Relief for Swap Dealers and Major Swap Participants Regarding the Obligation to Provide Certain Disclosures for Certain Transactions Under Regulation 23.431.

Summary: Relief for Swap Dealers and Major Swap Participants Regarding the Obligation to Provide Certain Disclosures for Certain Transactions Under Regulation 23.431.

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5977

Facsimile: (202) 418-5407

gbarnett@cftc.gov

Division of Swap Dealer and

Intermediary Oversight

Gary Barnett

Director

CFTC Letter No. 13-12

No-Action

May 1, 2013

Division of Swap Dealer and Intermediary Oversight

Re:

Relief for Swap Dealers and Major Swap Participants Regarding the Obligation to

Provide Certain Disclosures for Certain Transactions Under Regulation 23.431

Ladies and Gentlemen:

This letter is in response to requests from the Foreign Exchange Committee (“FXC”), the

Financial Markets Lawyers Group (“FMLG”), the Wholesale Markets Brokers Association

(“WMBA”) and Thomson Reuters Corporation (“Thomson Reuters”) on behalf of FX Alliance,

LLC and Reuters Transactions Services Limited (together, the “Requesting Parties”) to the

Division of Swap Dealer and Intermediary Oversight (“Division”) of the Commodity Futures

Trading Commission (“Commission”), in which the Requesting Parties requested relief from the

Division that would permit swap dealers (“SDs”) and major swap participants (“MSPs”), under

certain circumstances described herein, to enter into certain transactions without disclosing a pre-

trade mid-market mark (the “PTM”) to the non-SD, non-MSP counterparties (the

“counterparties”) to such transactions as required under Commission Regulation (“Regulation”)

23.431(a)(3)(i).1

Applicable Regulatory Requirements

Section 4s(h)(3)(B) of the CEA directs the Commission to adopt business conduct

standards for SDs and MSPs that:

require disclosure by the swap dealer or major swap participant to any

counterparty to the transaction (other than a swap dealer, major swap participant,

security-based swap dealer, or major security-based swap

ation”)

23.431(a)(3)(i).1

Applicable Regulatory Requirements

Section 4s(h)(3)(B) of the CEA directs the Commission to adopt business conduct

standards for SDs and MSPs that:

require disclosure by the swap dealer or major swap participant to any

counterparty to the transaction (other than a swap dealer, major swap participant,

security-based swap dealer, or major security-based swap participant) of –

* * *

1 Although FMLG and FXC are sponsored by the Federal Reserve Bank of New York, the letter requesting relief

states that the request was not endorsed by the Federal Reserve Bank of New York or the Federal Reserve System.

Page 2

(iii) (I) for cleared swaps, upon the request of the counterparty, receipt of

the daily mark of the transaction from the appropriate derivatives clearing

organization; and (II) for uncleared swaps, receipt of the daily mark of the

transaction from the swap dealer or the major swap participant.2

On February 17, 2012, the Commission issued final rules pursuant to 4s(h) of the CEA

prescribing certain business conduct standards for SDs and MSPs, which included Regulation

23.431.3 In relevant part, Regulation 23.431 reads as follows:

At a reasonably sufficient time prior to entering into a swap, a swap dealer or

major swap participant shall disclose to any counterparty to the swap (other than a

swap dealer, major swap participant, security-based swap dealer, or major

security-based swap participant) material information concerning the swap in a

manner reasonably designed to allow the counterparty to assess . . . [t]he material

incentives and conflicts of interest that the swap dealer or major swap participant

may have in connection with a particular swap, which shall include: (i) [w]ith

respect to disclosure of the price of the swap, the price of the swap and the mid-

market mark of the swap as set forth in paragraph (d)(2) of this section . .

sonably designed to allow the counterparty to assess . . . [t]he material

incentives and conflicts of interest that the swap dealer or major swap participant

may have in connection with a particular swap, which shall include: (i) [w]ith

respect to disclosure of the price of the swap, the price of the swap and the mid-

market mark of the swap as set forth in paragraph (d)(2) of this section . . . .4

The initial compliance date for § 23.431 was the later of 180 days after the effective date

of the publication of the final rule or “the date on which swap dealers or major swap participants

are required to apply for registration pursuant to Commission rule 3.10.”5 The Commission

subsequently postponed the compliance date for a number of the business conduct standards

rules, including § 23.431, until May 1, 2013.6

In describing the purpose of requiring SDs and MSPs to disclose the PTM, the

Commission stated that “the spread between the quote and mid-market mark is relevant to

disclosures regarding material incentives and provides the counterparty with pricing information

2 CEA Section 4s(h)(3)(B), 7 U.S.C. § 6s(h)(3)(B).

3 Business Conduct Standards for Swap Dealers and Major Swap Participants With Counterparties, 77 Fed. Reg.

9734 (Feb. 17, 2012) (hereinafter “Final Business Conduct Standards”). In the proposed business conduct standards

rules, the Commission proposed Regulation 23.431 to “provide specificity with respect to certain material

information that must be disclosed” by swap dealers and major swap participants. Business Conduct Standards for

Swap Dealers and Major Swap Participants With Counterparties, 75 Fed. Reg. 80638, 80643 (proposed Dec. 22,

2010).

4 Final Business Conduct Standards at 9824.

5 External Business Conduct Standards at 9734.

6 In September 2012, the Commission changed the compliance date of §§ 23.402; 23.410(c); 23.430; 23.431(a)–(c);

23.432; 23.434(a)(2), (b), and (c); 23.440; and 23.450 to January 1, 2013

r

Swap Dealers and Major Swap Participants With Counterparties, 75 Fed. Reg. 80638, 80643 (proposed Dec. 22,

2010).

4 Final Business Conduct Standards at 9824.

5 External Business Conduct Standards at 9734.

6 In September 2012, the Commission changed the compliance date of §§ 23.402; 23.410(c); 23.430; 23.431(a)–(c);

23.432; 23.434(a)(2), (b), and (c); 23.440; and 23.450 to January 1, 2013. See Confirmation, Portfolio

Reconciliation, Portfolio Compression, and Swap Trading Relationship Documentation Requirements for Swap

Dealers and Major Swap Participants, 77 FR 55904, 55942 (Sept. 11, 2012). The Commission later changed the

compliance date for these provisions to May 1, 2013. See Business Conduct and Documentation Requirements for

Swap Dealers and Major Swap Participants; Extension of Compliance Date, 78 FR 17, 20 (Jan. 2, 2013).

Page 3

that facilitates negotiations and balances historical information asymmetry regarding swap

pricing.”7

However, Regulation 23.431(c) provides an exception from the requirement for an SD or

MSP to provide the PTM. It states that the requirement to provide a PTM does not apply with

respect to a transaction that is “(1) [i]nitiated on a designated contract market or a swap

execution facility; and (2) [o]ne in which the swap dealer or major swap participant does not

know the identity of the counterpart to the transaction prior to execution.”8

The Division notes that pursuant to Section 1a(47)(E) of the Commodity Exchange Act

(“CEA”),9 the Secretary of the Treasury (“Secretary”) is vested with the authority to determine

whether foreign exchange swaps and forwards10 should be regulated as swaps under the CEA,

provided that the Secretary makes a written determination satisfying certain criteria specified in

CEA Section 1b

tion.”8

The Division notes that pursuant to Section 1a(47)(E) of the Commodity Exchange Act

(“CEA”),9 the Secretary of the Treasury (“Secretary”) is vested with the authority to determine

whether foreign exchange swaps and forwards10 should be regulated as swaps under the CEA,

provided that the Secretary makes a written determination satisfying certain criteria specified in

CEA Section 1b. On November 16, 2012, the Secretary issued a written determination that

physically-settled foreign exchange forwards and swap agreements should not be regulated as

swaps under the CEA (“Treasury Determination”).11 Nonetheless, CEA Section 1a(47)(E)(iv)

states that, notwithstanding the Secretary’s written determination, “any party to [an Exempt FX

Transaction12] that is a SD or MSP shall conform to the business conduct standards contained in

section 4s(h).”13 Thus, SDs and MSPs are required to comply with the business conduct

standards adopted by the Commission in subpart H of part 23 of the Commission’s regulations

by May 1, 2013, including § 23.431.

Previous No-Action Relief

In Staff Letter No. 12-42 (Dec. 6, 2012), the Division granted no-action relief from the

PTM requirement for limited types of foreign exchange transactions. Specifically, the Division

stated that it would not recommend that the Commission take an enforcement action against an

SD or MSP for failure to disclose the PTM, as required by Regulation 23.431(a)(3), to a

7 Id. at 9766. In the preamble to the proposed rule, the Commission noted that the “mid-market [mark] is a

transparent measure that would assist counterparties in calculating valuations for their own internal risk management

purposes.” Business Conduct Standards for Swap Dealers and Major Swap Participants With Counterparties, 75

Fed. Reg. 80638, 80646 (proposed Dec. 22, 2010).

8 Final Business Conduct Standards at 9824.

9 7 U.S.C. 1a(47)(E)

, the Commission noted that the “mid-market [mark] is a

transparent measure that would assist counterparties in calculating valuations for their own internal risk management

purposes.” Business Conduct Standards for Swap Dealers and Major Swap Participants With Counterparties, 75

Fed. Reg. 80638, 80646 (proposed Dec. 22, 2010).

8 Final Business Conduct Standards at 9824.

9 7 U.S.C. 1a(47)(E).

10 Foreign exchange swaps and foreign exchange forwards are defined in Sections 1a(24) and 1a(25), respectively,

of the Commodity Exchange Act.

11 Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange

Act, 77 Fed. Reg. 69694 (Nov. 20, 2012) (hereinafter, the “Treasury Determination”).

12 Physically-settled foreign exchange forwards and swap agreements that have been exempted from the definition

of swap by the U.S. Department of the Treasury are hereinafter referred to as “Exempt FX Transactions.” See

Treasury Determination.

13 Additionally, foreign exchange swaps and forwards are subject to reporting obligations, pursuant to Section

1a(47)(E)(iii) of the CEA, 7 U.S.C. § 1a(47)(E)(iii).

Page 4

counterparty in connection with: (a) foreign exchange swaps and forwards that, by their terms,

are physically settled, where each currency is one that is included among the top 13 deliverable

currencies (by volume) described in the Bank for International Settlements’ Triennial Central

Bank Survey, Report on Global Foreign Exchange Market Activity in 2010 (the “BIS 13

Currencies”),14 and where the transaction has a stated maturity of one year or less; and (b) vanilla

foreign exchange options that, by their terms, are physically settled, where each currency is one

included among the BIS 13 Currencies, and where the option has a stated maturity of six months

or less, provided that: (1) real-time tradable bid and offer prices for the applicable transactions

were available electronically in the marketplace to the counterparty; and (2) the counterparty to

the appl

eign exchange options that, by their terms, are physically settled, where each currency is one

included among the BIS 13 Currencies, and where the option has a stated maturity of six months

or less, provided that: (1) real-time tradable bid and offer prices for the applicable transactions

were available electronically in the marketplace to the counterparty; and (2) the counterparty to

the applicable transaction agreed in advance, in writing, that the SD or MSP need not disclose a

PTM.

The Division granted the no-action relief based on, among other things, representations

made by FXC and FMLG that the applicable transactions benefit from a combination of high

liquidity, narrow bid and offer spreads, and the existence of a significant amount of publicly

available information with respect thereto, arguing therefore that compliance with the PTM

requirement does not provide any significant additional informational value but would require

SDs and MSPs to create a new price stream when quotes are provided electronically and would

add additional operational requirements for dealers when quotes are conveyed by voice. With

their original request for relief, FXC and FMLG submitted data collected from foreign exchange

dealers and public sources showing that the PTM that would be disclosed by SDs and MSPs in

connection with the applicable transactions would be substantially similar to publicly available

information.15 In the letter granting no-action relief, the Division stated that it would consider

extending the no-action relief to other transactions, if sufficient data and other relevant

information were submitted to the Division establishing the appropriateness of an extension.

Summary of Additional Requests for Relief

Subsequent to the Division’s grant of no-action relief, FXC and FMLG submitted a letter

requesting that the Division expand the transactional scope of the no-action relief granted in Staff

Letter No

her transactions, if sufficient data and other relevant

information were submitted to the Division establishing the appropriateness of an extension.

Summary of Additional Requests for Relief

Subsequent to the Division’s grant of no-action relief, FXC and FMLG submitted a letter

requesting that the Division expand the transactional scope of the no-action relief granted in Staff

Letter No. 12-42 to include: (i) foreign exchange forwards or swaps, and transactions that would

be foreign exchange forwards or swaps but for the fact that they are non-deliverable, in each case

where each currency is one included among the top 31 currencies (by volume) described in the

Bank for International Settlements’ Triennial Central Bank Survey Report on global foreign

14 The BIS 13 Currencies referenced in Staff Letter 12-42 excluded the Korean won, which is a restricted currency.

Excluding the Korean won, the top thirteen deliverable currencies by volume are the US dollar, Euro, Japanese yen,

Pound sterling, Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona, New Zealand

dollar, Singapore dollar, Norwegian krone and Mexican peso. See Bank for International Settlements, 2010 BIS

Triennial Central Bank Survey, Report on global foreign exchange market activity in 2010 12 (Dec. 2010), available

at http://www.bis.org/publ/rpfxf10t.pdf.

15 In data submitted by the FXC and FMLG that was collected from major foreign exchange dealers and Bloomberg,

“the typical deviation from a publicly available mid (as provided by Bloomberg) is just $36 on a $1m notional

EUR/USD forward deal, $77 on a $1m notional AUD/USD forward deal and $254 on a $1m notional USD/MXN

forward deal.” Letter from FXC and FMLG to Gary Barnett at A-1 (Nov. 16, 2012).

ata submitted by the FXC and FMLG that was collected from major foreign exchange dealers and Bloomberg,

“the typical deviation from a publicly available mid (as provided by Bloomberg) is just $36 on a $1m notional

EUR/USD forward deal, $77 on a $1m notional AUD/USD forward deal and $254 on a $1m notional USD/MXN

forward deal.” Letter from FXC and FMLG to Gary Barnett at A-1 (Nov. 16, 2012).

Page 5

exchange market activity in 2010 (“BIS 31 Currencies”)16 and the transaction has a stated

maturity of two years or less, (ii) vanilla foreign exchange options whether deliverable or non-

deliverable, where each currency is one included among the BIS 31 Currencies and the option

has a stated maturity of two years or less, and (iii) multi-component transactions comprised

entirely of a combination and/or series of the foregoing transactions. As part of their request,

FXC and FMLG submitted data collected from foreign exchange dealers and public sources that

they believe shows that the PTM that would be disclosed by SDs and MSPs in connection with

the above referenced transactions would be substantially similar to publicly available

information. Therefore, they argue that the additional information that would be provided by the

PTM would be minimal.

In a separate letter, Thomson Reuters requested relief from the requirement to provide the

PTM for certain transactions executed on anonymous electronic trading platforms.17 Thomson

Reuters notes that Commission regulation § 23.431(c) provides that an SD or MSP need not

disclose the PTM with respect to a swap if the swap is (1) initiated on a DCM or SEF and (2) the

SD or MSP does not know the identity of the counterparty prior to execution. However, Exempt

FX Transactions are not required to be executed on SEFs or DCMs and may be executed on an

electronic trading platform that is not registered as a SEF or DCM

§ 23.431(c) provides that an SD or MSP need not

disclose the PTM with respect to a swap if the swap is (1) initiated on a DCM or SEF and (2) the

SD or MSP does not know the identity of the counterparty prior to execution. However, Exempt

FX Transactions are not required to be executed on SEFs or DCMs and may be executed on an

electronic trading platform that is not registered as a SEF or DCM. Thomson Reuters notes that

an SD or MSP that executes an Exempt FX Transaction on an electronic trading platform that is

not registered as a SEF or DCM will not be able to rely on § 23.431(c) for an exception to the

PTM disclosure requirement. This would be true even if the SD or MSP were matched

anonymously to the counterparty on the electronic trading platform and if real-time, pre-trade

pricing information was available to the counterparty prior to entering into the transaction.

Thomson Reuters argues that the pre-trade pricing information that is available on many

electronic trading platforms not registered as a SEF or DCM is not materially different than the

information that would be conveyed by disclosure of the PTM by individual SDs and MSPs.

Additionally, they argue that requiring disclosure would impose substantial additional costs that

would likely lead to a decrease in market liquidity and transparency due to decreased

participation on anonymous electronic trading platforms.

Therefore, Thomson Reuters requested that the Division provide no-action relief for SDs

and MSPs from the requirement to provide the PTM for certain foreign exchange swaps and

forwards, executed on a non-SEF, non-DCM anonymous electronic trading platform where: (1)

contracts executed on the electronic trading platform are Exempt FX Transactions, (2) only

eligible contract participants participate in the non-SEF, non-DCM anonymous electronic trading

16 The BIS 31 Currencies referenced in FXC and FMLG’s request are composed of the following: US dollar, Euro,

Japanes

us electronic trading platform where: (1)

contracts executed on the electronic trading platform are Exempt FX Transactions, (2) only

eligible contract participants participate in the non-SEF, non-DCM anonymous electronic trading

16 The BIS 31 Currencies referenced in FXC and FMLG’s request are composed of the following: US dollar, Euro,

Japanese yen, Pound sterling, Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona,

New Zealand dollar, Korean won, Singapore dollar, Norwegian krona, Mexican peso, Indian rupee, Russian rouble,

Chinese renminbi, Polish zloty, Turkish lira, South African rand, Brazilian real, Danish krone, New Taiwan dollar,

Hungarian forint, Malaysian ringgit, Thai baht, Czech koruna, Philippine peso, Chilean peso, Indonesian rupiah,

Israeli new shekel. See Bank for International Settlements, supra note 11, at 12.

17 For purposes of this letter, the term “electronic trading platform” means the platform on which the transactions are

executed.

Page 6

platform, (3) counterparties are automatically and anonymously matched and no price

negotiations occur for the transactions executed on these platforms, and (4) the non-SEF, non-

DCM anonymous electronic trading platform will maintain an audit trail and, upon request, will

provide to the Commission books and records to enable the Commission to reconstruct the

trades. WMBA requested similar relief for all types of transactions subject to the Commission’s

business conduct standards rules that are executed under circumstances where the SD or MSP

does not know the identity of the counterparty prior to execution.

Division No-Action Position

Based on the representations of the Requesting Parties and informed by discussions with

other market participants, the Division believes that relief is warranted under certain

circumstances and under certain conditions

uct standards rules that are executed under circumstances where the SD or MSP

does not know the identity of the counterparty prior to execution.

Division No-Action Position

Based on the representations of the Requesting Parties and informed by discussions with

other market participants, the Division believes that relief is warranted under certain

circumstances and under certain conditions. Accordingly, the Division will not recommend that

the Commission commence an enforcement action against an SD or MSP for failure to disclose

the PTM to a counterparty in a transaction, as required by Regulation 23.431(a)(3)(i), subject to

the following conditions:

(a)

The transaction is (1) a foreign exchange swap or forward that, by its terms, is physically

settled, where each currency is one of the BIS 31 Currencies and where the transaction

has a stated maturity of one year or less, or (2) a vanilla foreign exchange option that, by

its terms, is physically settled, where each currency is one included among the BIS 31

Currencies, and where the option has a stated maturity of six months or less;18

(b)

Real-time tradeable bid and offer prices for the transaction are available electronically, in

the marketplace, to the counterparty; and

(c)

The counterparty to the transaction agrees in advance, in writing, that the SD and MSP

need not disclose a PTM.

In addition, the Division will not recommend that the Commission commence an

enforcement action against an SD or MSP for failure to comply with Regulations 23.431(a) and

(b), in connection with an Exempt FX Transaction, subject to the following conditions:

(a)

The Exempt FX Transaction is initiated on an electronic trading platform and the SD or

MSP does not know the identity of the counterparty prior to execution, whether or not the

platform is a SEF or DCM;

an

enforcement action against an SD or MSP for failure to comply with Regulations 23.431(a) and

(b), in connection with an Exempt FX Transaction, subject to the following conditions:

(a)

The Exempt FX Transaction is initiated on an electronic trading platform and the SD or

MSP does not know the identity of the counterparty prior to execution, whether or not the

platform is a SEF or DCM;

(b)

Only eligible contract participants participate in the anonymous electronic trading

platform; and

18 The Division notes that the transactions for which it is granting no-action relief does not cover all transactions for

which relief was requested by FXC and FMLG. While it will continue to assess whether to grant additional relief, at

this time the Division is only expanding the relief that was granted in Staff Letter 12-42 (Dec. 6, 2012) to cover

additional currencies, as described in this letter.

Page 7

(c)

Real-time tradeable bid and offer prices for the Exempt FX Transaction are available

electronically, in the marketplace, to the counterparty.

The Division is applying this no-action relief based on, among other things, the

representations of the Requesting Parties that real-time tradable bid and offer prices are available

in the marketplace and that counterparties benefit from a combination of high liquidity, narrow

bid and offer spreads, and the existence of a significant amount of publicly available information.

The Division will continue to monitor market data with respect to the liquidity, bid and offer

spreads, and publicly available information for the transactions subject to relief under this letter,

and if the circumstances change, the Division may limit, impose additional or different

conditions on, or revoke this no-action relief

ence of a significant amount of publicly available information.

The Division will continue to monitor market data with respect to the liquidity, bid and offer

spreads, and publicly available information for the transactions subject to relief under this letter,

and if the circumstances change, the Division may limit, impose additional or different

conditions on, or revoke this no-action relief. The Division also notes that this no-action relief

does not affect any obligation to provide a daily mark pursuant to Regulation 23.431(d), nor any

obligation to report a transaction or information concerning a transaction under part 43 or part 45

of the Commission’s regulations.

This letter, and the positions taken herein, represent the view of this Division only, and

do not necessarily represent the position or view of the Commission or of any other office or

division of the Commission. In particular, notwithstanding the description of any foreign

exchange agreement, contract, or transaction herein, nothing in this letter is intended to address,

expand, interpret, or modify the definitions of foreign exchange swaps or foreign exchange

forwards in Sections 1a(24) and 1a(25), respectively, of the Commodity Exchange Act. The

relief issued by this letter does not excuse persons relying on it from compliance with any other

applicable requirements contained in the Act or in the Regulations issued thereunder. Further,

this letter, and the relief contained herein, is based upon the representations made to the Division.

Any different, changed or omitted material facts or circumstances might render this no-action

relief void.

ued by this letter does not excuse persons relying on it from compliance with any other

applicable requirements contained in the Act or in the Regulations issued thereunder. Further,

this letter, and the relief contained herein, is based upon the representations made to the Division.

Any different, changed or omitted material facts or circumstances might render this no-action

relief void.

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Should you have any questions, please do not hesitate to contact me at (202) 418-5977;

Ward Griffin, Associate Chief Counsel, at (202) 418-5425; or Adam Kezsbom, Special Counsel,

at (202) 418-5372.

Very truly yours,

Gary Barnett

Director

Division of Swap Dealer and

Intermediary Oversight

cc:

Regina Thoele, Compliance

National Futures Association, Chicago

Jamila A. Piracci, OTC Derivatives

National Futures Association, New York