Update on SEF Trading—CFTC Issues Relief from SEF Trading for Package Transactions
As we mentioned in our January 2014 "Update on SEF Trading—Bunched Orders, Standby Clearing, and Allocation Agreements," the CFTC has been considering providing relief to the market from certain aspects of the mandatory swap execution facility ("SEF") trading requirement that becomes effective on February 15. In response to various concerns raised during the comment period to the "Made Available to Trade" ("MAT") process, the CFTC issued no-action letter 14-12 ("NAL 14-12") on February 10.
NAL 14-12 provides market participants with relief until May 15 from mandatory trading of certain swaps executed as part of "package transactions."
Definition of "Package Transaction"
For purposes of the relief, a "package transaction" is a transaction involving two or more instruments:
- that is executed between two counterparties;
- that is priced or quoted as one economic transaction with simultaneous execution of all components;
- that has at least one component that is a swap that is made available to trade and therefore is subject to the CEA section 2(h)(8) trade execution requirement; and
- where the execution of each component is contingent upon the execution of all other components.
The CFTC provided a number of examples of common types of package transactions and credit default swap package transactions.
In the interest rate swap market, packages may include: swap curves (package of two swaps of differing tenors), swap butterflies (package of three swaps of differing tenors), swap spreads (government securities vs. swaps typically within similar tenors), invoice spreads (Treasury-note or Treasury-bond futures vs. swaps), cash/futures basis (Eurodollar futures bundles vs. swaps), offsets/unwinds, delta neutral option packages (caps, floors, or swaptions vs. swaps), and mortgage-backed security basis (to-be-announced swaps (agency MBS) vs. swap spreads).
In the credit default swap ("CDS") market, packages may include transactions where parties trade index options vs. index, tranches vs. index, and index vs. single name CDS. However, these examples are not meant to be exclusive, and the package transaction definition may include other types of trades not mentioned in their list.
This relief is meant to accommodate current market practice in the fixed income and credit trading space, where a swap is often paired with another asset or different type of swap and quoted as a single transaction. During the comment period to the various MAT determinations, market participants noted that where one part of a package was a swap subject to the SEF trading requirement, package transactions would need to be broken apart into component trades because SEFs were not operationally ready to facilitate trading of the non-mandated package components. Decomposing packages into two or more trades would have forced market participants to cross multiple bid–ask spreads in order to establish risk positions identical to the ones they could have obtained via package transactions, resulting in more settlement risk and increased costs of execution.
Given this potentially disruptive effect on the fixed income and credit markets, the CFTC has decided to temporarily exempt these trades from the trade execution requirement. The 90-day no-action period will provide CFTC staff with more time to consider the technological, operational, and jurisdictional issues for mandatory trading of package transactions. Please note that notwithstanding this temporary relief from the trading exemption, all applicable clearing requirements continue to apply to trades subject to the clearing mandate.
For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.
Joel S. Telpner
Jonathan J. Ching
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