On November 10, 2014, the CFTC staff issued no-action letter 14-137 (“Letter 14-37”), which extends and expands upon certain relief that was previously granted relating to “package transactions.” Complications have prevented market participants from trading some types of package transactions on swap execution facilities (“SEFs”) and designated contract markets (“DCMs”), and neither the industry nor the CFTC has yet developed solutions to these problems. In Letter 14-137, the staff recognized these complications but declined to provide the full breadth of relief requested by market participants.
Obstacles for SEF execution of package transactions
A package transaction is a transaction involving two or more instruments: (1) executed between two or more counterparties; (2) priced or quoted as one economic transaction with simultaneous or near simultaneous execution of all components; (3) that has at least one component that is a swap that has been determined to be made available to trade (“MAT”) and therefore is subject to the Commodity Exchange Act’s trade execution requirement; and (4) where the execution of each component is contingent upon the execution of all other components.
There are many different types of package transactions, usually differentiated based on the classification of the non-MAT component(s) of the transaction. The complications regarding SEF execution of package transactions vary depending on the type of package transaction at issue, but in general include:
- enablement mechanisms: If the non-MAT component of a package transaction is an uncleared swap, the counterparties must have settlement arrangements in place for that component and must comply with the CFTC’s swap trading relationship documentation requirements. These arrangements could violate another CFTC interpretation that prohibits the use of “enablement mechanisms” for SEF-executed swaps that are intended to be cleared (including the MAT leg of the package transaction).
- price reporting: Publicly reporting the price of a swap leg of a package transaction can be misleading since package transactions are priced as a whole.
- securities components: If one or more legs qualify as a security—such as transactions where one leg is a corporate bond or a mortgage-backed security—it is unclear whether and under what conditions SEFs would be able to facilitate the execution of these securities components due to SEC rules.
- futures components: If one or more legs is a futures contract—such as invoice spreads—it is similarly unclear whether SEFs can facilitate the execution of such contracts because futures must trade on DCMs.
The staff’s relief
In response to these complications, the staff’s Letter 14-137 provided different relief for different types of package transactions. If each of the non-MAT legs fall into the same category, the following relief applies:
|Each of the Non-MAT Leg(s) Are:||Counterparties may execute bilaterally until:||SEFs may facilitate without satisfying the RFQ-to-3 or order book requirements:|
|Cleared, non-MAT swaps||Relief expired on June 1, 2014||Relief expired on June 1, 2014|
|US Treasury securities||Relief expired on June 15, 2014||Relief expired on June 15, 2014|
|Agency mortgage-backed securities||May 15, 2015||May 15, 2015 (note: SEFs are not relieved from the order book requirement in § 37.3(a)(2))|
|Futures contracts||November 14, 2015||November 14, 2015|
Letter 14-137 also provides relief for certain specific types of package transactions where the non-MAT legs do not all fall within the same category. In general, counterparties to such package transactions may execute them bilaterally until February 15, 2015, and SEFs and DCMs may facilitate the transactions without complying with the RFQ-to-3 or order book requirements until February 12, 2016. One exception is where at least one non-MAT leg is a bond issued and sold in the primary market, in which case the counterparties may execute the transaction bilaterally until February 12, 2016.
If a particular transaction falls into more than one category, the broadest relief available under those categories applies.
The road ahead
Letter 14-137 provides the market with much-needed breathing room, but the relief provided may need to be extended yet again. For example, it is unlikely that the CFTC and SEC will agree upon the proper treatment of package transactions involving securities by February 15, 2015 (i.e., when such transactions other than those involving bonds in the primary market must be traded on SEFs or DCMs).
Some market participants argue that the obstacles to SEF or DCM execution of package transactions will never be overcome. But the CFTC does not seem ready to exempt package transactions from the SEF/DCM trading mandate at this time.
Read the SEF Rule.