to make swap execution facilities transparent. It released fact sheets outlining the rules late on Wednesday.
"I wouldn't criticize this if the CFTC pulled it back for reasons of caution," said Tammy Botsford, vice president and deputy general counsel at Penson Futures.
Firms, including GFI Group and IntercontinentalExchange Inc, hope to qualify as SEFs as the massive over-the-counter swaps market is forced to move from bilateral, private deals onto public venues.
Under tentative CFTC plans, the swap venues would be required to provide electronic trading systems or platforms that have a centralized limit order book open to all participants. They also could have a transparent quote system that meets certain requirements.
It also said SEFs would offer three tiers of transactions: larger trades that meet a specific level of volume, smaller trades that are not block trades but don't have major volume, and other transactions, such as block trades where a SEF could provide end users the chance to trade even though it's not required.
Without going into detail, Sommers expressed concern over the agency's preliminary plan and said it was too narrow in scope. Sommers later told Reuters she did not know the rule would be withdrawn, adding that she and Commissioner O'Malia "didn't ask for it to be pulled."
One important aspect of the rules would require that all participants in the market be able to see all relevant trade information under a so-called "request for quote" system. In the past, one party could limit which potential counterparties it wanted to allow to see a request.
The rules would go into effect 90 days after they're finalized, but provide a grace period for pending SEF applications.
CFTC said once certain conditions have been met, entities that meet the definition of a SEF could request the agency allow them to function as one while their application is reviewed.
Companies that traditionally have been big players in the over-the-counter swaps market are working to ensure they stay in the game as the business moves under the CFTC's regulatory oversight. Barclays, Credit Suisse, Morgan Stanley and others have met with the agency to discuss the new trading platform.
(Additional writing by Rachelle Younglai and Jonathan Spicer in New York; Editing by Walter Bagley)