the commission's ill-conceived rules in a rigid and restrictive fashion. Yet, I also knew the white paper would receive attention from Capitol Hill policymakers and financial media. I hoped it would convey that one can be in favor of market reform and yet oppose a peculiar implementation of the reform.
The white paper made a huge impact. It got very positive reviews from members of the influential Futures Industry Association, the global association for those who work with exchange-traded futures and options. Together with the ISDA—the association for those who work with derivatives not traded on exchanges—these two organizations were the leading resources on these markets for public officials and investors worldwide.
For years, I had known the friendly and fair-haired FIA president, Walt Lukken. We worked in the same building in lower Manhattan following the financial crisis. Lukken and I agree on many things, including love for rhythm and blues. He has done and said more about the issues I care about than anyone I know.
Lukken told me that the white paper was getting compliments for the quality of the writing, its comprehensive analysis of a range of issues, and its formulation of workable alternative proposals. Many market participants said that it addressed concerns that they had raised when the SEF rules were being proposed that had never been addressed. Lukken directed an FIA group to draft a set of specific rule-change proposals to bring to the CFTC.
More important was the paper's impact on the CFTC staff. In conversations, I could tell that they were becoming more conversant with the characteristics of over-the-counter swaps markets distinguishable from the exchange-traded futures markets with which the staff had long-standing expertise. Market participants told me that staff interactions were increasingly substantive and better informed. One long-standing CFTC watcher told me that the white paper encouraged agency staff to have a more open-minded approach to Dodd–Frank implementation.
Some of this change was undoubtedly due to the new collegial approach of Chairman Massad. Still, the white paper played a key role in this awakening with respect to swap exchange facilities.
Lawyer Steven Lofchie had this to say in his blog, the Cadwalader Cabinet:
“The [current] CFTC SEF trading rules did not receive substantial support from either the buy side or the sell side. Whether or not one agrees with the specific recommendations made by Commissioner Giancarlo, it is difficult to see the logic of the CFTC's continuing defense of market structures and trading rules that few participants favor and that do not contribute to market stability in any way. Significant credit should go to the Commissioner for his persistence in compelling the CFTC to revisit these flawed rules.”3
In August 2015, the first significant changes occurred. The agency staff agreed to recognize additional methods of swaps trading as acceptable under CFTC rules, as was reported, for instance, by Reuters' Mike Kentz.
“CFTC staff has deemed auction-style execution protocols for over-the-counter swaps as allowable under the Dodd–Frank regime for trading derivatives on swap execution facilities, putting to rest a controversial issue that had been playing out behind the scenes for over a year …
“The decision solidifies the use of another method of execution alongside the existing request-for-quote and central limit order book methods, which so far have not been enough to attract activity to the nascent trading platforms that launched two years ago …
“The CFTC had pushed back on approving auctions over the last year for fear of scuppering efforts to increase pre-trade transparency in OTC swaps, a key tenet of the Dodd–Frank Act.
“The argument that Dodd–Frank provides specifically for flexibility in execution methods via language that states SEFs may execute trades “through any means of interstate commerce … was first expounded by now-commissioner Christopher Giancarlo at the outset of the rule-making process five years ago, when he was executive vice-president at inter-dealer broker GFI Group … Giancarlo has stuck to his point but thinks the agency needs to codify the change publicly with more detail.”4
This decision was an essential step in allowing swaps trading some of the flexibility that Dodd–Frank authorized.
Action by No Action
A greater breakthrough came the following January 2016, almost a year after the white paper's publication. It was my first day back in Washington after Christmas break at our home in New Jersey. In the office, I met with my staff to hear their analysis of the agency's proposed individual permanent registrations for the first 18 Swap Execution Facilities. We went through each application. My staff counsel, Amir Zaidi, a rigorous lawyer and former analyst at the Federal Reserve Bank of New York, identified the different business models offered by each firm.
It quickly became apparent that the applications reflected a comprehensive range of business models. These included hybrid electronic and voice-based systems, mechanisms called “request for quote” and “central limit order books,” as well as fully electronic auction systems. Some of the applicants sought to serve primarily wholesale—or “sell side”—market participants, while others sought to serve both “sell-side” and “buy-side” players. Some of the SEFs focused on just a few types of swaps, while others planned to handle a wide range. It was clear that the staff had bent over backwards to allow SEFs to operate by “any means of interstate commerce” as Congress had promised in Dodd–Frank.
Though delighted with the result, I was disappointed by the elaborate, administrative procedure that produced it. That result was a fair amount of circumvention of the ill-conceived SEF rules. Those peculiar rules, by their terms, required SEFs to restrict their business models to just two means of interstate commerce: “request for quote” and “central limit order books.” CFTC staff were now recommending, however, approval of SEF registrations that allowed a broad set of trading methods. In my view, that was exactly the right outcome, because that was what Congress had always envisioned and specified in the language of the Act. But what a ridiculous, roundabout way to do the right thing.
The guts of the workaround hinged on conditioning SEF approvals on applicants' compliance with five staff letters, called “no-action letters.” Each letter effectively waived flawed swaps trading rules that I had identified in my white paper.
This was bad administrative law on several levels. First, rather than the CFTC lifting the inappropriate limits on SEF business models, the CFTC was just ignoring those limits. Second, the opaque mechanisms being used would make it very hard for other market participants to understand what modes of swap execution the CFTC was really permitting. Observers would have to pore over the fine print of each and every SEF registration that was approved and then extrapolate the unstated rules that were quietly being applied. Third, relying on a hodgepodge of “no action” letters would force market participants to jump through pointless hoops of make-work.
I told my staff I intended to issue a blistering public statement. I would declare that the whole thing was a sham and that “the Emperor had no clothes.”
Amir's face turned down. I asked why. He told me that market participants were sorely afraid of my doing so. Everyone knew that it was a charade to pretend that SEFs were being restricted in their business models when, in fact, they were being allowed to operate competitively. But the industry also knew that Dodd-Frank advocates needed to maintain the appearance that they were “cracking down” on Wall Street. If I was candid about what the staff had done, then Dodd–Frank proponents might have to profess shock and foist more restrictions on SEFs. In short, everybody was hoping that I would keep my mouth shut. I got the point.
So
