Alert May 28, 2013

CFTC Approves Core Principles and Other Requirements for Swap Execution Facilities

The CFTC approved a final rule establishing core principles and other requirements for swap execution facilities (“SEFs”), a new type of regulated entity established by the Dodd-Frank Act.  SEFs are defined in the Commodity Exchange Act, as amended by the Dodd-Frank Act, in part, as “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system….”

The rule, which has been eagerly anticipated by various industry participants that intend to launch SEFs, includes requirements and specifications pertaining to fifteen “core principles” governing SEFs that were originally included in the Dodd-Frank Act.  These include, for example:  Core Principle 4, which requires a SEF to establish and enforce rules and specifications detailing trading procedures and procedures for trade processing and to monitor trading in swaps to prevent manipulation, price distortion, and disruptions of the delivery or cash settlement process; Core Principle 8, which requires a SEF to adopt rules to provide for the exercise of “emergency authority” including the authority to liquidate or transfer open positions in any swap or to suspend or curtail trading in a swap; Core Principle 10, which requires a SEF to maintain records and issue reports to the CFTC; and Core Principle 13, which requires a SEF to have adequate financial, operational, and managerial resources to discharge each responsibility of the SEF.

The final rule also includes provisions governing the registration of SEFs with the CFTC.  Other provisions of the rule prohibit a SEF from using for business or marketing purposes any proprietary data or personal information it receives for the purpose of fulfilling its regulatory obligations (unless the person providing the data “clearly consents” to such use, but the SEF is prohibited from conditioning its services on receiving such consent).

The final rule requires a SEF to offer an “order book,” which is an electronic trading facility, trading facility, or trading system or platform in which all market participants in the trading system or platform have the ability to enter multiple bids and offers, observe or receive bids and offers entered by other market participants, and transact on such bids and offers.  The rule requires that transactions (other than block trades) executed on a SEF be made either via the order book or through a request for quote system in which a market participant transmits a request for a quote to buy or sell a specific instrument to at least three unaffiliated market participants (subject to a one-year phase-in period in which only two requests for quote are required), to which all such market participants may respond.  The proposed rule would have required that five quotes, rather than three with a phase-in of two, be solicited via the request for quote system.

The rule will become effective 60 days after its forthcoming publication in the Federal Register (with the exception of a provision concerning CFTC review of applicants that apply to register as SEFs on or after two years following the effective date).  Compliance is required with most provisions of the rules 120 days after publication in the Federal Register.