299 Park Avenue 10th floor New York, NY 10171 Tel 212 813-6300 www.marketaxess.com February 21, 2013 Ms. Melissa Jurgens Secretary
Commodity Futures Trading Commission Three Lafayette Centre
1155 21st Street, N.W. Washington, DC 20581
Re: Notice Of Intent To File An Application For A Swap Execution Facility Registration Exemption
Dear Ms. Jurgens:
In January 2011, the Commodity Futures Trading Commission ("CFTC" or
"Commission") proposed rules to implement core principles and other requirements for swap execution facilities ("SEFs") under the Commodity Exchange Act ("CEA") as amended by the Dodd-Frank Act.1 MarketAxess Corporation ("MarketAxess") is aware that the Commission may adopt final SEF rules in the near future. In anticipation of those final deliberations and rules, MarketAxess is filing this letter to notify the Commission of our intent to request a
conditional exemption from SEF registration as authorized under Section 5h(g) of the CEA once the Commission finalizes its SEF rules.
In brief, MarketAxess intends to request conditional exempt SEF status for the limited purpose of offering a facility for trading broad-based index credit default swaps ("Index CDS"). Our exempt SEF would offer many-to-many trading in Index CDS on the same electronic trading platform that is currently used by nearly a thousand institutional investors and over 80 broker-dealers to trade corporate bonds subject to comprehensive regulation by the Securities and
Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA"). As a condition of the exemption we intend to request, MarketAxess will comply with 19 specific regulatory conditions set out in this letter, including meeting any trading standard and pre-trade price transparency standard for SEFs established under the Commission's final SEF rules. Consistent with the purposes of the Dodd-Frank Act and the congressionally stated goal of Section 5h, the heavily-conditioned and limited registration exemption we intend to request "will
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promote the trading of swaps on [SEFs] and … promote pre-trade price transparency in the swaps market." Section 5h(e) of the CEA.
Summary
MarketAxess currently operates a leading electronic platform for corporate bond trading where, on average, over 4,000 corporate bond transactions are executed daily in compliance with the federal securities laws and SEC-FINRA oversight. We intend to use that same time-tested platform to offer a facility for trading Index CDS. Our facility would fall within the SEF definition under the CEA and would be subject to the SEF registration requirement under CEA Section 5h(a). Congress provided, however, that a SEF may be exempt from SEF registration if the facility is subject to comparable, comprehensive supervision and regulation by the SEC.2 MarketAxess qualifies for, and the Commission should grant, a product-limited, conditional exemption to MarketAxess to allow us to strive first to establish a solid foothold in the Index CDS market before incurring the substantial cost of full SEF registration.
In essence, MarketAxess is requesting an opportunity to operate a regulated electronic trading platform in Index CDS in compliance with most of the key SEF requirements without acting as a self-regulatory organization ("SRO"). This is the same business model we have followed for many years in the corporate bond and other credit markets under the watchful eyes of both the SEC and FINRA. The requested conditional exemption will allow us to offer a regulated trading platform in Index CDS without having to incur the significant additional start-up expense necessary to perform the SRO-like functions that full SEF regulation would require.
As the operator of a regulated electronic trading platform in corporate bonds, we have a strong natural interest in offering a complementary service for the Index CDS market, which we estimate today to involve about 3,000 transactions daily in Index CDS subject to CFTC
jurisdiction. Roughly half of those transactions are dealer to dealer; MarketAxess currently serves the client to dealer market. Although our target product market is considerably smaller than that served by traditional SROs that often execute millions of transactions a day, we have already spent more than ten million dollars to build new systems in anticipation of new
regulatory standards under the final SEF rules. Furthermore, our budget for full SEF registration is projected to exceed five million dollars in the first year of operation, and in subsequent years we expect our costs will exceed one million dollars annually to operate a registered SEF as an SRO. While these expenditures are and will be substantial, especially in light of the current scale of the Index CDS market, we still intend to operate a SEF in order to bring the benefits of
transparency and fully traceable electronic trading to the Index CDS market.
Rather than incur at the outset the steep start-up and operating costs associated with the SRO functions required of a registered SEF, we propose that the Commission allow us to
implement an approach that will phase-in those costs as market acceptance grows, while serving
2 See CEA § 5h(g) ("The Commission may exempt, conditionally or unconditionally, a swap execution facility
from registration under this section if the Commission finds that the facility is subject to comparable,
comprehensive supervision and regulation on a consolidated basis by the Securities and Exchange Commission, a prudential regulator, or the appropriate governmental authorities in the home country of the facility.").
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the CFTC's immediate regulatory interests as well as the public interest by making available a proven system for electronic trading to Index CDS market participants. When and if trading on our exempt SEF exceeds, on average for four months over a six month period, 20% of the daily notional transaction volume of all Index CDS trades executed in the U.S., we will promptly register with the Commission as a SEF and carry out the required SRO functions.3 (Again, by Index CDS we intend only broad-based index credit default swaps subject to the CFTC's jurisdiction.) Until such time, however, we would operate as an exempt SEF subject to
continued compliance with the 19 listed regulatory conditions, but without the expensive SRO requirements.
The CEA provides the Commission with ample authority to grant exempt SEF status to MarketAxess. Section 5h(g) specifically authorizes the Commission to grant unconditional or conditional exemptions from SEF registration if a "facility is subject to comparable,
comprehensive supervision and regulation on a consolidated basis by the Securities and Exchange Commission . . . ." Because MarketAxess now operates, and would use for Index CDS trading, the same fully-regulated facility we now use for trading securities under a
comprehensive regulatory structure administrated by the SEC and FINRA, we might qualify for an unconditional exemption under Section 5h(g). Nevertheless, we intend to apply for a
conditional SEF exemption subject to our compliance with the 19 regulatory conditions we set out in this letter.
Granting an exemption under Section 5h(g) would be consistent with the goals of Section 5h as a whole – more swaps trading and transparency – as expressed in the rule of construction Congress adopted in Section 5h(e). Allowing MarketAxess to defer the costs of SRO operations would enable Index CDS market participants to enjoy immediately the benefits of our well-regarded and fully implemented and tested electronic trading systems in a regulated Index CDS market, while enhancing competition in the Index CDS market. The exemption would also permit us to defer SRO functionality and costs until we have achieved daily transaction volume levels that are solid, but relatively modest when compared to our current rate of daily securities trading volume (averaging well over 4,000 trades daily). SRO operations will then begin once trading volumes rise to a level that merits the kinds of full-blown SRO activity we expect the Commission's final SEF rules will codify.
A balanced approach will reduce the barriers to entry that would otherwise result in a limited number of SEFs operated exclusively by established exchanges or deep-pocketed dealer-financed entities with the resources to build an expensive SRO infrastructure. Congress intended to transform the swap markets from a marketplace dominated by only a handful of dealers to one that promotes competition and attracts new market entrants. If the SEF entry barriers remain unnecessarily high, competition will be stifled and SEF trading will be limited to only a few large platforms that intend to offer multiple swap asset classes to the market. Granting our registration exemption would underscore Congress' wisdom in making certain that exempt SEFs
3 Recent Depository Trust and Clearing Corporation data indicate that currently worldwide average daily notional
trading volume of index CDS is approximately $65 billion, and we estimate that $25-$30 billion account for trades in the U.S. Although these are only estimates, the availability of more precise data will increase as more CDS transactions are reported under the CFTC's swap reporting rules.
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would be an integral part of the SEF landscape. See Section 2(h)(8) (permitting parties to satisfy the swap trade execution mandate by trading on exempt SEFs).
Our extensive list of conditions illustrates that we seek an exemption from SEF registration, not regulation. Under our exemption request, we would:
Use our existing electronic trading platform that is now widely used by
institutional investors and broker-dealers in the corporate bond and other credit markets;
Continue to be registered as a broker-dealer with the SEC and subject to SEC and FINRA regulation;
Reserve the right to terminate the trading privileges of any party that violates the terms of our user agreement;
Limit swap trading on our exempt SEF to Index CDS traded among eligible contract participants;
Meet all SEF reporting obligations under CFTC Part 43 (real-time reporting) and Part 45 (swap data reporting);
Meet all SEF trading standards adopted in the final SEF rules;
Meet the Commission's proposed conflict of interest standards for ownership;
Continue to meet the CFTC's proposed conflict of interest standards for Board governance and independent director requirements applicable to public
companies;
Maintain a complete audit trail;
Remain fully subject to CFTC fraud, manipulation and other statutory trading prohibitions;
Have a Chief Compliance Officer who meets the qualification requirements under the final SEF rules;
Require the Chief Compliance Officer to certify a daily review of all trades on our exempt SEF and refer to the appropriate Commission authorities any suspicious behavior; and
Register as a SEF once trading reaches a specified critical mass level.
Approving this product-limited, multiple-conditioned exempt SEF request is authorized by the CEA and would be perfectly compatible with both the Commission's regulatory goals and the public interest.
The sections following this Summary set out the following:
I. Background – MarketAxess is experienced in providing well-regulated, many-to-many electronic trading platform solutions to financial marketplaces that are otherwise dominated by one-to-one telephone brokered transactions.
II. The CFTC Has the Authority to Grant Our Exempt SEF Request – Granting a registration exemption is clearly within the Commission's authority and will
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advance a primary goal of Dodd-Frank – to promote competition among and trading on SEFs.
III. MarketAxess Will Meet Many of the Regulatory Requirements for SEFs and Will Register as a SEF When Trading Volume Meets a Specified Level – Our exemption request would be conditioned on meeting many of the significant regulatory
requirements for SEFs. If trading volume on our facility exceeds 20% of the daily notional transaction volume for all Index CDS trades (we estimate today that in the market we serve, there are approximately 1,500 daily transactions in the U.S. representing roughly $12.5-15 billion in notional value) on average for four out of six months, then MarketAxess would register as a SEF.
IV. The Commission Should Grant Our Limited Conditional Registration Exemption – The proposed conditional exemption would permit MarketAxess to compete with other trading platforms as an exempt SEF while avoiding the initial build-out of a costly SRO apparatus and still providing more than adequate substitute regulation to promote the goals of the CEA and encourage SEF trading.
I. Background
MarketAxess Is Experienced at Bringing New and Well-Regulated Electronic Trading Solutions to Dealer Markets
MarketAxess operates a leading electronic trading platform for investment industry professionals that promotes transparency, price discovery, and liquidity in the corporate bond and other fixed income markets, including Index CDS. MarketAxess was formed in April 2000 in response to investors' need for a single electronic trading platform with easy access to multi-dealer competitive pricing in a wide range of debt securities. Our annual trading volume has increased from $11.7 billion in 2001 to more than $500 billion during 2012. Currently, approximately 4,000 to 4,500 corporate bond transactions are executed on our platform daily, and during the fourth quarter of 2012 we represented approximately 13.6% of the total volume in U.S. high-grade corporate bonds, excluding convertible bonds, as reported on FINRA's Trade Reporting and Compliance Engine ("TRACE"), which includes inter-dealer and retail trading as well as trading between institutional investors and broker-dealers. We believe that we account today for substantially all of the U.S. high-grade corporate bond volume that is traded
electronically.
Traditionally, bond trading has been a manual process, with product and price discovery conducted over the telephone between two or more parties. In contrast, our multi-dealer trading platform allows our more than 950 active institutional investor clients to simultaneously request competing, executable bids or offers from any or all of our 88 broker-dealer market-maker liquidity providers and execute trades with the broker-dealer of their choice from among those that choose to respond. This enables our broker-dealer liquidity providers to efficiently reach our institutional investor clients for the distribution and trading of bonds. Through our disclosed multi-dealer request-for-quote ("RFQ") trading functionality, our institutional investor clients can determine prices available for a security, as well as trade securities directly with our broker-dealer crowd. We also provide fixed-income market data, analytics and compliance tools that
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help our clients make trading decisions, and our automated post-trade messaging facilitates the communication of trade acknowledgment and allocation information between our institutional investor and broker-dealer market participants.
Our trading systems provide numerous benefits to customers and the markets that traditional fixed-income trading methods do not offer, including:
Competitive Prices. By enabling institutional investors to simultaneously request bids or
offers from a large group of broker-dealers, our electronic trading platform creates an
environment that motivates broker-dealers to provide competitive prices and gives institutional investors confidence that they are obtaining a competitive price.
Transparent Pricing. Subject to applicable regulatory requirements, institutional
investors can search for bonds in inventory in a fraction of the time it takes to do so manually. Institutional investors can also request executable bids and offers on our electronic trading platform and may also elect to display live requests for bids or offers anonymously to all other platform users.
Improved Cost Efficiency. We provide improved efficiency by reducing the time and
labor required to conduct broad product and price discovery. In addition, our Corporate BondTickerTM service eliminates the need for manually-intensive phone calls or e-mail
communication to gather, sort and analyze information concerning historical transaction prices.
Greater Trading Accuracy. Our electronic trading platform includes verification
mechanisms at various stages of the execution process that result in greater accuracy in the processing, confirming and clearing of trades between institutional investor and broker-dealer clients.
Efficient Risk Monitoring and Compliance. Our electronic trading platform offers both
institutional investors and broker-dealers an automated audit trail for each stage in the trading cycle. As a result of our electronic connectivity to the trade processing operations of our participating dealers, the vast majority of the trades done on the MarketAxess trading platform are reported to TRACE within one to two minutes following execution, further enhancing transparency and price discovery in the markets we serve.
MarketAxess's current operations under the federal securities laws are consistent with the CFTC's SEF proposals for trading protocols, price transparency, audit trails, and financial
resources, and we would bring the same benefits to the Index CDS market that we have provided to the corporate bond market. Furthermore, as a public company we already adhere to
governance and independence standards that are consistent with the CFTC's SEF proposals.4 We
4 MarketAxess Corporation is the principal operating subsidiary of MarketAxess Holdings Inc., a public company
with no dealer(s) owning, individually or in the aggregate, more than 20% of MarketAxess's common stock. In addition, MarketAxess's nine-person Board of Directors includes eight individuals who meet the requirements for independence under the rules of the Nasdaq Stock Market.
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are also well-positioned to bring new competition to the Index CDS market through our technology solutions and vast trading network. We are ideally suited to achieve Dodd-Frank's objectives for SEFs, including pre-trade price transparency and efficient real-time reporting of trades.
II. The CFTC Has the Authority to Grant Our Exempt SEF Request
The Commission's authority to grant a SEF registration exemption is clear. CEA Section 5h(g) states that the Commission may exempt, conditionally or unconditionally, a SEF from registration if the Commission finds it is subject to comparable regulation and supervision. Congress gave the Commission broad authority to grant SEF registration exemptions. Granting a conditional Section 5h(g) registration exemption to allow MarketAxess to operate a limited Index CDS-only SEF will promote the goals of the statute and trading on SEFs.
The Commission Has the Authority to Grant SEF Registration Exemptions Under Section 5h(g)
Congress has authorized the Commission to grant SEF registration exemptions. Section 5h(g) of the CEA states:
The Commission may exempt, conditionally or unconditionally, a swap execution facility from registration under this section if the Commission finds that the facility is subject to comparable, comprehensive supervision and regulation on a consolidated basis by the Securities and Exchange Commission, a prudential regulator, or the appropriate governmental authorities in the home country of the facility.
MarketAxess is an SEC-registered broker-dealer and a FINRA member. Securities trading on MarketAxess's platform is subject to the federal securities laws, which are surely comparable to the protections for Index CDS in the CEA. As a registered broker-dealer, we are also subject to comprehensive SEC regulation, and the SEC and FINRA have extensive supervisory authority over MarketAxess's business operations. MarketAxess is required to file quarterly financial reports and audited annual reports. We are subject to both SEC and FINRA examinations, and we have been examined by FINRA in 2002, 2006, and 2010. MarketAxess and its employees are subject to statutory disqualification standards and the SEC's disciplinary authority, which prohibit persons with adverse disciplinary histories from becoming associated with the firm. Furthermore, MarketAxess employees are required to maintain adequate competency levels and satisfy FINRA qualification requirements. MarketAxess is also subject to the general antifraud prohibitions under the federal securities laws and additional antifraud prohibitions specific to broker-dealers.5 We are required to keep and retain accurate books and records and demonstrate compliance with applicable securities laws. In addition, we are required to maintain sufficient capital to operate safely pursuant to SEC rules.
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As this description demonstrates, the trading facility we would use to trade Index CDS as an exempt SEF is already subject to comprehensive regulation under the federal securities laws and comparable oversight by the SEC and FINRA. Accordingly, we could qualify for an unconditional exemption under the terms of Section 5h(g). However, we intend to apply for an exemption that is heavily conditioned as set forth below.
Congress Designed the CEA to Allow the Commission to Grant SEF Registration Exemptions to Promote Trading on All SEFs and to Satisfy the Trade Execution Mandate
The SEF exemption provisions are found in Section 5h(g) of the CEA. The goal of Section 5h of the CEA in its entirety, including Section 5h(g), is to "promote the trading of swaps on swap execution facilities and to promote pre-trade price transparency in the swaps market." CEA Section 5h(e). Granting appropriate SEF exemptions under Section 5h(g) surely advances this goal, as would the specific conditions in our exemption request which would meet the CFTC registered SEF standards for pre-trade and post-trade price transparency.
In addition, Congress understood that exempt SEFs would promote trading in swaps through the Section 2(h)(8) trading mandate. Section 2(h)(8) allows market participants to satisfy the swap trading mandate by executing swaps that are subject to that mandate either on a registered SEF or a SEF exempt from registration. CEA Section 2(h)(8)(A)(ii). Section 2(h)(8) thereby confirms that Congress envisioned that SEFs exempt from registration would fulfill one of the cornerstone requirements of the Dodd-Frank scheme for swaps regulation. Conversely, Congress mandated that the Commission adopt rules for "alternative swap execution facilities" ("ASEFs")6 but did not provide that trading on an ASEF would satisfy the trading mandate in Section 2(h)(8). Sections 5h(g) and 2(h)(8) read together illustrate that SEFs exempt from registration were expressly contemplated by Congress to play an important role in the new regulatory regime for swaps.
The Commission's Section 5h(g) Exemptive Authority Is Not Limited to Dual Registrants
Section 5h(g) authorizes the Commission to grant SEF registration exemptions. It has been suggested, however, that Section 5h(g) is merely intended to permit the Commission to exempt an SEC registrant from dual registration with the Commission once the SEC implements its regulatory regime for security-based SEFs ("SBSEFs") under Section 3D of the Securities Exchange Act of 1934 ("Exchange Act"). That suggested, limited reading of Section 5h(g) cannot be reconciled with other CEA provisions that were enacted as part of the Dodd-Frank Act.
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See CEA Section 5h(h) ("The Commission shall prescribe rules governing the regulation of alternative swap execution facilities under this section."); as of this writing, the Commission has not proposed rules for ASEFs.
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The language in Section 5h(a)(2) of the CEA and Section 3D(a)(2) of the Exchange Act precludes interpreting Section 5h(g) to merely permit the Commission or SEC to exempt dual SEF-SBSEF registrants. Section 5h(a) provides:
(1) IN GENERAL.–No person may operate a facility for the trading or processing of swaps unless the facility is registered as a swap execution facility . . . under this section.
(2) DUAL REGISTRATION.–Any person that is registered as a swap execution facility under this section shall register with the [CFTC]
regardless of whether the person also is registered with the [SEC]
as a [security-based] swap execution facility [sic].
Section 3D(a) of the Exchange Act has nearly identical language with respect to registration with the SEC "regardless of whether the person also is registered with the [CFTC] as a swap
execution facility." Sections 5h(a)(2) of the CEA and 3D(a)(2) of the Exchange Act confirm Congress's intent to have SEFs and SBSEFs dual registered with the CFTC and SEC (although neither provision precludes either agency from accepting a notice registration for a SEF or SBSEF that is fully registered with its sister agency). Thus, Congress intended the Commission to use its exempt SEF authority under CEA Section 5h(g) to exempt SEFs other than dual registrants.7
III. MarketAxess Will Meet Many of the Regulatory Requirements for SEFs and Will Register as a SEF When Trading Volume Meets a Specified Level
MarketAxess intends to request a limited exemption from SEF registration and is
proposing 19 specific conditions that must be met for MarketAxess to operate as an exempt SEF. These conditions require full compliance with many of the key SEF regulations, including trade execution and pre-trade price transparency requirements. The conditional exemption would be designed, however, to permit MarketAxess, as an exempt SEF, to begin to operate a regulated electronic trading platform for Index CDS without acting as an SRO. In the absence of the requested relief, the Commission's SEF rules would impose costly self-regulatory obligations that could create formidable barriers to entry and limit the development of SEFs to exchanges and the largest financial institutions with the resources to immediately begin operating as an SRO.
The first limitation on our exemption is important to emphasize. We are seeking an exemption only for the relatively small Index CDS market. We will offer no other types of
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In addition, Section 5h(g) grants the Commission broader authority to exempt a SEF from registration than the SEC's comparable registration exemption authority for SBSEFs. The CFTC may exempt a SEF from
registration if it is subject to comparable supervision and regulation by the SEC, a prudential regulator or a foreign authority. The related provision under Section 3D(e) of the Exchange Act limits the SEC's exemptive authority to SBSEFs that are subject to CFTC oversight and does not extend to SBSEFs subject to regulation by a prudential regulator or a foreign authority. Unlike the SEC, prudential regulators and foreign authorities will not have nearly identical statutory authority to the Commission to implement comparable SEF regulation. Because the Commission is authorized to assess regulatory regimes other than the SEC's, the authority in Section 5h(g) must be read to permit consideration of exempt SEF requests in a broader context than merely the SEC's regulatory regime for SBSEFs.
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swaps on our exempt SEF. Moreover, MarketAxess is only seeking an exemption from registration as long as the average daily notional volume of Index CDS executed through our trading platform is below 20% of the total daily notional volume of Index CDS trades executed in the U.S., for 4 out of 6 months. We estimate that the current average daily notional volume for Index CDS in the U.S. is approximately $25-$30 billion – comprised of roughly 3,000 daily transactions. Roughly one half of the 3,000 daily Index CDS trades in the U.S. are dealer to client, which is the type of market MarketAxess currently operates in corporate bonds and other fixed-income products, while the other half represents dealer to dealer trades.
Our exemptive request, therefore, would affect a small portion of the overall swap market. The U.S. Index CDS market is relatively small when compared to other regulated instruments that trade on traditional SROs like exchanges and often exceed well over a million daily transactions in a single product. Index CDS markets are also significantly smaller than the interest rate swap markets. According to the Bank for International Settlements, in mid-2012 the global notional amount outstanding for interest rates swaps was more than $490 trillion
compared to just over $9.7 trillion for Index CDS products.8 Thus, in the context of an Index CDS-only SEF as we intend to operate, a registration threshold set at 20% of the average
notional volume appropriately reflects a level of expected revenue that would begin to justify the costs attendant to operating an SRO.
This approach to permit limited trading activity on a platform before requiring SRO functionality through registration is not unprecedented. In our comment letter on the proposed SEF rules, MarketAxess informed the Commission of a somewhat similar regulatory precedent for alternative trading systems ("ATS") under the federal securities laws that exempt trading systems from registering as national securities exchanges if trading levels remain below certain thresholds.9 The SEC's regulatory approach for ATSs encourages development of regulated market platforms, and a similar approach is appropriate for Index CDS-only SEFs.
We note that the extensive list of regulatory conditions is subject to our review of the CFTC's soon-to-be-issued final SEF rules. It is possible that after reviewing those rules we may need to amend this list or that we may wish to add to it, as necessary. It is also possible that the Commission or its staff may suggest modifications to this list. MarketAxess would welcome those suggestions.
Conditions for SEF Registration Exemption
MarketAxess proposes to comply with the following items as conditions for a SEF registration exemption.
1. Electronic Trading System: MarketAxess will use the same trading system for Index CDS as it uses for corporate bonds today.
8 Bank for International Settlements, Statistical Release: OTC Derivatives Statistics at End-June 2012, p. 12
(Nov. 2012).
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2. SEC Registered Broker-Dealer: MarketAxess is, and will continue to be, an SEC-registered broker-dealer.
3. FINRA Membership: MarketAxess is, and will continue to be, a member of FINRA in good standing.
4. Access Agreements: MarketAxess's trading system will (i) enter into access agreements with all of its end users and dealers, and (ii) reserve the right to exclude any market participant from trading on our exempt SEF that violates the access agreement.
5. Limited to Index CDS: The exemption will be limited to Index CDS products (e.g., the exemption would not apply to interest rate swap trading). No other classes of swap products (e.g., interest rate swaps, commodity swaps, etc.) will be eligible to trade on MarketAxess' exempt SEF.
6. Swap Data Reporting: MarketAxess will comply with any and all of the CFTC's Part 43 real-time public reporting requirements and Part 45 swap data reporting requirements as if MarketAxess were a registered SEF.
7. Trade Execution Requirements: MarketAxess will comply with any and all of the CFTC's trade execution standards for swaps that are traded on a registered SEF and "made
available to trade" under Section 2(h)(8) as provided in the Commission's final SEF rules. 8. CFTC RFQ Requirements and Pre-Trade Price Transparency: MarketAxess will require
RFQs be sent to whatever minimum number of market participants the Commission requires in its final SEF rules.
9. Conflicts of Interest: MarketAxess will implement procedures that minimize conflicts of interest regarding ownership limitations and independent directors, as the Commission has proposed but not yet adopted.10
10.Recordkeeping and Audit Trail: MarketAxess will maintain records related to its business, including an audit trail of all Index CDS transactions executed on the trading platform for the period of time specified in the Commission's final SEF rules and allow the Commission the same access to such records as required in its final SEF rules. 11.Electronic Trading: MarketAxess will electronically capture and transmit information as
required in the Commission’s final SEF rules with respect to any and all Index CDS transactions executed on the trading platform.
12.Swaps Not Readily Susceptible to Manipulation: MarketAxess will not list for trading any Index CDS that are readily susceptible to manipulation.
13.Adequate Financial Resources: MarketAxess will maintain adequate financial resources in compliance with any financial resource standard for SEFs contained in the
Commission's final SEF rules and will remain in compliance with SEC net capital rules for broker-dealers.
10 MarketAxess's current operations are consistent with the CFTC's proposals on independence. As noted above,
MarketAxess Holdings Inc. is a public company, with no dealer owning more than 20% of MarketAxess's common stock, and eight directors of our nine-person Board meet the requirements for independence under Nasdaq rules.
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14.Position Limits: As is necessary and appropriate, MarketAxess will establish speculative position limits or accountability levels for Index CDS contracts on the facility in
compliance with the Commission's final SEF rules.
15.Anti-Fraud & Manipulation Prohibitions: MarketAxess and its participants will be subject to all anti-fraud and manipulation prohibitions under the CEA and CFTC rules, and MarketAxess will inform the CFTC if any suspicious trading occurs on its trading platform.
16.Chief Compliance Officer: MarketAxess will employ a chief compliance officer who meets the requirements set forth by the Commission in its final SEF rules.
17.Review of Trades: MarketAxess will require its chief compliance officer to oversee a daily review of all Index CDS trades executed on the trading platform and promptly report any abnormal or irregular trading activities to the Commission.
18.Trading Eligibility Requirements: MarketAxess will permit only eligible contract participants to trade on its exempt SEF in Index CDS.
19.Compliance with Block Trading Rules: MarketAxess will comply with the CFTC's final rules for block trades as if MarketAxess were a registered SEF.
Trading Threshold Triggers for MarketAxess's SEF Registration Exemption
MarketAxess proposes that if granted a conditional SEF registration exemption, we would register as a SEF with the CFTC once the following notional transaction volume threshold is met. If, during any 4 months within a 6 month period, MarketAxess's trading system is used to execute more than 20% of the daily notional transaction volume in Index CDS products subject to CFTC jurisdiction (we estimate today that market-wide approximately 3,000 daily transactions are executed involving a U.S. counterparty, representing roughly $25-$30 billion in notional value; half of those transactions are in the client to dealer market we currently serve),
MarketAxess will:
File a temporary SEF registration application with the Commission within 90 days, and
Register as a SEF with the Commission within 180 days.
The proposed volume trigger for MarketAxess's SEF registration is similar to the SEC's regulatory scheme for ATSs. Regulation ATS was adopted to impose "market-oriented
regulation" and permits broker-dealers to operate trading platforms that provide electronic execution of orders without becoming an SRO by registering with the SEC as a national securities exchange.11 Through this volume threshold, the Commission could be certain that if MarketAxess achieves a certain level of trading activity in Index CDS on its exempt SEF, MarketAxess will quickly become a registered SEF and will promptly discharge its SRO obligations. In this way, the Commission would be striking an appropriate regulatory balance
11
Regulation of Exchanges and Alternative Trading Systems, 63 Fed. Reg. 70844, 70847 (Dec. 22, 1998); 17 C.F.R. §§ 242.300-303.
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that would promote swap trading while ensuring pre-trade price transparency for SEF trading.
See Section 5h(e).
Finally, we note that Index CDS are not the types of bespoke, complex instruments – such as credit default swaps on tranches of structured vehicles holding mortgage-backed securities – that some viewed as having played a key role in the 2008 financial crisis. Rather, these are widely-accepted, plain vanilla Index CDS, which are safer and less volatile than many corporate bonds and other securities that are subject to extensive SEC regulation and are
currently traded on MarketAxess and other platforms. Even so, under our exemption request, the Commission would retain regulatory authority and oversight of the Index CDS traded on our platform under our heavily-conditioned and limited exemption proposal.
IV. The Commission Should Grant Our Limited Conditional Registration Exemption
The Commission should grant MarketAxess a limited conditional SEF registration exemption when filed. This action will reduce entry barriers and promote the development of and competition among SEFs. Requiring full SEF registration for a limited product platform would be burdensome and inefficient, especially in light of a registered SEF's obligation to have a fully operational SRO regimen from the outset of operations.
In the absence of a registration exemption, MarketAxess and others would face a cost-benefit quandary. We expect that initial daily trading in Index CDS may be limited; in these circumstances, it would be cost prohibitive to require full SEF registration. In our experience, it may take years to develop sustained new product trading volume. When that occurs on our platform for Index CDS, we will apply for SEF registration. In the interim, under our proposed conditional SEF exemption, the Commission will retain ample regulatory authority over
MarketAxess and its market participants while further advancing the goal of Section 5h – as codified in Section 5h(e) – to promote trading on SEFs.
Our budget for full SEF registration is projected to exceed five million dollars in the first year of operation, and we estimate our costs will be more than $1 million annually to perform the SRO functions of a registered SEF. These costs will substantially surpass the revenues from trade execution fees a SEF could reasonably expect to receive for only Index CDS in the first year or years of operations. Requiring a start-up SEF with a limited product offering to operate a fully functional SRO will not improve market efficiencies or otherwise serve the public interest. Absent an exemption, even with only a limited number of expected trades, MarketAxess would be required to conduct surveillance, be capable of conducting lengthy investigations and hearings for alleged misconduct, and provide arbitration capability for market participants.
Rather than impose burdensome SRO requirements on our fledgling Index CDS market, the Commission should grant MarketAxess conditional exempt SEF status. Similar to
Regulation ATS, an exempt SEF that experiences episodic trading could avoid building a costly internal SRO apparatus until its market's trading volume matures. Under our proposal, the CFTC would retain regulatory authority over our conditionally exempt SEF and would benefit from the real-time public reporting and daily chief compliance officer review of trades executed on the platform. As trading grows on the MarketAxess platform, full SEF registration could follow.
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For now, the substitute regulation of the SEC, FINRA, and our proposed conditions are more than adequate to promote the goals of the CEA's SEF provisions in Section 5h.
Conclusion
MarketAxess very much appreciates the Commission's consideration of our intention to file a request for a conditional SEF registration exemption. Based on our experience operating a successful SEC and FINRA regulated electronic trading platform, we request that the
Commission grant the proposed SEF registration exemption to promote competition among and trading on SEFs. We believe strongly that this model is completely appropriate for limited-product SEFs like ours to allow us to defer the cost of implementing SRO functionality until our SEF market develops a critical mass of trading volume.
We look forward to working with the CFTC to achieve the congressional objective of promoting swap trading on SEFs. If you have any comments or questions about this letter or the SEF issues generally, please contact me or our General Counsel, Chuck Hood, at (212) 813-6053.
Respectfully,
Richard M. McVey
Chairman and Chief Executive Officer MarketAxess Holdings Inc.
Cc:
Chairman Gary Gensler Commissioner Jill Sommers Commissioner Bart Chilton Commissioner Scott O'Malia Commissioner Mark Wetjen
