On April 26, Commodity Futures Trading Commission (“CFTC”) Chairman Giancarlo and the CFTC Chief Economist published a white paper titled “Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps” (the “White Paper”). At the International Swaps and Derivatives Association, Inc. (“ISDA”) annual meeting where the White Paper was initially presented, Chairman Giancarlo described the White Paper as “economy-focused” and stated that regulatory role of the CFTC is focused on “what’s in the best interest of markets.”

The White Paper assesses the CFTC’s implementation of the swaps reform under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) to date, relying on academic research, market activity, and the agency’s regulatory experience, and recommends improvements to the regulatory framework. As discussed below, the paper examines the following five key areas: (i) central counterparties, (ii) reporting rules, (iii) execution rules, (iv) dealer capital and (v) the exceptions for corporate end-users under the clearing and uncleared margin requirements. The White Paper notes at the outset that the CFTC was, by 2014, the first regulatory agency to implement most of the internationally agreed-upon swaps reforms and, as a result, is “in a position to recognize success, address flaws, recalibrate imprecision and optimize measures in the CFTC’s initial implementation of swaps market reform.”

1. Central Counterparties. The White Paper describes the clearing requirement as the most far-reaching and consequential of the swaps reforms under Dodd-Frank. According to the White Paper, the clearing requirement has significantly increased the volume of swaps cleared through central counterparties (“CCPs”), which has led to a number of challenges:
   • Ensuring safety and soundness under extreme (but plausible) conditions. The CFTC currently supervises CCPs in connection with the risk that clearing members may default. According to the White Paper, however, further analysis is warranted with respect to ensuring the liquidity of funded resources, understanding correlated defaults and network effects and properly accounting for liquidation costs.
   • Recovery plans. The White Paper states that considerable progress has been made in addressing how a CCP, in an extreme adverse scenario, would allocate losses, restore its matched book and replenish its financial resources, but various issues remain, including the transparency and predictability of recovery plans and the role of unfunded resources.
   • Resolution by government authorities. The White Paper states that plans for resolutions by government authorities, in the event that recovery plans prove inadequate, should be ready and transparent, and that the CFTC and Federal Deposit Insurance Corporation should work collaboratively along those lines.
2. Reporting Rules. The White Paper highlights that swap data repositories “still cannot provide regulators with a complete and accurate picture of counterparty credit risk.” According to the White Paper, this is the case, in part, because of faulty implementation by regulators, including the CFTC, by virtue of providing insufficient technological detail and specification in the initial approach to swaps reporting. The White Paper therefore suggests that the CFTC devote high-level resources to completing the process of data standardization and cross-border harmonization, which would entail:
   • further dialogue with industry participants; and
   • examining opportunities to utilize emerging digital technologies, including cloud computing, automated “big data analysis,” and – ultimately – distributed ledger technology.
3. Trade execution. According to the White Paper, the CFTC, in implementing the trade execution requirement under Dodd-Frank, excessively limited the methods of swaps execution and imposed market practices from highly liquid futures markets onto less liquid swaps trading. The result of this “flawed implementation” has been to fragment swaps trading into artificial market segments, increase market liquidity risk, hinder swaps market innovation, and incentivize a significant amount of price discovery and liquidity formation to take place off of swap execution facilities. To address these issues, the White Paper proposes:
   • removing what it describes as “ad hoc constraints on methods of execution and other inapposite forms taken from futures markets”; and
   • expanding the category of swaps that are subject to the execution requirement to include all swaps subject to the CFTC’s clearing mandate.
4. Dealer Capital. According to the White Paper, the current swap dealer capital regime is biased against swaps, in part because regulators have not allowed regulator-approved internal models in all cases. The White Paper argues that standardized regulatory capital models inappropriately rely on swap notional amount to measure risk, do not sufficiently recognize offsetting swap positions between pairs of counterparties, and do not sufficiently acknowledge the risk-mitigation of posted margin. The White Paper therefore recommends that regulators find a way to rely more heavily on internal risk models.
5. Exceptions for Corporate End-Users. The White Paper recommends that small financial end-users be exempt from both the clearing and uncleared margin requirements through a material swaps exposure threshold. According to the White Paper, such market participants (similar to currently-exempted commercial end-users) are not sources of systemic risk, and also find the requirements particularly costly. By contrast, according to the White Paper, larger financial end-users may be sources of systemic risk and, therefore, should remain subject to the clearing and uncleared margin requirements.

Chairman Giancarlo noted that the CFTC was committed to implementing the reforms proposed in the White Paper, stating: “We have an ambitious timetable, and we will get this done, but we will do this right. We will move forward in regular order and in good order – we will get this done.”