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Gary DeWaal's Bridging the Week: January 13-17 and 20, 2014 (Mandatory IRS Trading on SEFs and DCMs; MiFID II Coming; More Enforcement & Prosecution)

Bridging the Week    Compliance Weeds    My View    Helpful to Getting the Business Done   
Published Date: January 20, 2014

Mandatory execution on Swap Execution Facilities and Designated Contract Markets of certain interest rate swaps beginning February 15 will initiate for most US persons the home stretch of reforms envisioned at the Pittsburgh 2009 G-20 Summit related to the handling of OTC swaps transactions, as a result of CFTC action last week. However, once again, the launch of a new CFTC initiative is marred in controversy, this time over the execution of so-called "package transactions" involving multiple components, where only one piece involves swaps subject to the new mandatory execution requirement.

This CFTC action, MiFID II, many international proposals relevant to the financial services industry and a few notable enforcement actions worldwide, are all discussed in this week's "Gary DeWaal's Bridging the Week," as described below:

Also, this week the CFTC's Technology Advisory Committee meets in Washington, DC on January 21. SEFs and Made Available for Trading determinations are on the agenda.

In addition, with less than 75 days for most US FCMs, Swap Dealers and Major Swap Participants to prepare and file their Annual Compliance Report with the CFTC, my helpful hints regarding preparing the Annual Compliance report, originally published on September 4, 2013, are worth reviewing again at: http://www.garydewaalandassociates.com/?p=766. Other practical ideas to help firms maintain better Compliance programs are also included as distinct articles or as a section(s) within composite articles contained in the section of my website, Compliance Weeds. Check out: http://www.garydewaalandassociates.com/category/compliance-weeds/.

Video version:
 

 
Article version:

CFTC Deems Certified First Execution Mandate for Certain Interest Rate Swaps

Last week the CFTC's Division of Market Oversight announced that it had "deemed certified" Javelin SEF's self-certification of made available to trade determinations of certain interest rate swaps. This now requires that beginning February 15, 2014, all such swaps must be traded through a designated contract market or a swap execution facility and, if executed through a SEF, subject to the Commission's trade execution requirements, unless an exception applies (e.g., end user exception).

In issuing this announcement, the CFTC's DMO indicated that in connection with package transactions, involving more than one swap or financial instrument and at least one swap subject to a MAT determination, the swap subject to the MAT determination must be traded through a DCM or SEF. However, DMO anticipates holding a roundtable to consider "whether and under what conditions to grant limited relief for package transactions to ensure proper implementation of the execution mandate."

Commissioner Scott O'Malia, one of the three CFTC commissioners at the present time, expressed his disappointment over this decision:

"It is hard to imagine a federal agency regulatory process that is more flawed than the Made Available-to-Trade ("MAT") determination. The Commission staff has certified all interest rate benchmarks and related packaged transactions for mandatory trading on [SEFs or DCMs], while at the same time, stated that it will consider some future action for all packaged transactions. And to complicate things further, the Commission has been excluded from a major regulatory decision that significantly reshapes current market infrastructure.

I find this approach especially troubling given the CFTC Chief Economist's assessment that these packaged transactions comprise 50 percent of the notional volume of the rates market. By accepting Javelin's determination and then immediately contemplating further action with respect to half of the MAT transactions, the Commission creates uncertainty in the market and sets a dangerous precedent for future MAT determinations."

The CFTC Technology Advisory Committee will meet in Washington DC, on January 21 and discuss the MAT determination as part of its agenda, among other topics.

European Parliament and European Council Agree in Principle on MiFID II; Position Reporting for Commodity Derivatives and Enhanced Regulation of HFTs Coming

The European Parliament and European Council (heads of European Union member states) agreed last week in principle to updated rules for markets in financial instruments – so called MiFID II. This new regime is aimed, among other things, at requiring a shift in the trading of financial instruments to multilateral, regulated trading platforms; imposing a harmonized EU-wide system for position limits on commodity derivatives; and strengthening investor protection. Restrictions on certain high frequency trading will occur too.

Non-EU market access by third-country firms to professional and eligible counterparties will be based on an equivalence assessment of the third-country. A transitional period will apply for three years for this international aspect.

Among the specific elements of MIFID II,

(For a full report, initially published the same date as the European Parliament announcement, access: http://www.garydewaalandassociates.com/?p=1839.)

And briefly:

Compliance Weeds: The CFTC requires hedgers in grains, the soy complex, and cotton to file periodic reports of their cash positions when they maintain futures position in excess of Federal reportable levels. Two reports (CFTC Form 204 (regarding wheat, corn, oats, soybean complex and other grains) and CFTC Form 304 (regarding fixed priced cotton commitments) are required to be filed monthly as of the close of business on the last Friday of the month (by 3 business days at the Chicago CFTC office for the Form 204; by 2 business days at the NY CFTC office for the Form 304). A report regarding unfixed-price cotton "on call" (CFTC Form 304) must be filed weekly as of the close of business on Friday and also must be received within 2 business days at the NY CFTC office. Other deadlines apply to special calls.

Helpful to Getting the Business Done: Although the minimum adjusted net capital requirement is either very low (US $45,000), in the case of a non-guaranteed introducing broker) or non-existent, for a guaranteed IB, the costs for all IBs of ongoing operation cannot be underestimated because of system and other expenses necessary to comply with regulatory requirements such as preparing and maintaining required records. Since December 21, 2013, IBs must also even tape record all conversations that lead to the execution of regulated trades and retain those recordings for at least one year, unless they have failed to generate more than US $5 Million in total aggregate gross revenue over the prior three years. Also, to the extent that IBs intermediate order flow, clients often will insist that the IB maintain resources substantially greater than required by law, because of the potential error risk related to trade execution, among other reasons.

            My View: One word: chutzpah!

My View: The proposed Principles are a fascinating political economic document. They appear to endeavor enlisting asset managers and asset owners in the Japanese' government's effort to revitalize the country's economy (the "Japan Revitalization Strategy") by encouraging them pro-actively to promote "sustainable growth" at companies in which they invest. Talk about activist shareholders!

For additional information, see:

Basel III Liquidity Exposure:
http://www.bis.org/publ/bcbs270.pdf.
BIS Guidance Regarding Effective AML and Anti-Terrorism Financing Risk Management:
http://www.bis.org/publ/bcbs275.pdf.
CFTC Interest Rate Swaps MAT Determination:
http://www.cftc.gov/PressRoom/PressReleases/pr6831-14.

See also:

Comments of Commissioner Scott O'Malia:
http://www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement011614.
Agenda of the January 21, 2014, Technology Advisory Committee:
http://www.cftc.gov/About/CFTCCommittees/TechnologyAdvisory/tac_012114agenda.

CFTC v. Multigrain and Agricola Xingu:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfmultigrainorder011514.pdf.
CFTC v. New World Holdings:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfnewworld010814.pdf.
CSA Proposed Rule Related to Customer Clearing Protection of Customer Collateral and OTC Derivatives Positions:
http://albertasecurities.com/Regulatory%20Instruments/4727004-v2-CSA_Staff_Notice_91-304_-_Customer_Clearing_and_Protection_of_Customer_Collateral_and_Positions.pdf.
Federal Reserve and Banks Engagement of Physical Commodity Activities:
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140114a1.pdf.
FCA Guidance on Inducements to Advisory Firms:
http://www.fca.org.uk/static/documents/finalised-guidance/fg14-01.pdf.
FINRA v. Gutman, Tyndall and Settlements; AWC against Kenneth Critelli:
http://disciplinaryactions.finra.org/viewDocument.aspx?DocNb=33623.
http://disciplinaryactions.finra.org/viewdocument.aspx?DocNB=34961.
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p431923.pdf.
http://disciplinaryactions.finra.org/viewdocument.aspx?DocNB=32899.
IOSCO Assessment Methodologies for Non-Bank, Non-Insurer Global Systemically Important Financial Institutions"
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD435.pdf.
Japan FSA Asset Manager Obligations Regarding Equity Investments:
http://www.fsa.go.jp/en/news/pub/01.pdf.
SFC Action v. Tsoi Bun (Market Manipulation):
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=14PR6.

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of January 18, 2014, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article. Gary DeWaal is a member of the CFTC's Technology Advisory Committee.

 


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