“On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The legislation was enacted to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things, providing for the registration and comprehensive regulation of swap dealers and major swap participants….” (CFTC 17 CFR Part 37)
i. Compliance with core principles
SEFs must operate in compliance with the core principles (outlined below).
ii. Compliance with rules
A SEF must establish a number of rules governing swap trading, have the resources necessary to enforce those rules, and discipline swap participants in violation of the rules. (details)
A SEF must
- Enforce the terms of swap deals traded through its facility;
- Establish and enforce rules governing trade procedures and processing, and prohibit abusive trading practices;
- Ensure impartial access by all members and market participants;
- Have the necessary personnel and technological resources to enforce its rules. This includes access to documents, sufficient staff, an automated surveillance system, and real time monitoring or an approved third-party regulatory provider;
- Capture and retain all data necessary to create an audit trail, including:
- Original source documents
- Transaction history database
- Electronic analysis capability
- Safe storage capacity
(Audit trails must be regularly checked, and sanctions be placed on those swap participants not in compliance with SEF rules.)
- Establish clear investigative and disciplinary procedures, including the creation of Review and Hearing panels. Swap participants allegedly in violation of rules must be notified of charges, have the right to representation in front of a Hearing panel, and have the right to appeal. SEFs may establish their own rules outlining the timetable for disciplinary rulings. SEFs also must have the ability to take emergency disciplinary action.
- Ensure that swap dealers and participants are in compliance with all clearing requirements.
iii. Swaps not readily susceptible to manipulations
SEFs must only permit trading in swaps which are not easily susceptible to manipulation by calculating their own reference price or using a reliable third-party index.
iv. Monitoring of trading and trade Processing
SEFs are responsible for monitoring swap trades to prevent price manipulation, distortion, and disruptions through the use of real-time monitoring, trade reconstruction, and impartial disciplinary practices. (details)
Specifically, the SEF must:
- Collect and evaluate market data on a daily basis to detect and deter manipulation, distortion, and disruption using a real-time electronic monitoring system;
- Use additional monitoring for physical-delivery and cash-settled swaps. For physical-delivery swaps, SEFs must monitor and assess the deliverable supply to determine if the terms are appropriate. For cash-settled swaps, SEFs must monitor the index used to settle the swap.
- Require that traders keep full records all their activity, so that it can comprehensively and accurately reconstruct all trades.
- Establish and maintain risk control mechanisms.
v. Ability to obtain information
An SEF must establish and enforce rules allowing it to obtain any and all necessary (including non-routine) information, be able to hand that information over to the CFTC upon request, and have the capacity to carry out information-sharing agreements as the CFTC requires.
vi. Position limits or accountability
To reduce the risk of market manipulation, SEFs shall impose position limits or position accountability as it deems necessary. The limits shall be no higher than the Commission’s own limits.
vii. Financial integrity of transactions
SEFs must establish and enforce rules to ensure the financial integrity of their transactions. (details)
- Swaps cleared via a registered clearing organization must also meet minimum financial standards established by the SEF.
- For non-cleared swaps, SEFs must require participants to demonstrate that they have credit documentation, have sufficient collateral, meet credit filters, and comply with any other standard the SEF chooses to employ.
iix. Emergency authority
SEFs shall create emergency procedures to be exercised in conjunction with the CFTC, including the authority to liquidate or transfer open positions and suspend or curtail trading.
ix. Timely publication of trading information
SEFs must have the ability to capture information on price, trading volume and other data and make it available in a timely manner.
x. Recordkeeping and reporting
SEFs must maintain all business records, including audit trails, for at least 5 years, and report this information to the CFTC and the SEC as required.
xi. Antitrust consideration
SEFs shall not unreasonably restrict free trade or impose any significant anti-competitive burdens on trades.
xii. Conflicts of interest
SEFs should create rules and procedures to minimize conflicts of interest in its decision-making process, and establish a protocol to deal with any conflicts which do arise.
xiiv. Financial resources
SEFs must have adequate resources to carry out their duties for a one-year period, calculated on a rolling basis. (details)
- These resources may be of the SEFs own capital or any other resource deemed acceptable by the CFTC. At least 6 months of the 12 months capital must be in cash or highly liquid securities.
- SEFs must recalculate its operating costs and fiscal resources quarterly, and report its findings to the CFTC (including documentation of methodology).
xiv. System safeguards
SEFs must create a procedure to analyze, identify, and minimize sources of risk, using appropriate procedures and automated systems. They must also create emergency back-up procedures and systems. (details)
An SEFs risk analysis program must include:
- Information security;
- Business continuity-disaster recovery (“BC-DR”) planning and resources;
- Capacity and performance planning;
- Systems operations;
- Systems development and quality assurance;
- Physical security and environmental controls.
Automated systems and emergency procedures must be tested on a regular basis to ensure they are functional.
xv. Designation of Chief Compliance Officer
An SEF’s board of directors must appoint a Chief Compliance Officer to administer SEF policy and report to the board and to the CFTC. (details)
The CCO’s duties include:
- Overseeing SEF compliance with core principles;
- Moderating conflicts between business decisions and compliance considerations or open access requirements, and conflicts between the SEFs management and its board;
- Writing and administering policy and procedure to comply with Dodd-Frank and CFTC rules, including the creation of a compliance manual;
- Establishing and enforcing disciplinary procedures for non-compliant parties;
- Supervising the SEFs self-regulatory mechanisms, including real-time surveillance and audit trail requirements;
- Prepare and submit a compliance report for the CFTC to be submitted no less than annually containing the SEFs policies, procedures, disciplinary actions, an honest self-assessment, and discussion of areas to improve. This shall first be submitted to the board of directors or senior officer, and then sent to the CTFC not more than 60 days after the end of the SEFs fiscal year.
