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24 January 2013

Behind the Lines of the Dodd-Frank Reporting Wars

The war of words between the CME and DTCC over the reporting of trade data to swap data repositories may not seem like a big deal, but the outcome is likely to dictate who will dominate the new derivatives landscape, and market participants may be caught in the crossfire.

Perhaps the strangest development in the unfolding story of Dodd-Frank implementation is the current war over the reporting of trade data to swap data repositories (SDR). On the surface, this looks like the proverbial tempest in a teapot -- I mean, who cares where you report trade data, as long as it gets reported? But upon closer examination, this fight is really about trading and clearing, and about who will dominate the new derivatives landscape.

CME Rule 1001                                            

To understand what’s happening, let’s begin with what’s on the surface. It’s all about CME Rule 1001, which has been submitted to the CFTC for approval. The rule reads, in its entirety:

For all swaps cleared by the Clearing House, and resulting positions, creation and continuation data shall be reported to CME’s swap data repository for purposes of complying with applicable CFTC rules governing the regulatory reporting of swaps. Upon the request of a counterparty to a swap cleared at the Clearing House, the Clearing House shall provide the same creation and continuation data to a swap data repository selected by the counterparty as the Clearing House provided to CME’s swap data repository under the preceding sentence.

If we recognize that Parts 43 and 45 of the CFTC’s rules specify that the reporting party has the right to choose the SDR to which it reports, and that the clearinghouse is the reporting party for cleared trades, this rule would seem uncontroversial, even superfluous. But it is anything but uncontroversial. Twenty-seven comment letters were submitted (eight by DTCC alone), one lawsuit has been filed (and withdrawn), and another has been threatened. Meanwhile, the CFTC extended the comment period by a month, to mid-January.

The War of Words

The two protagonists in this war of words are DTCC and the CME, both of which have called in reinforcements in the letter-writing campaign. The DTCC’s position is probably best stated in its January 8 comment letter:

CME proposes to illegally tie CME’s SDR and DCO services by requiring its clearing customers as a condition to using its clearing services to have CME direct their cleared trades to CME’s own captive SDR. This proposed tying of services is contrary to the fair and open access core principle set forth for DCOs in the Dodd-Frank Act—the Dodd-Frank Act’s prohibition of market infrastructures from engaging in anti-competitive practices—and the U.S. antitrust laws.

The CME, for its part, says, in its January 16 letter:

Rule 1001 merely details how CME Clearing, as a DCO, is satisfying and will satisfy its reporting obligations under Part 45 of the CFTC’s regulations for swaps that it clears. In doing so, Rule 1001 is entirely consistent with CFTC regulations. Despite DTCC’s contentions, Rule 1001 does not force counterparties to report to a "captive SDR." Nor does Rule 1001 create or increase any risk to the financial system.

What’s Behind It All?

In order to make sense of all of this, we need to understand a couple of things behind the scenes. First, DTCC regards the SDR function as a business, from which it expects to earn a return. Its fee schedule says:

DDR [DTCC’s SDR] will impose monthly maintenance fees per swap based on the aggregate number of swaps reported under the Dodd-Frank Act, regardless of asset class. Maintenance fees will be imposed on swap dealers and major swap participants (SD/MSPs) on a per-side basis, regardless of who is actually the reporting party. ...Each swap above the 10,000 threshold will be charged a maintenance fee of eighty cents (80¢) per swap per month. [In addition,] “large users” [defined as having more than 300,000 swaps at DTCC] will, in addition to monthly maintenance fees, also be charged a quarterly large user fee through June 30, 2013, of $834,000 per quarter.

So DTCC has a lot of revenue riding on its selection as the SDR of choice. The CME, on the other hand, has indicated in its comment letter that:

CME's SDR has already determined not to charge for any mandatory reporting services through at least September 13, 2013. Market participants that elect to have CME Clearing report cleared swap data to an SDR in addition to CME SDR may be assessed a fee designed to cover costs we incur in making the report. We expect this fee to be modest.

The second behind-the-scenes factor is that Part 45 requires the following reporting of valuation data for cleared swaps:

Valuation data for the swap must be reported as follows:

(i) By the derivatives clearing organization, daily; and

(ii) If the reporting counterparty is a swap dealer or major swap participant, by the reporting counterparty, daily.

In other words, the SD or MSP must report daily valuations on cleared swaps to the SDR, in addition to the valuations reported by the clearinghouse. (This requirement was delayed until 6/30/13 by the CFTC in a no-action letter dated 12/17/2012.) Why, you might ask, would the CFTC want thousands of separate valuations on cleared swaps, when the clearinghouse’s valuation is the one that counts in the marketplace? I asked them that very question, and their answer was, “We don’t want them. The prudential regulators want them.”

Thus the banking regulators (the Fed, OCC, etc.) want these daily valuations, not as a market mechanism, but as a way of keeping an eye on their charges. The first complication in the war of the swaps data, then, is that SDs and MSPs would have to report daily valuations to the CME instead of DTCC. And it shouldn’t surprise us that the ICE, which also has a clearinghouse and an SDR, has written the CFTC in support of the CME’s rule.

The Changing Market Landscape

But there is even more going on behind the lines in this war. With the proliferation of clearinghouses that we expect, and the increase in mandatory clearing we already see on the horizon, the business dynamics of swaps are shifting. For example, we have begun to see the large clearing firms offer price discounts on those trades done with their trading desks, and Rule 1001 has a major impact on the pricing of reporting services. Finally, we have seen the first electronic trading venues for swaps, even before the CFTC has issued rules for SEFs.

As the swaps landscape changes, market participants are moving rapidly to capture the high ground, even before all the rules are finalized. If you are doing an OTC cleared swap, and clearing it on the CME, I’ll bet that the CME will help you report the original uncleared swap to their SDR at a very low cost. And since they will extinguish the uncleared swap when they clear it, there won’t be any residual reporting expense.

Furthermore, reporting efficiencies may lead traders to select one clearinghouse over another, especially if the initial margin requirements are essentially the same. If the CME (and other DCOs) regard free reporting as a low-cost method of building their clearing business, they will wreck DTCC’s business model. So we shouldn’t be surprised that the DTCC has rolled out the heavy artillery. The battle has just begun, and we should be aware that there may be no innocent bystanders in this war.

Spotlight-white-trans For more stories in the OTC Derivatives Reform Spotlight Series click here.

Comments | Post a Comment

7 Comments to "Behind the Lines of the Dodd-Frank Reporting Wars":
  • Comment_tabb_-_larry_tabb_hi-res_wo
    ltabb

    24 January 2013

    George - like usual you are right on point here.

    This is/will be a huge battle that probably won't stop until it gets into a pretty senior court.

    While swap futures seem to be the perfect solution to managing risk in the swaps market (pre and post trade transparency, product standardization, widely distributed market data, and universal margining) it also creates many significant issues once you roll back the covers.

    The SDR issues are one of them. There is also horizontal vs. vertical clearing, and also margin treatment with futures using 1day margin vs 5d margin for many swaps. How margin is calculated has everything to do with the amount of margin firms need for swap futures - 1day var will require less margin than 5 day VaR. Also futures products are easier to leverage portfolio margin strategies and margin compression vs swaps.

    If the ICE/CME get their way with these products, it will tip much more business into the swaps futures world, which is vertically aligned and where both CME and ICE have much better economics than would be expected in a world where there is horizontal clearing, and more competition.

    The battle lines are drawn and it will be interesting to see how this battle, or should I say war plays out.

  • Missing
    barney

    25 January 2013

    apologies - please remove previous comment

    I  was wondering whether you agree with an observation I heard that clearing and running an exchange are disappointingly unprofitable and that the real money is in selling information or accelerated access to information?

  • Comment_grody5080_new
    agrody

    25 January 2013

    The date for comments to the CFTC has been extended  by 45 days to March 6, 2013 with the CFTC stating "The proposed rule raises novel or complex issues that the Commission has determined require additional time to review.  "  Also, see my recent article that appered in Futures & Options World Magazine a week ago "Technology and the Politics of Swaps Data Repository Issues"  on how technology can provide simpler, cost effective and geopolitcally savvy solutions to reporting swaps data. Link at:

    http://www.fow.com/Article/3142570/What-has-Technology-to-do-with-Resolving-the-Politics-of-Swaps-Data-Repository-IssuesEverything.html

    Allan

  • Comment_g_bollenbacher2
    gbollenbacher

    25 January 2013

    Barney, the profitability of SEFs, DCOs, FCMs, and SDs is all up in the air. Initially, it looked like there would be a surfeit of SEFs and DCOs, but the initial enthusiasm may have waned, It already looks like reporting may be a lead-in to clearing, and clearing may be a lead-in to trading. Suffice it to say that the new derivatives world will look a lot like Deadwood during the gold rush, at least until things settle down.

    Allan the CFTC announcement says that the review period has been extended, but it doesn't say anything about extending the comment period. Do you have something from the CFTC saying that the comment period was extended?

  • Comment_grody5080_new
    agrody

    25 January 2013

      

    Below is the actual CFTC statement.  The posting of the CFTC's  related 2013 comment period's  web page goes up only till March 1, so perhaps they have not yet posted the new March 6 date.  Given that the CFTC had always taken time after the comment period was over for review it would not seem logical that their annoucement of extending the review period 45 days did not refer to the comment period. But hey, who knows! FYI - Tony DeLuca's comment letter (Moore Capital) suggested a 60 day comment period extension.

    Allan

    RELEASE: PR6498-13 January 18, 2013

    CFTC Extending Review Period on a Request from the Chicago Mercantile Exchange Inc. to Adopt New Chapter 10 (“Regulatory Reporting of Swap Data”) and New Rule 1001 (“Regulatory Reporting of Swap Data”) of CME’s Rulebook

    Washington, DC – The Commodity Futures Trading Commission (Commission) is extending the time period for which it is reviewing a request from the Chicago Mercantile Exchange Inc. (CME) for approval of a rule (Rule 1001) submitted pursuant to section 40.5 of the Commission’s regulations.  The proposed rule raises novel or complex issues that the Commission has determined require additional time to review. The review period is being extended 45 days to expire on March 6, 2013.

  • Comment_g_bollenbacher2
    gbollenbacher

    25 January 2013

    Allan, here's the comment page language, and it doesn't show an extension of the comment period.

    Comments for Industry Filing IF 12-014

    Industry Filing  IF 12-014

     

    Request from the Chicago Mercantile Exchange Inc. to Adopt New Chapter 10 (“Regulatory Reporting of Swap Data”) and New Rule 1001 (“Regulatory Reporting of Swap Data”) of CME’s Rulebook

    The Commodity Futures Trading Commission (Commission) is accepting public comment on an amended request from the Chicago Mercantile Exchange Inc. (CME) for approval of a rule (Rule 1001) submitted pursuant to section 40.5 of the Commission’s regulations.

    Open Date: 12/10/2012
    Closing Date: 1/7/2013
    Extended Date: 1/14/2013
     
    This may be Jamie Dimon's tempest in a teapot, though.

  • Comment_grody5080_new
    agrody

    25 January 2013

    George, I think my earlier post was in route when yours went out - to repeat the key items from the earlier post:

      The posting of the CFTC's related 2013 comment period's web page goes up only till March 1, so perhaps they have not yet posted the new March 6 date. Given that the CFTC had always taken time after the comment period was over for review it would not seem logical that their annoucement of extending the review period 45 days did not refer to the comment period. But hey, who knows! FYI - Tony DeLuca's comment letter (Moore Capital) suggested a 60 day comment period extension.

    Allan

    See CFTC RELEASE: PR6498-13 January 18, 2013

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