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One footnote to rule them all: Close reading of the CFTC’s SEF rules reveal a controversial requirement

If you thought the debate on swaps reform in the United States was settled, you were wrong. A new row has emerged between the Commodities and Futures Trading Commission (CFTC), international regulators, and firms as the definition of who is a Swap Execution Facility (SEF) has been greatly expanded under a controversial footnote in the rules proposal.  This discovery will have huge implications for all institutions that trade or execute trades in swaps.

Footnote 88 in the rules text has expanded the scope of who needs to register as an SEF, even if they are executing swaps that are not required to be executed. The rule reads:

“Therefore, a facility would be required to register as a SEF if it operates in a manner that meets the SEF definition even though it only executes or trades swaps that are not subject to the trade execution mandate. The Commission also notes that transactions involving swaps on SEFs that are subject to the trade execution mandate are considered to be “Required Transactions” under part 37 of the Commission’s regulations, whereas “Permitted Transactions” are transactions not involving swaps that are subject to the trade execution mandate.”

This of course means that suddenly many institutions who were not expecting to have to register as SEFs are required to do so.  And those firms who were not expecting to have to clear through SEFs suddenly do.  This will have impacts across the firm, from legal, who have to figure out what this all means, to trading systems, reporting and reference data.

The problem is that this is not the first time the CFTC has hidden such a game-changing requirement in a footnote.  Recently, the CFTC’s rules on substituted compliance included a footnote which stated that US branches of non-US MSPs/SDs would still be subject to transaction-level Dodd-Frank requirements.

What will the CFTC’s next steps be going forward? Given the likelihood of widespread non-compliance, some sort of compromise looks likely, whether in the form of amendments or no-action letters. But, this is complicated by the need to align requirements with the EU, who are due to issue their final statement on whether the US’ rules are equivalent with their own in the coming months. However, at this point, it is too early to make definitive predictions on the result of the SEF rules debate.