Bloomberg L.P. said it filed a lawsuit in U.S. District court yesterday against the top U.S. derivatives regulator, to prevent a “flawed rule” that imposes higher margin requirements on swaps as compared to comparable contracts known as swap futures.
“We opposed a ruling [imposing] longer liquidation periods for financial related swaps, than on other related swap futures,” said Eugene Scalia, partner at Gibson, Dunn & Crutcher, Bloomberg’s outside counsel, in a press briefing this morning.
The final rule requires a margin to cover a five -day liquidation period for traditional swaps versus a one –day minimum liquidation period for swap futures, which would hurt plans by Bloomberg and other companies to operate a swap execution facility (SEF).
[For more on Bloomberg Delivers Ultimatum to the CFTC on Swaps Trading, see Ivy Schmerken's related story.]
The Commodity Futures Trading Commission is obligated to examine the costs and benefits of the rule, which Bloomberg’s attorney called arbitrary.
The requirement in the final rule was not expected and was not in the proposed rule, according to Scalia, who noted that the Commission failed on the cost benefit analysis, since it didn’t include any financial, quantitative, economic estimate for the impact it would cause. “Instead the proposed rule said the minimum liquidation periods would vary according to whether the product was traded through a swap execution facility or a designated contract market. Commentators on the proposed rule objected to the CFTC imposing longer minimum liquidation periods on SEFs, pointing out that SEFs were encouraged by Dodd-Frank and lead to further transparency,” he said. “The CFTC agreed with that and said they would not impose longer liquidation times.”
But the final rule will have negative effects on SEFs as well, Scalia noted.
The legal step is a follow up to the March 11 letter sent by Bloomberg’s outside counsel to CFTC Chairnan Gary Gensler, in which it threatened to take legal action to block the rule unless a response is received by Tuesday, March 19.
Impact on SEFs
The rule could be harmful to Bloomberg, which operates large trading platforms that execute $100 billion in credit default swaps and interest rate swaps on active days. Bloomberg also provides transparency to the market through providing data on swaps from the sell side to the buy side.
“We care about this debate not because it’s a debate between SEFs and exchanges, but because it’s a debate over market structure,” said Ben Macdonald, who is Head of Product at Bloomberg.
Reporters on the call pointed out that swaps and futures have been regarded as different and have had separate regulatory requirements for about 20 years, which is why SEFs were created under Dodd-Frank to bring in more transparency.
“We’re not saying that swaps and futures shouldn’t have different requirements,” said Macdonald. “We’re saying the swaps and swap futures should have the same margin requirements because they inherently have the same risk profile,” explained Macdonald.
Emphasizing that both instruments have the same risk profile, Macdonald said, “The fact that margin is different is really a problem,” he said. "The risk based approach is the one that feels right to us. It makes sense that it comes under the same margin requirement,” said Macdonald.
According to Greg Babyak, Head of Government Affairs for Bloomberg, what the CFTC is doing is “overriding the ability of the clearinghouse to make the determination of risk.”
The different margin rules which appear to favor swap futures could push clients toward the futures products.
“With the difference in margin rules, we see a potential movement from a swap product to the futures product and you move from a swap data reporting regime to an environment that doesn’t have those requirements,” said Macdonald. He said that the consequences of this disparity in margin rules is reducing transparency and increasing risk for the end investor.
Now that Bloomberg has sued the regulator, the question is will others that oppose the rule take legal action. Scalia said the firm had heard from a number of entities and there is a broad concern in the marketplace, but hard to predict. Without speculating on the actions that others might take, Babyak noted that at a CFTC roundtable on “futurization” of swaps held in January that dozens of market participants raised the same concerns. Babyak added, that the firm is acting on behalf of its clients on both the buy and sell sides.
Since the lines are blurring between swaps and futures, one reporter asked Bloomberg if it was considering setting up a futures exchange. Macdonald replied: "We’re not there yet, in terms of whether we should set up an exchange. That’s really not what the debate is about right now."