CFTC Adopts Final Rules Implementing Real-time Public Reporting of Swap Data and Re-Proposes Rules Relating to Block Trades

March 23, 2012

Implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd Frank Act")[1] requires agencies to promulgate hundreds of new rules.  The Commodity Futures Trading Commission ("CFTC") is at the forefront of implementing the derivatives title of Dodd-Frank,[2] and is approximately halfway through issuing roughly 50 new rules.  When Congress was considering the Dodd-Frank Act, a principal hallmark of the legislation was increased transparency.  The real-time public reporting rule, recently issued by the CFTC, will dramatically change the content and amount of derivatives transactional information that is shared with the public.  It also imposes new and potentially daunting burdens on companies that use derivatives products.

This alert discusses (A) the final rule issued by the CFTC for Real-time Public Reporting of Swap Transaction and Pricing Data (the "final release"), including the reporting and public dissemination requirements on registrants and registered entities; and (B) the impact and implications that the CFTC’s further notice of proposed rulemaking for Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades (the "block trade re-proposal") would have on pre-trade and post-trade price transparency, including trading on swap execution facilities ("SEFs"), determination of appropriate minimum block sizes based on swap categories and limitations on the public dissemination of certain information.  We discuss several key issues that clients should be concerned with in connection with the real-time public reporting and block trade rules.

Because public comment is still being taken on the block trade re-proposal, there is an opportunity for concerned clients to shape and provide input on the final rules relating to block trades, including the determination of block trade sizes and execution on SEFs and designated contract markets ("DCMs").  All public comments must be submitted to the CFTC by May 14, 2012. 

I. Real-time Public Reporting Final Rule

On December 20, 2011, the CFTC unanimously approved the final release.[3]  Section 727 of the Dodd-Frank Act added section 2(a)(13) to the Commodity Exchange Act ("CEA") and authorized the CFTC to promulgate rules relating to the public reporting of swap transaction data.  Specifically, CEA section 2(a)(13)(B) authorizes the CFTC to make swap transaction data available to the public in such form and at such times as the CFTC determines appropriate to enhance price discovery.  Further, CEA section 2(a)(13)(A) defines "real-time public reporting" to mean "to report data relating to a swap transaction, including price and volume, as soon as technologically practicable after the time at which the swap transaction has been executed."

The final release creates Part 43 of the CFTC’s regulations, which implements the real-time reporting mandate in Section 727 of the Dodd-Frank Act.  While the final release implements many aspects of CEA section 2(a)(13), it did not specify criteria for determining what constitutes a block trade or large notional off-facility swap for particular markets or contracts, as required pursuant to CEA section 2(a)(13)(E)(ii).  Further, the final release did not specify the manner in which certain transactions in the "other commodity" asset class, which includes swaps that reference underlying physical commodities, should be publicly disseminated to protect the identities of participants or the business transactions and market positions of any person – hence, such swaps in the "other commodity" asset class were not subject to the final release.  The CFTC indicated in the preamble of the final release that it intended to address these issues in the block trade re-proposal (discussed in Part II below).

A. What swaps are subject to real-time public reporting (Part 43)?

The final Part 43 rules define "publicly reportable swap transaction" to mean (1) any executed swap that is an arm’s length transaction between two parties that results in a corresponding change in market risk between the two parties; or (2) any termination, assignment, novation, exchange, transfer, amendment, conveyance or extinguishing of rights or obligations of a swap that changes the price of the swap.[4] 

While there is no definition of "arm’s length," the definition of "publicly reportable swap transaction" provides, by way of example, that internal swaps between 100% owned subsidiaries of the same parent entity and portfolio compression exercises may not be considered arm’s length transactions and therefore not considered to be publicly reportable swap transactions.  The preamble explains the CFTC’s position that publicly disseminating data relating to certain swaps between affiliates would not enhance price discovery and may create an inaccurate appearance of market depth.  Although the preamble states the CFTC’s reasoning for excluding such swaps from the definition, exclusions from the definition of "publicly reportable swap transaction" appear to be limited by the language in footnote 44 of the preamble, which states that the CFTC considers "any covered transaction between affiliates as described in Sections 23A and 23B of the Federal Reserve Act to be publicly reportable swap transactions."  The CFTC may issue interpretive guidance to clarify footnote 44 in light of the definition and discussion in the final release of the term "publicly reportable swap transaction."

The final release notes that certain publicly reportable swap transactions not executed on a SEF or DCM ("off-facility swaps") in the "other commodity" asset class are not subject to Part 43 rules under the final release, but would be addressed in the block trade re-proposal.[5]

B. Who must report real-time swap transaction and pricing data?

For publicly reportable swap transactions executed on a SEF or DCM, the SEF or DCM must report the real-time swap transaction and pricing data to a swap data repository ("SDR").  For off-facility swaps, the reporting party must report real-time swap transaction and pricing data to an SDR based on the following hierarchy:

• If one party is a swap dealer ("SD") or major swap participant ("MSP") and the other is a non-SD/non-MSP (e.g., end-user), the SD or MSP is the reporting party;
• If one party is an SD and the other is an MSP, the SD is the reporting party; or
• If parties are the same designation (i.e., a swap between two end-users), then the parties shall decide which party is the reporting party. 

The final Part 43 rules permit the parties to agree, prior to execution, that the party other than the party described in the hierarchy above, will serve as the reporting party for a particular publicly reportable swap transaction.  Further, the final Part 43 rules do not prevent a reporting party, SEF, or DCM from using a third-party (including a derivatives clearing organization ("DCO")) to assist in reporting obligations (although the SEF, DCM, or reporting party still maintains the obligation to report).

C. Where and when must real-time data be reported?

All real-time swap transaction and pricing data must be reported to an SDR "as soon as technologically practicable" after execution.  Execution occurs simultaneous with or immediately following the affirmation of a swap, but prior to the confirmation of a swap.

D. What data must be reported to an SDR?

SEFs, DCMs and reporting parties must provide the SDR with the data necessary for the SDR to ensure the public dissemination of the data described in Appendix A to Part 43. 

E. What data must be publicly disseminated and who is responsible for publicly disseminating the data?

            (1) SDRs must ensure public dissemination

An SDR must ensure the public dissemination of the data fields described in Appendix A to Part 43.  An SDR may use a third-party (including a DCO) to assist in its public dissemination obligations under Part 43; however, the obligations would still remain with the SDR to ensure the information is publicly disseminated pursuant to the rules of Part 43.

            (2) Embargo Rule

SEFs and DCMs may share swap transaction and pricing data with their market participants upon transmission of such data to the SDR pursuant to Part 43.  The preamble to the final release clarifies that "market participants" means both persons with trading privileges on the platform, as well as those that pay for data streams from the platform.  Similarly, SDs and MSPs may share data with their customer base upon transmission of such data to an SDR pursuant to Part 43.  The "customer base" includes those that maintain accounts with or have been swap counterparties with such SD or MSP.  In both cases, the market participants or swap counterparties must be given advance notice of such disclosure and any such disclosure must be non-discriminatory.

These provisions may enable market participants and customers to receive swap transaction and pricing data prior to the public dissemination of such swap data by an SDR. 

            (3) Data to be publicly disseminated

The data described in Appendix A to Part 43 includes, among other things, an execution timestamp, start date, end date, underlying asset(s), price notation, rounded notional amount, payment frequency, reset frequency, indication of other price affecting terms (i.e., an indication of whether or not a swap is bespoke), and an indication of collateralization.  Appendix A to Part 43 also provides additional data fields related to the public dissemination of data related to options, swaps with embedded options and swaptions.  Part 43 prohibits information relating to the identities of counterparties, the market positions and business transactions of any person from being publicly disseminated.

            (4) Notional caps

While SEFs, DCMs and reporting parties must report the actual notional amount of a publicly reportable swap transaction to an SDR, the notional amounts that will be publicly disseminated will be capped.  The final Part 43 rules create interim notional caps that vary based on asset class.  The interim notional caps will be adjusted to align with the appropriate minimum block size, once such appropriate minimum block sizes are established.  The interim notional caps are $25 million for "other commodity" swaps, $100 million for credit swaps, $75 to $250 million for interest rate swaps[6] and $250 million for foreign exchange ("FX") and equity swaps.  For example, a two-year interest rate swap with a notional amount of $550 million would be publicly disseminated as "$250 MM+."

F. When must swap transaction data be publicly disseminated?

Until the CFTC promulgates final rules for distinguishing between block trades (or large notional off-facility swaps) and transactions that do not qualify as block trades (or large notional off-facility swaps), public dissemination of all swaps subject to Part 43 will be subject to time delays.  After the CFTC establishes an appropriate minimum block size for a swap category, only block trades and large notional off-facility swaps will be subject to time delays prior to public dissemination, as described in Part 43.[7]

Pursuant to the final release, the time delays for public dissemination will vary depending on the type of entity, whether the swap is subject to the clearing mandate, the type of execution, and asset class.  The SDR is responsible to publicly disseminate the swap transaction and pricing data immediately upon expiration of the time delay (measured to the time of execution).

Regardless of the time delay for public dissemination, real-time data must still be reported to SDRs by SEFs, DCMs and reporting parties "as soon as technologically practicable" after execution of the swap.

G. What are the effective and compliance dates for the final release?

The effective date of the final release was March 9, 2012, however the final release sets out a schedule for compliance with the Part 43 rules based on the type of entity, type of execution, and asset class.  The compliance schedule is as follows:

II. Block Trade Re-proposal

On February 23, 2012, the CFTC voted 3-2 to approve the block trade re-proposal, with Commissioners O’Malia and Sommers voting no.[9]  The block trade re-proposal provides criteria for determining swap categories within each asset class, methodologies for setting appropriate minimum block sizes for each swap category and limitations on the public disclosure of certain swap transaction and pricing data.  As discussed, the final release adopted several provisions related to and referenced in the block trade re-proposal, including several relevant definitions (e.g., block trade, large notional off-facility swap and appropriate minimum block size), phased in time delays and "interim cap sizes."  Functionally, the block trade re-proposal would add to Part 43 rules relating to block trades, large notional off-facility swaps and public dissemination of swaps in the "other commodity" asset class. 

The preamble to the block trade re-proposal includes over 100 specific questions which include variations and alternatives to the proposed approaches discussed below.  The last day for interested parties to submit public comment related to the block trade re-proposal is Monday, May 14, 2012.

A. What are the effects of the block trade re-proposal on transparency?

            (1) Pre-Trade Transparency

For any swap that is required to be executed on a SEF or DCM, after an appropriate minimum block size is set for the relevant swap category, if such swap has a notional amount equal to or greater than the appropriate minimum block size (i.e., a block trade), then, pursuant to the rules of the SEF or DCM, such swap may be executed away from the trading system or platform.  Swaps that are considered block trades could be removed from the pre-trade bid and offer transparency requirements that would be required if the notional amount of the swap was less than the appropriate minimum block size.  Therefore, the appropriate minimum block size for a swap has a direct effect on how that swap will be traded on a SEF or DCM.[10]

            (2) Post-Trade Transparency

After an appropriate minimum block size is set for a swap category, only swaps in that swap category that have notional amounts equal to or greater than such appropriate minimum block size (i.e., block trades or large notional off-facility swaps) are eligible to receive the time delays adopted in the final release.  All publicly reportable swap transactions with notional amounts less than the appropriate minimum block size must be publicly disseminated "as soon as technologically practicable."

B. How are swap categories determined?

While Part 43 defines five distinct asset classes: interest rates, credit, equity, FX and other commodity, the block trade re-proposal breaks down each of these asset classes into swap categories to determine an appropriate minimum block sizes for each category.  In determining swap categories within an asset class, the CFTC intended to categorize swaps having common risk and liquidity profiles, while minimizing the number of swap categories to avoid unnecessary complexity. 

The block trade re-proposal provides for the swap categories in each asset class as follows:

            (1) Interest Rates

• 24 interest rate swap categories based on tenor and currency (8 tenor groups and 3 currency groups)

            (2) Credit

• 18 credit swap categories based on tenor and spread (6 tenor groups and 3 conventional spread groups)

            (3) Equity

• One swap category for the entire asset class
• Equity swaps are not eligible to be considered block trades or large notional off-facility swaps (i.e., all equity swaps would have to be publicly disseminated "as soon as technologically practicable" and would not be eligible to receive a time delay for public dissemination)

            (4) FX

• Over 400 FX swap categories based on unique currency combinations
• Currency combinations would be distinguished as futures-related FX currency combinations and non-futures related FX currency combinations

            (5) Other Commodity

• Over 120 other commodity swap categories grouped based on economically related[11] swaps
  • Each of the 42 referenced contracts in Appendix B would be considered a separate swap category.[12]
  • In addition to the swap categories created by Appendix B to Part 43, there would be 18 other commodity swap categories for futures-related swaps, in which the relevant futures contract is subject to the block trade rules of a DCM.
  • Other commodity swap categories are differentiated based on futures and options to the extent that a DCM has different block sizes for each.
• Additional swap categories would be established for all other commodity swaps by grouping them based on individual other commodity and other commodity groups.

C. Implementation Phases – What are the appropriate minimum block sizes and notional caps for each of the implementation phases?

            (1) Interim Period

During the Interim Period established by the final release, all swaps will receive a time delay for public dissemination until appropriate minimum block sizes are set in the Initial Period (discussed below).  During the Interim Period, the publicly disseminated notional amounts will be capped at the specific dollar amounts set forth in the final release until the Initial Period commences. 

            (2) Initial Period

The Initial Period becomes effective 60 days after the publication of the final block trade rules in the Federal Register and will last for no less than one year after an SDR has collected "reliable" data for a particular asset class.  The block trade re-proposal provides specific appropriate minimum block sizes for each swap category which would be used during the Initial Period.  During the Initial Period, any publicly reportable swap transaction that has a notional amount equal to or greater than the appropriate minimum block size assigned to the swap category in which it falls will continue to be eligible to receive a time delay, while all publicly reportable swap transactions with notional amounts less than the appropriate minimum block size must be publicly disseminated "as soon as technologically practicable."  Further, the caps on publicly disseminated notional amounts will adjust from the specific dollar amounts set in the Interim Period to the appropriate minimum block sizes set during the Initial Period, but only to the extent that the appropriate minimum block size is greater than the notional cap set in the Interim Period.  During the Initial Period, the CFTC will analyze data to adjust appropriate minimum block sizes and notional cap sizes for the Post-Initial Period.

            (a) Appropriate Minimum Block Sizes During the Initial Period

The block trade re-proposal provides initial appropriate minimum block sizes (found in proposed Appendix F to Part 43) for swap categories within all asset classes, except equity.  The appropriate minimum block sizes during the Initial Period would be determined in the following manner:

            (i) Interest Rates and Credit

• Each swap category is assigned an appropriate minimum block size (in U.S. dollars) based on a 67% notional amount calculation using three months of data provided to the CFTC through the OTC Derivatives Supervisors Group.
• Based on the data, approximately 6% of trades in the interest rate and credit asset classes would be equal to or greater than the appropriate minimum block sizes and therefore eligible for time delays for public dissemination.

            (ii) Equity

• No swaps will be treated as block trades.

            (iii) FX

• For futures-related FX currency combinations:
  • The interim appropriate minimum block size is based on DCM block sizes.
• For non-futures-related FX currency combinations:
  • All non-futures related FX swaps would qualify to be treated as a block trade or large notional off-facility swaps.

            (iv) Other Commodity

• For futures-related other commodities:
  • If the related futures contract has a DCM block size, then the interim appropriate minimum block size is based on DCM block sizes.
  • If the related futures contract does not have a DCM block size, then such swaps will not be treated as a block trade.
• For non-futures-related other commodities:
  • With respect to Appendix B natural gas or electricity swaps, the appropriate minimum block size would be set at $25 million.
  • With respect to swaps that fall within the Appendix D other commodity swap categories, all such swaps would be treated as block trades.

                 (b) Notional Cap Amounts During the Initial Period

Pursuant to the block trade re-proposal, the notional amounts that are publicly disseminated would be adjusted to the greater of (i) the interim cap size for such swap (as provided in the final release) or (ii) the appropriate minimum block size.  For example, if a five-year U.S. dollar interest rate swap with a notional amount of $400 million is entered into during the Interim Period, the notional amount that would be publicly disseminated would be "$250 MM+," whereas if that same swap is entered into during the Initial Period, the notional amount would be publicly disseminated as "$380 MM+."  If there is no appropriate minimum block size set in the Initial Period, then the notional cap will continue to be set at the interim cap size.

            (3) Post-Initial Period

The Post-Initial Period begins on the first day of the second month following the publication of post-initial appropriate minimum block sizes on the CFTC’s website. 

            (a) Setting Appropriate Minimum Block Sizes During the Post-Initial Period

The appropriate minimum block sizes in the Post-Initial Period would be set, for all asset classes (except the equity asset class which would have no block trades), based on a calculation of 67% of the notional amount of the observed data set.  The CFTC will rely on at least one year’s worth of data collected by SDRs to perform this calculation and will review the appropriate minimum block sizes no less than once each calendar year.[13]

            (b) Setting Notional Cap Amounts During the Post-Initial Period

The notional cap amounts in the Post-Initial Period would be set, for all asset classes, based on a calculation of 75% of the notional amount of the observed data set.  Therefore, in the Post-Initial Period the notional caps would always be greater than the appropriate minimum block sizes meaning that some block trades would not be reported with a capped notional amount.

D. Election to be Treated as a Block Trade or Large Notional Off-facility Swap

SEFs or DCMs must notify the SDR of the election to treat a publicly reportable swap transaction as a block trade.  Similarly, a reporting party that executes an off-facility swap with a notional amount at or above the appropriate minimum block size must notify the SDR of the election to treat such publicly reportable swap transaction as a large notional off-facility swap.

E. Limitation on Public Disclosure of Geographic Information for Publicly Reportable Swap Transactions in the "Other Commodity" Asset Class

In order to ensure that the public dissemination of swap transaction and pricing data would not unintentionally disclose the identities, market positions and business transactions of any swap counterparty to a publicly reportable swap transaction, the block trade re-proposal provides a means for top-coding the geographic detail of certain swaps in the "other commodity" asset class.  The geographic top-coding differs based on the type of product and whether the location is in the U.S. or outside the U.S.  For example, pursuant to the block trade re-proposal, if there is a Mid-C Financial Off-Peak Daily power swap, it would be publicly disseminated to mask the specific trading point location (i.e., Mid-Columbia) and instead would be publicly disseminated with the FERC Electric Power Market in which the trading point falls (i.e., Northwest).

The top-coding of geographic detail would not apply to swaps executed on or pursuant to the rules of a SEF or DCM and would not apply to swaps referencing or economically related to one of the 42 contracts listed in Appendix B to Part 43.

III. Conclusion

The final Part 43 rules require SDRs, SEFs, DCMs, SDs, MSPs, and non-SDs/non-MSPS (including non-financial end-users) to comply with real-time public reporting requirements within a given compliance timeline.  To comply with the real-time reporting and public dissemination requirements, a swap participant must understand its specific obligations under Part 43 and ensure that sufficient technological, process and legal solutions are in place.   

The block trade re-proposal raises issues for market participants relating to the initial and post-initial appropriate minimum block sizes for swap categories in all asset classes.  With respect to swaps subject to both the clearing and trading mandates, the appropriate minimum block sizes determine which swaps must be executed on SEFs and DCMs by permitting execution away from the trading system or platform for swaps that are equal to or greater than such amount.  The appropriate minimum block sizes also will determine what post-trade swap transaction and pricing data is subject to time delays for public dissemination, which raises further issues related to liquidity, front-running and off-setting risk.  Clients should prepare for the likely effects that the block trade re-proposal and the final Part 43 rules will have on liquidity, pricing and trading in particular contracts and markets.  For example, the initial appropriate minimum block size for U.S. dollar interest rate swaps with a tenor greater than 10 years but less than or equal to 30 years would be $210 million dollars.  If a counterparty were to enter into a 15-year U.S. dollar interest rate swap with a notional amount of $200 million, regardless of the reference index, such swap would not be considered a block trade.  To the extent that such swap is subject to both the clearing and trading mandates, it would be required to be executed on a SEF’s or DCM’s trading system or platform (i.e., bilateral execution away from the SEF or DCM but pursuant to its rules would not be permitted).  Regardless of whether or not such swap is subject to the clearing and trading mandates, the swap would not be eligible for a time delay for public dissemination and public dissemination of the swap transaction and pricing data, including the exact notional amount, would occur "as soon as technologically practicable."  Swaps in other asset classes would be treated in the same manner, by referencing the appropriate minimum block size for the swap category in which they are grouped.

Additionally, clients should be aware that the block trade re-proposal’s rules related to the public dissemination of notional caps and underlying assets in the "other commodity" asset class may raise concerns related to the protection of counterparty identities and proprietary trading information.

Gibson Dunn can assist participants in the derivatives markets that want to learn more about the real-time public reporting rule or block trade re-proposal, or that want to attempt to shape development of the block trade re-proposal.