The Commodities Futures Trading Commission Commissioner Dan Berkovitz made a speech at the Commodity Markets Council State of the Industry for 2019; the speech was entitled “Competition, Concentration, and Cartels in the Swap Market.”

Dan Berkovitz

Berkovitz emphasized the importance of healthy and competitive markets in swaps.

“Free market principles are a cornerstone of the derivatives markets.  One of the longstanding purposes of the Commodity Exchange Act is to ‘promote fair competition.’  In the Dodd-Frank Act, Congress applied the principles of open markets and fair competition to swaps trading.  The Act requires swap execution facilities, or ‘SEFs,’ to provide all market participants with impartial access to the market and enable them to trade with many other market participants.”

Continuing on, he argued that healthy markets are threatened because SEFs are concentrated in a few large and powerful banks.

“Today, the swap market is concentrated in a few large bank dealers.  A review of data from the swap data repositories shows that the largest five dealing institutions are party to about 70% of all reported swap transactions and 80% of the notional amount traded.” Berkovitz said. “Our futures commission merchant data shows that five bank FCMs provide clearing for about 80% of cleared swaps.  These high levels of concentration show that the largest dealers possess considerable market power.  These high levels of concentration also present potential systemic risks, since the failure of one of these firms in a highly interconnected market could have significant impacts on the other firms in the market.”

Berkovitz said that in November 2018 the CFTC voted in favor of a proposal which he felt would stifle competition; Berkovitz voted against the proposal.

According to the federal registrar, here is a summary of the proposed rule.

“Among other amendments, the proposed rules apply the SEF registration requirement to certain swaps broking entities and aggregators of single-dealer platforms; broaden the scope of the trade execution requirement to include all swaps subject to the clearing requirement under the Act that a SEF or a DCM lists for trading; allow SEFs to offer flexible execution methods for all swaps that they list for trading; amend straight-through processing requirements; and amend the block trade definition.”

Later on in the speech, Berkovitz stated why he opposed the rule.

“The Proposal would allow SEFs to create exclusive markets for swap dealers.  What I call the Proposal’s ‘exclusionary access’ provision would perpetuate and strengthen the current two-tier market structure for cleared swaps.  In one tier end-users and proprietary traders buy from or sell swaps to dealers.  In the other tier, dealers trade with each other exclusively and lay off the risks from their swaps at prices that only dealers can access.

“Without access to the highly liquid dealer-only market, non-dealers cannot price swaps to end-users as efficiently as the dealers.  As a practical matter, under this structure only dealers can economically and efficiently offer cleared swaps to end-users.

“The Proposal also would repeal the method-of-execution rules that require request-for-quote, known as ‘RFQ,’ and order book trading systems for liquid swaps that are made available to trade on a SEF.  The Proposal provides no evidence to support its claim that allowing ‘flexible methods of execution’ will benefit end users.  The Proposal fails to identify any trading method that can or will provide lower costs to end users than the RFQ method.  I will say more about this later.

“In the absence of any constraints, the dealers undoubtedly will push trading with non-dealers to less transparent single-dealer platforms and platforms that only allow one-to-one trading where there is no direct, real-time price competition with other dealers.  Today, everyone can trade commodities, stocks, and futures with a wide variety of other participants on open, all-to-all platforms where competitive prices from multiple prospective buyers and sellers are posted.”