Streetwise Professor

May 14, 2013

FFS About EFS.

Filed under: Commodities,Derivatives,Energy,Exchanges,Regulation — The Professor @ 1:16 pm

This story is very bizarre, and I can’t figure out what is going on, exactly.  Or put differently, what has put a bee in the CFTC’s bonnet about CME Clearport’s Exchange of Futures for Swaps (EFS) facility after all these years.

The Commodity Futures Trading Commission has issued a “special call” asking Wall Street banks and other traders to provide documents that would prove recent derivatives transactions known as “exchanges of futures for swaps” were legal. Lawyers at the CFTC enforcement division are also scrutinising the trades for possible violations.

. . . .

The new inquiry centres on whether large traders and market-makers used unregulated over-the-counter swaps markets to trade what were in fact futures, strictly regulated contracts that are economically identical to swaps.

Trading futures off an exchange is illegal, and regulators are concerned that traders may have used these deals, known as EFSs, to agree prices that did not reflect the market.

“They’ve made information requests to everybody that’s ever traded an EFS. They’re saying, ‘prove to us that the swap was legitimate’,” said a recipient of a CFTC document request

The only thing that makes sense is that the CFTC believes that market participants engaged in EFS transactions without having a legally binding swap agreement in place first, meaning that the parties would have engaged in futures trades off-exchange.  Or something.

Note that even if the parties had entered a swap, it may have been in effect a very short period of time-just as long as it took to execute the deal and submit it to Clearport for clearing.

I also find it curious that the article mentions that the CFTC is looking only at deals done post-Frankendodd, even though deals have been done this way since the 2002 time frame, if memory serves.  One explanation is that CFTC believes the alleged conduct was permissible under CFMA, but not under DFA.  Another guess on my part.

If there is a violation here, it seems to be a highly technical one.  The end result is pretty much the same if they did or they didn’t execute a binding swap first: each party has futures positions obtained at a privately negotiated price.

CFTC has a lot on its plate already: is this really a priority? Really?

Moreover, the party that usually screams the loudest about off-exchange trading of futures is the futures exchange.  But Clearport is a CME system, and EFS is a CME procedure, and it seems that CME is totally fine with this.  Actually, if the following quote relates to the EFS issue (and it’s not clear that that’s the case from the article), CME is actually hacked at this:

Terry Duffy, CME executive chairman, said in a letter to CFTC last week: “In our view, nothing is served by piling on duplicative reporting mandates.”

For certain, though, CME was perfectly satisfied with the way market participants were doing EFS deals.

So who is the victim here?

It’s actually ironic that EFS was the CME’s way of implementing clearing for energy and metals.  And the CFTC is rah-rah about clearing.  But it is looking askance at the CME’s way of implementing clearing.  I guess it’s a case of that was then, this is now.

CFTC also effectively killed EFS as a mechanism for facilitating OTC clearing by determining that a swap, no longer how short its existence before conversion into futures, counted towards a firm’s annual $8 billion (to be reduced to $3 billion) de minimus swap volume for the purpose of determining whether it is a swap dealer.  As a result, market participants are moving to block futures trades rather than EFS to clear energy transactions: block futures trades that are negotiated away from the central market, just as the allegedly phantom swaps were. So this is last year’s war.  If traders weren’t doing papering officially a swap deal, they were effectively engaging in block futures trades, which is what they are doing now.  If it’s OK now, other than the technical violation, was it so horrible then that it requires a full blown investigation?

So what’s up?  A burdensome, intrusive “Special Call” to investigate a possible technical violation that the exchange that would be hurt by a violation doesn’t seem to care about, and which is of little relevance going forward.

Wow.  That seems like a totally reasonable use of scare resources-resources Gensler claims he doesn’t have nearly enough of.

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  1. Of course it is a good use of his scarce resources – it gives him more ammo to ask for more scarce resources! Really Perfesser, think bureaucracy 101.

    BTW, new definition : CFTC = Chutzpah from total C***S!

    Comment by Sotos — May 14, 2013 @ 2:32 pm

  2. SWP, thanks for the post- and figured you were on the task :). Can you explain how a voice-brokered block trade, matched off-exchange, but cleared through ClearPort, is different technically… from a voice-brokered swap transaction, that the counterparties later decide to move to the clearing house.

    It is simply a question of weather the clearing function is agreed before the price-matching, or after? Or does it have it have to do with changing the size the swap transaction to equal the exact contract size of listed future? Or something else.

    Energy firm are pulling there hair out with a nested traps set by the gigi.

    Comment by scott — May 14, 2013 @ 3:15 pm

  3. I suggest the futures-like trades w/o futures -reflected pricing are likely a baksheesh function of the traders. Since custodian banks’ window for abusing customer forex transactions (high tick for buyers at end of day; the reverse for sellers) have been outed, these folks are maybe climbing thru smaller windows to steal the same gelt.

    Comment by t c phillips — May 15, 2013 @ 7:18 am

  4. I would offer that this could be about the ability of the OTC swap to reduce on exchange positions size and exposure to exchange reporting rules, like CFTC . A larger position concentration could affect margin declarations by CME or could run into limits for some commodities.

    The original purpose of an EFS was so that someone or some algo does not slip in between two parties that already have an OTC transaction between them and want to reduce exposures through the exchange.

    Comment by Justin — May 20, 2013 @ 2:34 pm

  5. […] FFS About EFS This story is very bizarre, and I can’t figure out what is going on, exactly.  Or put differently, what has put a bee in the CFTC’s bonnet about CME Clearport’s Exchange of Futures for Swaps (EFS) facility after all these years. […]

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  6. […] for swaps (and other related positions (Risk subscription required-unless you know the trick.)  (I expressed my amazement at this ex post facto scrutiny when the story first broke.)   Why is the CFTC giving EFS the stink eye after years of not merely acquiescing to them, but […]

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