May 12th, 2014
The CFTC issued on May 1 deadlines for the implementation of made‐available‐to‐trade requirements for packaged swaps transactions, dashing dealers’ hopes for permanent relief from the mandate. The new rules will demand changes in the relationships between dealers and customers.
When the CFTC issued its made-available-to-trade (MAT) ruling for certain swaps in February, it generated considerable discussion, and one of the most discussed subjects was packaged transactions, where multiple swaps, or swaps combined with other instruments, are executed as one transaction, with linked prices. Any such transaction runs the risk of being broken up if one of the swaps is MAT, so the CFTC issued a no-action letter (NAL) in February postponing the MAT requirement for packaged transactions until May 15, while it considered a more permanent solution.
On May 1, however, the other shoe dropped, and it made rather a thud when it hit. But before we get into the details, we should look at the CFTC’s definition of a packaged transaction:
“A transaction involving two or more instruments: (1) that is executed between two or more counterparties; (2) that is 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 is made available to trade and therefore is subject to the CEA section 2(h)(8) trade execution requirement; and (4) where the execution of each component is contingent upon the execution of all other components.”
When we read that definition, our eye is drawn to clause 2, the all-in pricing, and clause 4, the all-or-nothing execution requirement, as being impacted by the MAT ruling.
To reconcile those two clauses with the possibility of having one leg MAT and another not is a stretch, to say the least. The dealer community views acting as principal on all sides of a packaged trade at the same time as the only way such trades can be done. It is possible, of course, to attempt to do your customer’s trade on a SEF, but you have to leave the customer order there for 15 seconds before you can execute against it, far too much uncertainty for most dealers So, you can imagine that the dealers were arguing for some permanent relief.
In fact, in its original NAL, the CFTC:
“… stated that during the period of relief provided, it would further consider whether, and under what conditions, to grant relief for package transactions such that there is an appropriate balance between recognizing the commercial utility of package transactions while not compromising the policy goals of the trade execution requirement.”
It was not to be. The May 1 NAL granted no permanent relief, and set four dates for the MAT rules to take effect:
- June 1 for “MAT/Non-MAT Cleared Package Transactions,” comprised of cleared swaps only, at least one of which is MAT;
- June 15 for “U.S. Dollar Swap Spreads,” comprised of one swap and one or more Treasury securities;
- November 15 for “MAT/Non-MAT Uncleared Package Transactions,” comprised of at least one MAT swap and at least one uncleared (and thus non-MAT) swap; and
- November 15 for “MAT/Non-Swap Instruments Package Transaction,” comprised of at least one MAT swap and any non-swap that isn’t a Treasury.
To put these requirements in perspective, at a January 31 CFTC open meeting on this subject, one industry expert estimated that 60% of transactions in the affected swaps (IRS and CDS) are packaged deals, so the impact of these dates can hardly be overstated.
As for solutions, there are a few possibilities. One that is already on the table is SEFs and DCMs listing the package itself. That might work for transactions that are all swaps, but it is hard to see it working for transactions that are comprised of a swap and a security. It is equally hard to imagine that solution working where the non-MAT swap is so bespoke that it trades once in a blue moon. Given the current listing requirements for SEFs, I don’t expect them to be able to list any but the most common packages.
Perhaps a more realistic possibility is an arrangement where the dealer guarantees the customer a price for the total package, based on the individual prices the dealer is willing to do. Then the MAT product is put out on the SEF and the dealer waits to see what happens. If someone steps into the MAT trade, it means that the dealer has a little room to execute the rest of the package and still give the customer the guaranteed price – unless, of course, the MAT piece was the one the dealer really wanted!
None of this works, of course, in a situation calling for the earliest implementation, a package involving two MAT swaps. Here the dealer has almost no control over the transaction, which may mean that this type, to the extent it exists now, will become extinct. In this case the dealer can’t even guarantee an all-in price, because it could lose both sides of the trade.
Finally, the parties can modify the structure so as to exclude any MAT swaps. This may be easier to do than it first appears. For example, in vanilla rate swaps that don’t start and end on IMM quarterly dates, MAT swaps are the traditional tenors starting and ending out to T+2. As many dealers have discovered, starting and ending a swap further out makes it non-MAT. Voila. Welcome to the new swaps market.
Any of these changes, of course, will demand modifications to the current documentation, which is already being worked on. They also demand changes in the relationships between dealers and customers, along with all the other changes everyone is dealing with. So if you haven’t gotten regulatory fatigue by now, this ought to do it.
