Comment Text:
September 28, 2023
Mr. Clark Hutchinson, Director, Division of Clearing and Risk
Mr. Vincent McGonagle, Director, Division of Market Oversight
Ms. Amanda Olear, Director, Market Participants Division
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st, NW
Washington, DC 20581
RE: Request for Comment on the Impact of Affiliations on Certain CFTC-Regulated Entities
Dear Division Directors.
AEGIS SEF, LLC (“AEGIS SEF”) welcomes the opportunity to comment in response to CFTC staff’s questions regarding the Impact of Affiliations on Certain CFTC-Regulated Entities. Our ability to create an affiliate that was a SEF has been materially important for our business, and the controls in place through the combination of regulation and the SEF approval process are effective in avoiding conflict of interest in doing so. In addition, a robust, new commodity market providing liquidity and increased transparency regarding swap transactions has been created.
To our knowledge, AEGIS SEF is the first and, thus far, only bilateral Swap Execution Facility created in response to the CFTC’s determination that Aegis Hedging Solutions (“AHS”) and other similarly situated Commodity Trading Advisors (CTAs) are required to execute client-assisted transactions on a SEF. Once AHS became aware of the need to have their CTA-assisted transactions on a SEF, AHS sought a SEF where its uncleared bilateral swaps could be executed. Unable to find one, AHS made the choice to create such a SEF so that we could continue to support clients in assistance negotiating swaps. AHS began work on a SEF application in 2020, submitted the application in February 2021, had that application reviewed by the CFTC over the next 17 months and was granted registration for AEGIS SEF in July 2022. AEGIS SEF has now been in operation for a year.
The steps taken to become a registered SEF are important to the discussion about the Conflicts of Interest between SEFs and affiliate CTAs/IBs/CPOs. The application process enabled CFTC staff to review and vet AHS’s creation of a CTA and a separately managed and registered SEF. Without the ability to have an affiliated SEF, AHS would have been forced to cease its CTA operations given an unaffiliated SEF was not available to execute uncleared bilateral swaps through a Request for Quote (RFQ) system. AHS, in coordination with the Staff at the CFTC, took great care to ensure that the SEF and CTA would not have the conflict of interest concerns. Each Exhibit in the application was carefully examined to maintain compliance with SEF Core Principles, notably Core Principle 2 for impartial access for all CTAs, Core Principle 12 for Conflicts of Interest, and Core Principle 15 for administration and execution of all of the above. Among the Exhibits reviewed was the Governance of the SEF, Rulebook, Compliance Manual, Code of Business Conduct & Ethics, Shared Services Agreement, and Regulatory Oversight Committee Charter, all of which enforce firm separation of affiliated entities.
As an advisor CTA/IB-assisted platform, AEGIS SEF was designed to assist Participants and their Dealers with Over the Counter bilateral swap transactions. None of these Dealers were present on any SEF to assist their bilateral client counterparties. The commodity swap products that these CTA clients needed to hedge were not listed on any SEF. Today, AEGIS SEF has 23 Dealers (and growing) to assist with hundreds of different bilateral commodity swaps. The SEF affiliate was created to meet the need of a CTA affiliate that was simply not present elsewhere.
Here is a numbered summary of the efforts and protections which address affiliations between a SEF and a CTA/IB/CPO, as raised in the questionnaire. They support the conclusion that existing structures, processes and regulations are extensive and sufficient for managing the relationship between a SEF and its affiliate.
(1) Minimizing Conflict of Interest was a matter of great attention in AEGIS SEF’s application to become an approved Swap Execution Facility. They were addressed as follows:
(a) CFTC Oversight. A SEF Rulebook, Compliance Manual, and Regulatory Oversight Committee Charter are written with explicit consideration of the issues where a regulated SEF would have oversight over an affiliated CTA or IB. Those documents make rules and provisions for the proactive minimization/elimination and handling of Conflict of Interest.
(b) Independent Governance. Both a SEF Board and SEF ROC are separate from the CTA and parent Company’s oversight. They also have outside public directors who are obligated to check any use of improper influence in all SEF matters, including surveillance and disciplinary matters.
(c) Disciplinary Panels. There are clear and detailed CFTC regulations requiring extensive vetting of Conflict of Interest in the formation and deliberation of enforcement panels. This includes §1.64, which requires at least one outside person who is not a member of the SEF on its panels.
(d) Calved entities. The legal structure of the entities are separated so that SEF and CTA are different entities, sister organizations with different Executive Staff that are in no way tied to one another.
(e) Separate Dedicated Staff for Compliance and Surveillance. Staff responsible for compliance and surveillance is dedicated to the SEF and not shared with any affiliate.
(f) Regulatory Services Provider (RSP). The use of a third party, such as the National Futures Association (NFA), to perform T+1 Trade Practice Surveillance and to assist with all T+1 surveillance, investigations and disciplinary matters provides unbiased oversight complementing a Conflicts of Interest policy. Through regular and consistent day to day involvement in all matters of trade surveillance, an independent third party/auditor is bound by a duty to be fair and consistent with all IB/CTA Broker Firms.
(2) Measures taken to address concerns about Impartial Access. Impartial access is continually vetted when maintaining compliance with the running of a SEF. A SEF must maintain impartial access for all classifications of users, be they Dealers, Market Participants, CTA/IB Broker Firms or ISVs. When distributing access between affiliated and unaffiliated intermediaries, a number of provisions ensure impartiality:
(a) they are governed by the same rules
(b) they use the same platform
(c) disciplinary matters are transparent to the CFTC
(i) An RSP, who performs T+1 Trade Practice Surveillance as a third party for all entities
(d) A Regulatory Oversight Committee (ROC), comprised of Public Directors who are expressly forbidden to have any material relationship with the affiliates, overseeing Conflict of Interest to entities
(e) SEF Officers, employees and their agents are expressly forbidden from sharing any material non-public information as it relates to any CTA/IB Broker Firm interest, be that an affiliate OR non-affiliate interest.
(3) Mitigating potential for differentiated Market Surveillance of non-Affiliated entities. A SEF is accountable to the CFTC for monitoring and protecting market integrity. An RSP, as a third party entity, assists directly with Trade Practice Surveillance and Market Surveillance. If a SEF treated one IB/CTA unequally from another, be that an affiliate or otherwise, that would be made known to the CFTC or RSP through required disclosure of the results of disciplinary activities or Surveillance activities of the neutral RSP.
(4) Mitigating potential for competitive advantages to an affiliate over other peer CTAs/IBs. A SEF has a profit incentive and needs to adhere to Core Principle 13, sufficient resources. It is therefore incentivized to encourage trading sourced from any and all CTAs/IBs, affiliated or otherwise. This increases transparency in the swaps market for all participants. SEF fees are uniform for all CTA/IB Broker Firm participants. The same Dealers are accessible by each and every CTA/IB Broker Firm.
(5) Providing limits on sharing resources between affiliated entities. A SEF is restricted from sharing any personnel with affiliated CTAs or IBs. Personnel are segregated into separate physical space. Through a parent structure, some marketing, treasury, and technology functions can be shared through a CFTC-approved Shared Services Agreement which is carefully administered for Conflict of Interest. Employees who perform services for both the CTA and SEF affiliates undergo annual training and are supervised if a task is to share core function information. Further, should a task involve performing a core function, shared resources are required to observe a predetermined period wherein they are restricted from performing work for the opposing entity. These “shared” services should be allowed because the benefits to the marketplace outweigh concerns given the non-core information being worked with which does not create conflict. In the event that they could possibly do so, there should be detailed procedures to comply with in such an event.
(6) Restrictions on sharing information between affiliates. SEF Compliance data and information are separate from all other files and restricted to SEF staff. The CTA and SEF affiliates’ employees are restricted from seeing each other’s data and information.
(7) Mitigating potential for unequal access to SEF trade execution. Trade Execution is governed by the same mechanical platform functionality, limitations and rules for all entities. Trade Execution is siloed, so that one CTA/IB’s transacting activities are not comingled in any way with another CTA/IB’s transacting activities. The audit trail would uncover unequal treatment should abuse be present. An RSP would be aware of uneven enforcement. Conflict of Interest rules are lengthy within a SEF Rulebook and Regulatory Oversight Charter, further ensuring an open platform.
(8) Chances for favoring Product Listings of Affiliates over Unaffiliated CTAs/IBs. Product listings are the lifeblood of a SEF. A SEF is incentivized to do more business, so new Products would be in their interest. Logically, a competing CTA/IB Broker Firm’s Client participants and the client participants of an affiliated CTA/IB Broker Firm (of the SEF) would likely be transacting in nearly the same products and thus it would be highly unlikely if not impossible for such efforts to be distributed with unequal effort. If there was a Product that was deemed to be withheld, the CTA/IB Broker Firm could easily seek assistance through numerous channels, including the SEF ROC or the CFTC itself. AEGIS SEF, as a matter of record, has listed many products that its affiliate does not require, because it is making them available to other CTAs to attract business.
(9) Mitigating potential for Contagion Risk between a SEF and its affiliate. Market Surveillance is carried out by a SEF and its RSP. If contagion risk would become a possibility, all parties involved in a particular market that may be affected should be notified. SEF records to this effect should bare that out in such a circumstance.
(10) Disclosure of the SEF affiliations with a CTA. Public disclosure of affiliated CTA/IB Broker Firms should be made by a SEF. AEGIS SEF has made the disclosure that AEGIS CTA is a Broker Firm customer. However, a SEF protects all participants by not disclosing names unless that entity deals with another entity directly on the platform. So, if a CTA/IB joins or leaves, that participation should remain confidential.
(11) Equal Treatment of Affiliated and Unaffiliated entities. A SEFs Rulebook, Fee Schedule and Regulatory Oversight Charter, which are publicly available, provide the transparency for the policies and procedures which afford all entities equal treatment and “arms length” treatment of affiliates. Affiliated and unaffiliated entities under the authority of a SEF (whether a IB/CTA or a trading Participant) require the same oversight under the same SEF rules and the same CFTC regulations.
In summary, the CFTC and AEGIS SEF have taken many steps to mitigate the impact of having an affiliate CTA transact on its platform. The benefits of delivering a commercially viable solution for the CTA, in combination with the protections afforded to every affiliated and unaffiliated Participant, have enabled the CFTC to deliver on its Dodd Frank mandate to bring transparency to the swaps market. The marketplace for advisor-assisted transactions now has a governed rulebook with greater speed, transparency, and recordkeeping for all Participants.
Respectfully submitted,
Andrew Furman
Chief Compliance Officer
AEGIS SEF, LLC
