At a meeting of the CFTC Market Risk Advisory Committee ("MRAC"), subcommittees and industry representatives provided updates on the transition to the Secured Overnight Financing Rate ("SOFR") and the impact of the pandemic on market infrastructure and trade volumes.

MRAC Interest Rate Benchmark Reform Subcommittee

Thomas Wipf (Vice Chair, Institutional Securities, Morgan Stanley) reported that the subcommittee held a "tabletop exercise" to consider CME and LCH's proposed approaches for transitioning discounting and price alignment interest for certain products to SOFR, scheduled for October 2020. Based on the exercise, the subcommittee provided a series of broad "guiding insights" for market participants including: (1) enhanced education for "all involved parties," (2) risk mitigation strategies ahead of discounting, including trade compression and re-couponing, and (3) internal preparation and engagement by all impacted stakeholders. The subcommittee also offered specific recommendations for central counterparties ("CCPs"), futures commission merchants ("FCMs"), buy-side firms and regulators.

Climate-Related Market Risk Subcommittee

Subcommittee Chair Bob Litterman promised meeting participants that a subcommittee report on market responses to climate change should be available in late August.

Market Structure Subcommittee

In its report, the subcommittee stated that it has refocused its efforts on market performance in light of the pandemic. The subcommittee provided agendas of recently established working groups on trading, clearing and reporting.

As to market performance during the pandemic, presenters from Clarus Financial Technology, Bloomberg and Tradeweb described impacts on market volumes. They found, among other things, that clearing volumes of OTC derivatives products at CCPs reached an "all-time record" in March of 2020. The presenters generally focused on (i) risk transfers and portfolio maintenance trades as they relate to market volatility and (ii) the benefit of regulations, such as the Dodd-Frank Act, during periods of stress by promoting "on-venue trading and pre-trade price transparency."

In a presentation titled "Observations on COVID's Impact to Margin, Processing, Operation Health in Cleared Derivatives - A CCP perspective," Lee Betsill (of the CRO CME Group) cited CCPs' demonstrated resilience during recent volatility in mitigating credit and liquidity risks. In a presentation titled "Cleared Derivatives during COVID-19," Richard Haynes (of the CFTC Division of Clearing and Risk) provided data on the derivatives clearing organization's margin model, daily risk surveillance and risk analytics, including supervisory stress testing. In a presentation titled "Impact of COVID-19 Pandemic on Derivatives Clearing," Alicia Crighton (of the Financial Conduct Authority) highlighted, among other things, recent "record-setting" exchange volumes and an increase in customer funds.

Commentary

Firms involved in clearing interest rate swaps should review and consider the Interest Rate Benchmark Reform subcommittee's recommendations relating to the CCP discounting shift. (As Mr. Wipf noted, these are summarized on page 6 of the subcommittee presentation on the "tabletop" exercise.) Mr. Wipf's summary repeatedly indicates a concern among subcommittee members that there is a lack of information flow about the discounting transition. End users of cleared swaps should be thinking about their preferred approaches and elections; providers (e.g., FCMs) should be thinking about client outreach efforts to ensure a smooth transition.

Primary Sources

  1. CFTC Press Release: CFTC's Market Risk Advisory Committee to Meet on July 21
  2. CFTC Statement, Heath P. Tarbert: Opening Statement of Chair Heath P. Tarbert before the Market Risk Advisory Committee Meeting
  3. CFTC Statement, Rostin Behnam: Opening Statement of Commissioner Rostin Behnam before the Market Risk Advisory Committee

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