A staff report issued by the Commodity Futures Trading Commission’s (CFTC) Division of Swap Dealer and Intermediary Overight (DSIO) has been seized upon by CFTC commission Brian Quintenz to support his argument that the use of notional amounts for the $8 billion de minimis threshold for firms to be considered Swap Dealers is misguided.
Quintenz has previously argued that the regulation needs more nuance and should exclude in the calculation exchange-traded and cleared swaps – a move widely seen as leading to many non-bank firms not having to register.
The report was created and published following a directive from CFTC chairman Christopher Giancarlo last year that real data and more detailed analysis be used to judge the effectiveness of the rule and to possibly inform alternative metrics for establishing the threshold. The de minimis exception to the Swap Dealer rule states that a person shall not be deemed to be a swap dealer unless its swap dealing activities exceed an $8 billion aggregate gross notional amount threshold.
In a statement following the report’s release, Quintenz say it elucidates two “fundamental” facts about the de minimis exception, firstly that the removal of exchange-traded and cleared swaps from the calculation would result in no reduction of regulatory coverage and secondly that it highlights the “glaring deficiencies” of using notional value as the registration threshold.
The report measures the estimated “regulatory coverage” of the market – the percentage of the market subject to swap dealer regulation – under various “exclusion scenarios.” Under the existing $8 billion threshold, it estimates that 99.95% of the swaps market is subject to swap dealer regulation, and that when exchange-traded and cleared swaps are excluded, that percentage remains unchanged – 99.95% of the market continues to be covered by swap dealer regulation. “The regulatory coverage of the market remains the same because, although exchange-traded and cleared swaps represent a significant amount of activity, applying the $8 billion de minimis threshold to uncleared activity captures the same universe of swap dealers,” says Quintenz.
He adds, “The report clearly demonstrates that exchange-traded and cleared swaps can be removed from an entity’s swap dealer analysis without sacrificing the regulatory protections that are at the core of the Commission’s swap dealer regime. The Commission has already opened up the door to excluding this type of activity from the de minimis calculation through its recent floor trader no-action letter, which allows proprietary trading firms to exclude exchange-traded and cleared swaps from their de minimis calculations if they register as floor traders and comply with minimal swap dealer regulatory requirements. The Commission should revise its regulations to make this policy applicable to all market participants, not just a select few.”
Quintenz also contends that the report “clearly demonstrates that notional value is a poor measure of activity in the swaps market”, arguing that this is evidenced by the comparison of the impact that removing exchange-traded and cleared swaps has on notional coverage, relative to the impact that removing those swaps has on transaction and counterparty coverages. “If exchange-traded and cleared swaps are excluded, notional coverage decreases from $221 trillion to $127.8 trillion (57.80% of the baseline market),” he states. “However, when you apply the same exclusions to transaction coverage, the number of covered transactions only declines from 3.8 million to 3.22 million (84.70% of the baseline market). Similarly, when excluding exchange-traded and cleared swaps, counterparty coverage only decreases from 30,879 to 30,631 (88.09% of the baseline market).
“The impact of these exclusions on notional coverage is dramatically more severe than on transaction and counterparty coverages,” he continues. “The disparate impact demonstrates that notional value is a poor measure of a firm’s activity in the market and that relying solely on notional amounts as the basis for triggering swap dealer registration may result in instances of “false positives,” whereby firms with a relatively small footprint in the marketplace are nonetheless required to register. In my view, the Commission should move away from using notional value in its registration thresholds and move toward adopting metrics more representative of an entity’s actual size and risk in the market.”