Comment Text:
Gordon F. Peery
K&L Gates LLP
D: 949.623-3535
F: 949.253.0902
June 9, 2011
Submitted Electronically and Sent via Overnight Mail
Mr. David A. Stawick
Secretary of the Commission
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581
Re: Swap Data Recordkeeping and Reporting Requirements; RIN 3038-AD48
Dear Secretary Stawick:
K&L Gates LLP respectfully submits this letter on behalf of an asset management firm based in the United States in response to the request of the Commodity Futures Trading Commission (the “Commission” or the “CFTC”) for comment concerning the Commission’s proposed rulemaking (the “Proposed Rule”) to implement swap data reporting and recordkeeping provisions within Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”).
Dodd Frank requires the reporting of extensive data concerning all swaps in existence as of July 21, 2010, and “historical” swaps in existence as of or after publication of the Proposed Rule to give regulators a “complete picture of the swap market which the comprehensive regulatory framework and reporting requirements of the statute are designed to provide.” Included within the Proposed Rule is the obligation to provide, for historical swaps that have not expired or terminated as of the compliance date specified in the final regulations, “ongoing reporting of required swap continuation data during the remaining existence of the swap.”
The reporting that the Proposed Rule would require must be viewed with other proposals, including those on the subject of real-time reporting, by the CFTC and the Securities and Exchange Commission (“SEC”) (specifically, the CFTC’s proposed rule requiring that all block transactions are to be reported within 15 minutes of execution, almost without exception, and also the Commission’s proposed rule that requires traders to ask for quotes from no less than five market participants). When viewed in the aggregate, the new, proposed regulatory regime subjects non-deliverable forwards and many other currency and other derivatives to unprecedented disclosure requirements (and accompanying administrative, operational and other burdens), even though many of these trades played little or no role whatsoever in the market crises that led to the subsequent enactment of Dodd Frank.
The Proposed Rule Is Unnecessarily Broad, in that
It Requires Extensive Reporting for Derivatives
such as Currency and Interest Rate Swaps,
which Played Little or No Role in the 2008 Market Crises.
The Commission interprets the reporting mandates set by Dodd Frank in an exceedingly broad manner to require, if its Proposed Rule is adopted, comprehensive trade data for all swaps, including but not limited to non-deliverable forwards (whether open on July 21, 2010 or thereafter), at several stages during the life cycle of the swaps, without regard to whether the swaps played any role in the 2008 market crises by: (a) contributing to systemic risk, (b) causing or contributing to widespread losses in the market during those crises; or (c) failing to settle in an orderly market.
The Proposed Rule casts a blanket that is as far as it is wide, across the entire universe of the derivatives that come within the Dodd Frank “swap” (and, it appears from the Proposed Rule, “mixed swaps” and “multi-asset swaps”), without regard to how certain segments within the over-the-counter (“OTC”) derivatives market performed during the years that led up to, and including 2008.
In proposing that this data be reported, the Commission draws no distinction between the OTC derivatives markets in which widespread losses were sustained (e.g., the market for credit default swaps) on the one hand, and on the other markets in which currency- and interest rate derivatives for example, functioned properly and no widespread losses were experienced in 2008 relative to losses in structured products and certain credit derivative markets.
To the extent that a category of derivatives did not contribute to losses from the 2008 market crises, the Commission should not impose historic or real time data reporting requirements for swaps, especially in cases where there is little supporting evidence that such swaps resulted in losses due to market seizure or contributed to systemic risk (many short-dated currency-based trades, for example, settled without incident). Imposing data reporting requirements in the absence of any real harm, when certain OTC derivatives markets properly performed and trades settled, does not further any meaningful public policy yet potentially causes more potential harm, such as creating a disclosure regime that would compromise sensitive trading data from lawful derivative-based investment activities.
The Proposed Rule Requires the Reporting of 19 Economic Terms for
Interest Rate Swaps and 13 Economic Terms for Currency Swaps,
Creating the Potential for Leaks and Competitors to
Connect-the-Dots to Reconstruct and Predict Trading Patterns.
If the reporting in the Proposed Rule becomes a part of the final rule, the Commission must not only ensure complete anonymity, but do everything in its power to eliminate the possibility that reporting through third party vendors may compromise the lawful trading activities of end users including my client.
Section 46.6 of Part 46 within the Proposed Rule states that counterparties that are required to report swap data for any pre-enactment or transition swap “may contract with third party service providers to facilitate reporting.” These service providers, which may or may not be within the jurisdiction of the Commission, may inadvertently disclose or permit disclosure of any one or more of the economic terms to competitors. My client, along with other end users, is not in privity of contract with third party service providers and therefore would have no recourse for such disclosure (i.e., disclosure of any one or more of 19 economic terms for interest rate swaps, and 13 economic terms for currency swaps) , is not in a position to know whether disclosure has occurred, and would require swap dealers and major swap participant counterparties to provide a complete indemnity for losses (which indemnity such counterparties would not likely provide).
Even if swap data is reported anonymously and no third party service provider leaks take place, real-time data reporting called for under Dodd Frank (and implementing (proposed)) rules, coupled with the pre-enactment, transition and life cycle trading requirements within the Proposed Rule could enable competitors of my client to construct trading patterns and “connect-the-dots” to compromise lawful derivatives trading activities.
In markets in which there are a discrete and limited number of end users actively trading, the disclosure of the 13 and 19 economic terms for currency and interest rate swaps, respectively, would (even with complete anonymity) enable competitors to identify a significant trader and trading strategy. This would not only have a dramatically negative effect on liquidity of the market in which those trades occur, but it would result in extreme commercial detriment to the party placing the trades. Public disclosure would also bring about an anticompetitive pricing distortion and discourage trading in the United States unless law- and rule-making is conducted with complete cohesiveness in currency and interest rate markets throughout the world.
* * *
In summary, in the absence of evidence that supports a finding that a category of derivatives did not, prior to 2009: (a) contribute to systemic risk, (b) cause or contribute to widespread losses; or (c) fail to settle in an orderly manner, we recommend that the Commission not require real time reporting, and reporting of pre-enactment and historic trades of swaps within such categories. Alternatively, in the event that such reporting is part of the final rule, it is requested that a bare minimum of the economic terms (not 13 and 19 categories of economic terms as proposed for currency and interest rates swaps in the pre-enactment and historic swap categories in the Proposed Rule) be required for reporting, and the Commission require indemnification of third party service provider leaks that result in losses.
We appreciate the opportunity to comment during the rulemaking phase of the Dodd Frank Act implementation process.
Respectfully submitted,
Gordon F. Peery
K&L Gates LLP
ENDNOTES
i Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps, 76 Fed. Reg. 22833 (April 25, 2011).
ii Id. at 22837 (referencing Commodity Exchange Act Section 4r(a)(2)(A)).
iii Id. at 22837-38.
iv See, e.g., Regulation SBSR – Reporting and Dissemination of Security-Based Swap Information (Security and Exchange Commission File No. S7-34-10) and Real-Time Public Reporting of Swap Transaction Data, RIN 3038-AD08).
V Id. at 22838.
vi For example, far from seizing, the market in foreign exchange-based derivatives thrived even during the 2008 market crises. Bank for International Settlements Report on OTC Derivatives Market Activity in the Second Half of 2008 (At the end of 2008, notional amounts outstanding of foreign exchange derivatives was $49.8 trillion. Gross market values rose by 73.2% to $3.9 trillion). Interest rate derivative notionals rose 5 percent over 2007. International Swaps and Derivatives Association, Inc., 2008 Year-End Market Survey.
vii Id. at 22838.
Viii These terms include, for interest rates swaps in the pre-enactment and transition categories, the contract type, the transition, effective and end dates, notional amounts, fixed rate payer and payment frequency, and for currency swaps, the currencies, notional amounts for both, settlement agent of the reporting and non-reporting party, settlement currency, exchange rates, swap delivery (cash or physical), expiration date. For both the interest rate and currency swaps, the Proposed Rule requires “Any other primary economic term(s) of the swap matched by the counterparties in verifying the swap.” Id. at 22847.
vixSee, e.g., Regulation SBSR – Reporting and Dissemination of Security-Based Swap Information (Security and Exchange Commission File No. S7-34-10) and Real-Time Public Reporting of Swap Transaction Data, RIN 3038-AD08).
