CFTC Approves New Swaps Rules: Uses Some Old Jargon

Derivatives, Regulatory 22 May 2013

Why do so many people use the word “methodology” when the word “method” would work just fine? I don’t have a “methodology” for making orange juice in the morning.  I have a “method,” which starts with locating a can with the word “concentrate” on it. If I called that my “methodology” I would be considered unbearably pretentious.  And that would be an accurate assessment.

The latest offender to pique my curiosity is Gary Gensler, the current chair of the Commodity Futures Trading Commission.

Four new rules

In a meeting May 16, the CFTC approved four new rules pertinent especially to swap trades. Two of these rules became final by 3 to 2 votes, one by a 4-1 vote, one unanimously. The goal of the whole set is to bring the CFTC into line with the mandates set out by the Dodd-Frank Act, signed by President Barack Obama in July 2010.

In pertinent part, that Act amended the Commodity Exchange Act, providing for the registration of swap dealers and major swap participants, imposing clearing and trade execution requirements on standardized products, while creating recordkeeping and real-time reporting regimes. In particular the law requires the public availability of swaps data in such a manner as the CFTC deems appropriate, and requires the CFTC to specify what constitutes a block trade, or a “large notional swap transaction.” Trades that aren’t large notional swaps are to be reported more rapidly and thoroughly than those that are, apparently because the convenience that block trading offers institutions must be balanced against the need for enhanced transparency.

The new rules create a phased-in approach to the implementation of appropriate block sizes. Gensler, in his opening statement, said that during the initial period “block sizes for foreign exchange and other commodity asset classes will be based upon the block sizes that designated contract markets have set for economically related futures contracts,” but that after that initial period the CFTC “will determine block sizes using a methodology that relies on the data collected by swap data repositories.”

The idea is that once the necessary data is in, block sizes will be set in such a way that two-thirds of the notional amount of a particular category will get both “pre-trade transparency and enhanced post-trade transparency.” That’s the method, or approach, or any other appropriate word you want to use, that the CFTC has now approved. Whatever they say, though, it isn’t a “methodology.”

At any rate, the treatment of block sizes in the final rule has left SIFMA unhappy. In an immediate statement,  SIFMA’s acting president, Kenneth E.  Bentsen Jr., said that the phase-in procedure for the first year “is an improvement on what had been proposed,” but the methodology (yes, he uses that word too) is flawed and will result in “arbitrary outcomes that are not based on observable market data.”

In this he was echoing Commissioner Jill Sommers, who said Thursday that she regretted the 67% notional amount formula applied across all asset sizes: “Minimum block sizes should be driven by the most current objective data available, not an automatic across-the-board formula based on stale data.”

But all that sounds like an inside-the-clique sort of argument, which is presumably why words like “methodology” are thrown about. That is generally a good sign that “ordinary people need not join this conversation.”

Final Thoughts

The aspect of these regulations though that has burst the bounds of intra-industry debate and become something of a mainstream cause is the price solicitation system, also known as “requests for quote” system, an aspect of the rule on Swap Execution Facilities in particular. An earlier proposed form of the rule said that asset managers would have to contact at least five banks while seeking a price for a swap. Apparently this was an idea close to Gensler’s heart, although it was not mandated by anything in the underlying legislation.

At any rate, after a lot of push-back from the banks, the CFTC modified the rule in its final form. The final rule as approved requires only two RFQs during a transitional period. The number will rise to three in fifteen months.

One final thought. The only proper use of the term “methodology,” aside from we’re-in-the-club posturing, is the meaning the etymology suggests. Methodology is the study of methods, in the same way that technology is the study of techniques, epistemology is the study of knowledge, and  Scientology is … well, never mind that last one.

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