Jeff Steiner of Gibson Dunn offers a high-level recap of the CFTC’s Futurization Roundtable on Jan 31st.
On January 31, 2013, the Commodity Futures Trading Commission (“CFTC”) held a public roundtable to discuss the “futurization of swaps.” The roundtable consisted of the following four panels: (1) General Industry Views and Concerns Regarding the Futurization of Swaps in the Different Asset Classes; (2) Clearing and Different Margin Requirements for Swaps and Futures; (3) Transaction-Related Matters Including Appropriate Block Rules for Swaps and Futures; and (4) The Effect of the Conversion of Swaps to Futures on End-Users.
The roundtable highlighted the differences in opinions among market participants with respect to the futurization of swaps. Designated contract markets (“DCMs”) and market participants primarily engaged in the energy markets generally supported the conversion of swaps into futures contracts, explaining that there is regulatory certainty in the futures markets and the conversion of swaps to futures is consistent with the Dodd-Frank Act’s purpose of reducing systemic risk. On the other hand, potential swap execution facilities (“SEFs”) and companies not primarily engaged in the energy markets generally supported an environment that allows for continued trading in the swaps market, explaining that forced futurization may damage competition, harm end-users, and undermine the goals of the Dodd-Frank Act.
One general theme throughout the day was whether or not the CFTC should “level the playing field” between the swaps and futures markets by ensuring consistent block sizes, consistent transparency requirements, and consistent margin requirements for cleared products. Some panelists explained that if a swap is converted into an economically equivalent futures contract, the swap from which it was converted should be subject to the same block trade sizes and margin requirements as the equivalent futures contract. These panelists explained that by not leveling the playing field, the CFTC opens itself up to a “regulatory arbitrage” situation instead of letting the markets decide how to best execute derivatives. Further, some panelists explained that the current regulatory framework encourages futures over swaps, pointing to (1) one-day margin for futures compared to five-day margin for cleared swaps; and (2) inconsistent, lower block trade sizes set by DCMs for futures compared to consistent, higher block sizes set by the CFTC for swaps.
Conversely, other panelists explained that there are fundamental differences between the futures markets and the swaps markets that require different block trade and margin rules. These panelists explained that because swaps can be traded on any SEF or DCM while futures contracts can only be traded on the DCM on which they are listed, such a distinction between the futures and swaps regulations is justified. Further, they explained that migration from swaps to futures is good for the market and reduces systemic risk.
End-users were given the opportunity to discuss their views on the futurization of swaps and there was a sharp contrast between those end-users involved primarily in the energy markets compared to those that are not engaged primarily in the energy markets. The energy end-users generally supported the futurization of swaps explaining that (i) the transition has been seamless; (ii) there are minimal costs for them to use futures; and (iii) that at this time there is more clarity with respect to compliance requirements for futures compared to swaps. On the other hand, non-energy end-users explained that the swaps market is necessary as it (i) provides customization and the ability to make adjustments; (ii) reduces the number of transactions thereby lowering operational costs; (iii) provides greater liquidity in longer-dated products; (iv) does not tie up capital by requiring margin; and (v) provides flexibility on the types of acceptable collateral. Some panelists explained that the Dodd-Frank Act recognized the importance of the over-the-counter swaps market for non-financial end-users to hedge or mitigate commercial risk by providing an explicit exception from clearing and execution requirements; however, the futurization of swaps and potential margin requirements on uncleared swaps may reduce liquidity and increase costs, effectively denying end-users of this exception and the ability to use swaps.
CFTC Commissioner O’Malia has stated publicly that the transition from swaps to futures in the energy market has been facilitated by extremely low block thresholds in the futures contracts and that the CFTC and market participants need to think through the issue. The CFTC has not yet issued final rules relating to swaps block trade sizes and has mentioned proposing new rules relating to futures block trade sizes. Given that the roundtable panelists seemed to fall on one side of the fence or the other in the futurization debate, it will be interesting to see if the CFTC takes any action over the next few months to try to level the playing field between economically equivalent futures and swaps with respect to block trade sizes, margin, and other requirements.
