The War of Words
The two protagonists in this war of words are DTCC and the CME, both of which have called in reinforcements in the letter-writing campaign. The DTCC’s position is probably best stated in its January 8 comment letter:
CME proposes to illegally tie CME’s SDR and DCO services by requiring its clearing customers as a condition to using its clearing services to have CME direct their cleared trades to CME’s own captive SDR. This proposed tying of services is contrary to the fair and open access core principle set forth for DCOs in the Dodd-Frank Act—the Dodd-Frank Act’s prohibition of market infrastructures from engaging in anti-competitive practices—and the U.S. antitrust laws.
The CME, for its part, says, in its January 16 letter:
Rule 1001 merely details how CME Clearing, as a DCO, is satisfying and will satisfy its reporting obligations under Part 45 of the CFTC’s regulations for swaps that it clears. In doing so, Rule 1001 is entirely consistent with CFTC regulations. Despite DTCC’s contentions, Rule 1001 does not force counterparties to report to a "captive SDR." Nor does Rule 1001 create or increase any risk to the financial system.
What’s Behind It All?
In order to make sense of all of this, we need to understand a couple of things behind the scenes. First, DTCC regards the SDR function as a business, from which it expects to earn a return. Its fee schedule says:
DDR [DTCC’s SDR] will impose monthly maintenance fees per swap based on the aggregate number of swaps reported under the Dodd-Frank Act, regardless of asset class. Maintenance fees will be imposed on swap dealers and major swap participants (SD/MSPs) on a per-side basis, regardless of who is actually the reporting party. ...Each swap above the 10,000 threshold will be charged a maintenance fee of eighty cents (80¢) per swap per month. [In addition,] “large users” [defined as having more than 300,000 swaps at DTCC] will, in addition to monthly maintenance fees, also be charged a quarterly large user fee through June 30, 2013, of $834,000 per quarter.
So DTCC has a lot of revenue riding on its selection as the SDR of choice. The CME, on the other hand, has indicated in its comment letter that:
CME's SDR has already determined not to charge for any mandatory reporting services through at least September 13, 2013. Market participants that elect to have CME Clearing report cleared swap data to an SDR in addition to CME SDR may be assessed a fee designed to cover costs we incur in making the report. We expect this fee to be modest.
The second behind-the-scenes factor is that Part 45 requires the following reporting of valuation data for cleared swaps:
Valuation data for the swap must be reported as follows:
(i) By the derivatives clearing organization, daily; and
(ii) If the reporting counterparty is a swap dealer or major swap participant, by the reporting counterparty, daily.
In other words, the SD or MSP must report daily valuations on cleared swaps to the SDR, in addition to the valuations reported by the clearinghouse. (This requirement was delayed until 6/30/13 by the CFTC in a no-action letter dated 12/17/2012.) Why, you might ask, would the CFTC want thousands of separate valuations on cleared swaps, when the clearinghouse’s valuation is the one that counts in the marketplace? I asked them that very question, and their answer was, “We don’t want them. The prudential regulators want them.”
Thus the banking regulators (the Fed, OCC, etc.) want these daily valuations, not as a market mechanism, but as a way of keeping an eye on their charges. The first complication in the war of the swaps data, then, is that SDs and MSPs would have to report daily valuations to the CME instead of DTCC. And it shouldn’t surprise us that the ICE, which also has a clearinghouse and an SDR, has written the CFTC in support of the CME’s rule.
The Changing Market Landscape
But there is even more going on behind the lines in this war. With the proliferation of clearinghouses that we expect, and the increase in mandatory clearing we already see on the horizon, the business dynamics of swaps are shifting. For example, we have begun to see the large clearing firms offer price discounts on those trades done with their trading desks, and Rule 1001 has a major impact on the pricing of reporting services. Finally, we have seen the first electronic trading venues for swaps, even before the CFTC has issued rules for SEFs.
As the swaps landscape changes, market participants are moving rapidly to capture the high ground, even before all the rules are finalized. If you are doing an OTC cleared swap, and clearing it on the CME, I’ll bet that the CME will help you report the original uncleared swap to their SDR at a very low cost. And since they will extinguish the uncleared swap when they clear it, there won’t be any residual reporting expense.
Furthermore, reporting efficiencies may lead traders to select one clearinghouse over another, especially if the initial margin requirements are essentially the same. If the CME (and other DCOs) regard free reporting as a low-cost method of building their clearing business, they will wreck DTCC’s business model. So we shouldn’t be surprised that the DTCC has rolled out the heavy artillery. The battle has just begun, and we should be aware that there may be no innocent bystanders in this war.