The CFTC is facing threats of legal action from Bloomberg over the differences in the proposed treatment of swaps and swap-futures margins.
Bloomberg is preparing to launch a swap execution facility (SEF), or a trading venue that will offer trading in standardized swap instruments, which is regulated by the CFTC. These types of swaps and swap-execution facilities that Bloomberg intends to create, will have higher margin requirements than swap futures.
The Trade News reports that Bloomberg’s SEF will be subject to rules in the Dodd-Frank Act, one of the aims of which is to reduce systemic risk in the OTC derivatives market by pushing swaps onto exchange-like venues and clearing houses.
Some industry analysts see this as positive, believing this will facilitate more trading to more uniform swap-futures products, while others believe this will reduce investor abilities to accurately hedge their trades and increase systemic risk.
While many of the new swaps rules are already in force, including reporting and clearing of credit and interest rate derivatives for swap dealers and major swap participants, Bloomberg’s threat is not the only legal action facing the CFTC.
In early March, the Depository Trust and Clearing Corporation threatened to sue the agency after it approved a CME Group rule that requires trades conducted on its market to be reported to their data repository. The CFTC also had give up several proposals related to position limits for commodities after coming under fire from several firms on Wall Street.
At the heart of Bloomberg’s threat to the CFTC, concerns the lower initial margin payment required for swap futures compared to swaps, which the firm believes will drive liquidity away from SEFs. The Trade News reports that futures usually require margin based on one-day value-at-risk (VaR) calculation, while for swaps margin is based on a five-day VaR — which raises the cost for institutional investors that use the instruments for hedging purposes.
Bloomberg is asking for an equal, one-day VaR margin methodology to apply to cleared swaps and futures, and has requested a response to its letter by March 19th, in order to meet, if required, mandatory clearing starts for US financial entities on June 10th.
