January 18, 2011

Elizabeth Murphy
Secretary
Securities and Exchange Commission
100 F Street, NE.
Washington, DC 20549-1090

Re: File No. S7-34-10 - Proposed Regulation SBSR—Reporting and Dissemination of Security-
Based Swap Information (75 Fed. Reg. 75208)

Dear Ms. Murphy:

The International Swaps and Derivatives Association, Inc. 1 (“ISDA”) and the Securities Industry and
Financial Markets Association2 (“SIFMA”) (hereinafter referred to as the “Associations”) are writing in
response to the proposed Regulation SBSR—Reporting and Dissemination of Security-Based Swap
Information (the “Proposed Regulation”) issued by the Securities and Exchange Commission (the
“Commission”) to implement provisions of Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (“Dodd-Frank Act”).

The Associations respectfully submit the following comments regarding the Proposed Regulation. The
comments are organized as follows:

• The first section identifies issues and presents our suggestions for future action relating to block
trade exemption rules, which we regard as a critically important element of the reforms contained
in Title VII of the Dodd-Frank Act.

• The second section sets out some general considerations that apply to all areas of the Proposed
Regulation.

1
ISDA, which represents participants in the privately negotiated derivatives industry, is among the world’s largest global
financial trade associations as measured by number of member firms. ISDA was chartered in 1985 and today has over 800
member institutions from 54 countries on six continents. Our members include most of the world’s major institutions that deal in
privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-
the-counter derivatives to manage efficiently the risks inherent in their core economic activities. For more information, please
visit: www.isda.org.
2
SIFMA brings together the shared interests of hundreds of securities firms, banks, and asset managers. SIFMA’s mission is to
support a strong financial industry, investor opportunity, capital formation, job creation and economic growth, while building
trust and confidence in the financial markets. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional
member of the Global Financial Markets Association. For more information, please visit: www.sifma.org
 • The third section addresses specific points relating to the reporting of trade information under
Proposed Rule 901(c).

• The fourth section deals with considerations relating to the reporting of collateral and valuation
information under Proposed Rule 901(d).

• The fifth section responds to the Commission’s questions relating to responsibility for reporting,
including consideration of issues relating to extraterritorial application of the Proposed
Regulation.

There are two Annexes to this letter. The first contains a table mapping the comments in the different
sections of this letter to the specific questions contained in the Proposed Regulation. The second contains
a study entitled “Block trade reporting for over-the-counter derivatives markets” (the “Block Trading
Study”), which has been prepared by ISDA and SIFMA, with support from Oliver Wyman, to begin
addressing considerations relevant to block trades, as explained in further detail in Section I below.

I. Block Trades - Appropriate Block Size Threshold and Public Dissemination Delay

The Associations consider the development of appropriate block trading exemptions from certain of the
requirements of real time public dissemination of security-based swap (“SBS”) information to be of
critical importance to the successful implementation of Title VII of the Dodd-Frank Act for the SBS
market. This is also explicitly recognized in the Dodd-Frank Act, which requires the Commission to
specify the criteria for determining what constitutes a large notional SBS transaction (block trade) for
particular markets and contracts and to take into account whether the public disclosure will materially
reduce market liquidity 3.

The importance of appropriate block trade exemptions can be demonstrated with a simple example. If a
corporate end-user plans to raise a significant amount of capital by issuing a large bond to investors, it is
exposed to the risk that interest rates may rise by the time it is ready to issue the bond. It can hedge that
risk by entering into an interest rate swap with a market maker that is willing to provide liquidity. The
market maker would then typically hedge the risk it has just taken on by entering into one or more interest
rate swap or other hedging transactions with other market participants, indeed the price of the interest
rate swap will likely be related to the price at which the market maker believes it can hedge the risk. If
however the interest rate swap with the corporate end-user is reported to the market, then other potential
counterparties will know that a market maker has executed a large swap and will be looking to hedge that
risk in the market, and will change their prices accordingly, causing a risk of loss to the market maker. A
rational market maker might react to this increased risk by either refusing to enter into the large
transaction with the corporate end-user (thereby reducing liquidity), or by increasing the price of the
interest rate swap offered to the corporate end-user to provide a buffer against the increased risk. The end-
user may react by choosing to break the trade into smaller pieces, thus exposing itself to the liquidation
risk that previously the market maker was tasked with managing. Any of these results is clearly

3
Section 13(m)(1)(E) of the Securities and Exchange Act of 1934, as amended by the Dodd-Frank Act.

2
detrimental to the end-user’s interests, and will have a negative impact on that end-user’s ability to raise
capital, damaging investment in the U.S. economy.

Alternately, if the corporate end-user, instead of issuing a bond, plans to raise capital using a loan, the
lender may hedge its credit risk to that borrower by buying single name credit default swap protection on
the borrower from a market maker that is willing to offer liquidity. In this case the lender’s willingness to
lend or the price of the loan it is willing to offer the borrower will in part be determined by the price of
that credit default swap offered by the market maker. The market maker will, in turn, typically hedge the
risk it has just taken on by entering into one or more credit default swaps or other hedging transactions
with other market participants. If however the credit default swap entered into by the lender and the
market maker is reported to the market, then other potential counterparties will know that a market maker
has executed a large credit default swap and will be looking to hedge that risk in the market, and will raise
their prices accordingly, causing a risk of loss to the market maker. A rational market maker might react
to this increased risk by either refusing to enter into the large transaction with the lender to the end-user
(thereby reducing liquidity), or by increasing the price of the credit default swap protection offered to the
lender. The lender may react by choosing to break the trade into smaller pieces, taking on liquidation risk.
Any of these outcomes may result in a more expensive loan for the end-user. As in the example above,
this will reduce the end-user’s ability to raise capital.

Although the Proposed Regulation does allow for a delay in the reporting of a block trade’s notional size,
this would only provide a partial solution, as the size and direction of a transaction can be inferred based
on the liquidity premium that can be derived from the reported price before notional size is publicly
disseminated. Even assuming that it is feasible to remove the liquidity premium from the price of a large
trade, leaving only a normalized price for a standard (non-block) size trade to be reported in real time,
with actual price including liquidity premium being reported when size is reported, such disclosure can
serve as a signal to the market that the price, if higher, represents a large size trade (price is reported in
real time and it varies from the previously reported normalized price.) For example, in an equity total
return swap (“TRS”) entered into between a market maker and an investor, in which the market maker
wishes to hedge its position by buying shares, as a result of the disclosure other market participants may
start buying the shares before the market maker has an opportunity to hedge the trade, which increases
share price and can drive up the cost to hedge thereby commercially disadvantaging the investor, who is
now forced to bear higher costs. Disclosure of multiple price points (i.e., the “normalized” price in real
time and the real block price on a delayed basis) could be misleading and, therefore harmful to the price
discovery process. Similarly, if the size of the block trade were not disseminated in real time but the price
were to be disseminated in real time with a “proxy” size, such as the size of the block trade threshold or a
randomized size, with no identifier showing that the trade is a block trade, this would create
misinformation in the market. Market participants might rely on the publicly disseminated information,
but if this is a proxy and not real data, the information will not be representative of the true trade and
could be misleading.

From the examples above, it can be seen that the risk of adopting block trading rules that are not
appropriate to the OTC derivatives markets is that end-users’ ability to hedge their risk will be damaged
through a reduction in the opportunities to hedge that risk or through an increased cost of that hedging
activity. The final rules should be constructed so that block trades can be both executed and hedged

3
without negatively impacting liquidity. The Associations do not believe that the percentile test of block
threshold size discussed in the Proposed Regulation is likely to be a sufficiently well-calibrated test to
avoid this risk. 4 Furthermore, given that the distribution of transaction sizes in the SBS market is likely to
be discontinuous and fat tailed, it is natural to expect that a significant percentage of SBS transactions
would qualify as block transactions.

To develop appropriate and well-calibrated block trading exemption rules, the Associations believe that
significant detailed research on SBS markets must be performed before the appropriate block size
threshold and reporting delay for particular SBS transactions can be determined. The Block Trading
Study, attached as Annex 2 to this letter, was prepared by ISDA and SIFMA to begin the research
process, and is submitted for consideration by the Commission. The Block Trading Study was undertaken
to help inform decisions about appropriate block trade reporting rules for OTC markets. It explores the
goals of transparency, the importance of block trade reporting exemptions and the experience of other
markets with transparency regimes and then uses trade-level data to identify unique characteristics of the
OTC interest rate and credit derivatives markets. It also includes specific analysis of the proposals
contained in the Proposed Regulation. While the Block Trading Study concludes that transparency can be
increased in the OTC derivatives markets while preserving liquidity, it also finds that the Proposed
Regulation, requiring full disclosure of notional trade size (albeit on a delayed basis) for block trades,
would likely impair liquidity for larger transactions in the credit default swap market, potentially leaving
end-users with significant credit risk exposures.

ISDA and SIFMA believe that, while the Block Trading Study is a significant contribution to the analysis
undertaken to date on this subject, substantial additional research into appropriate block trade exemptions
is still required. We therefore strongly support the Commission’s intention to collect and analyze
additional data on the SBS market in the coming months and suggest that research should be directed
towards determining the size of a transaction that would likely “move the market” (i.e. change the prices
that market participants would demand or accept for a particular SBS transaction). The Associations
recommend that relevant considerations should include the average daily trading volume for the relevant
product and the size of two-way markets typically made by market makers, and that further investigation
is required to ascertain whether these are in fact determinative factors. The analysis should be performed
separately for different asset classes (in particular, applying the concepts discussed in the Block Trading
Study to asset classes beyond interest rates and credit derivatives) and likely for different products within
each asset class, as the appropriate test for one product may not be appropriate for another product, in fact
it may be appropriate to use different tests to determine the appropriate block size threshold and/or
reporting delay for different products.5

4
The Associations note that the Commodity Futures Trading Commission (the “CFTC”), in its Notice of Proposed Rulemaking
on Real-Time Public Reporting of Swap Transaction Data (75 Fed. Reg. 76140 (December 7, 2010)) (the “CFTC Real-Time
Reporting NPR”), in addition to a percentile test also proposes a test based on applying a fixed multiplier to the “social size”
(the greatest of the mode, median and mean) of transaction sizes for the relevant category. The Associations also do not believe
that this is a sufficiently well-calibrated test.
5
The Commission may also find instructive the Committee of European Securities Regulators (“CESR”) proposal which
supports deferred publication of equity transactions. We recommend the Commission focus its attention on the CESR framework,
which establishes reporting intervals based on a matrix that looks both to the characteristics of the individual transaction and the
liquidity characteristics of the market for the relevant underlying security. The CESR proposal permits reporting to occur at the
end of day and where there are potential reductions in liquidity close to the end of a trading day, CESR recommend extending the

4
The Associations recommend that independent academic research be undertaken to supplement the Block
Trade Study and to determine the appropriate methodology for determining block size thresholds, public
dissemination delays and the information publicly disseminated for block trades. ISDA has previously
helped to co-ordinate similar research that examined the status of transparency in interest rate and credit
derivative markets. This research was first committed and then presented to an international group of
supervisors, including the Commission 6. ISDA would be pleased to work with the Commission to help
co-ordinate a similar study in relation to block size thresholds and reporting delays, and recommends this
course of action to the Commission.

The type of study envisioned above would require sufficient time to arrange and complete. We estimate
that work could be completed by the end of the first quarter of 2011 (or within three months of the
commencement of the study). This timing may be later than the Commission’s anticipated publication of
specific block trade thresholds (the Proposed Regulation suggests that the Commission would propose
specific block trade thresholds simultaneously with the adoption of the Proposed Regulation). However it
should be stressed that this need not delay promulgation of the rules in the Proposed Regulation, merely
the calibration of the block size thresholds and the appropriate reporting delay for block trades, which
could be determined and published at a later date, independently of the other elements of the Proposed
Regulation.

In whatever methodology is eventually selected to determine block size thresholds, it is important that
specific block size thresholds be updated frequently, at a minimum of once every three months, to reflect
the latest market data, because liquidity in OTC markets can change quickly7.

Subject to the outcome of the further research proposed above, we believe that if a transaction is a block
trade, then the size of that transaction (other than the fact that it is a block trade) should not be disclosed
at any time, similar to the Financial Industry Regulatory Authority’s Transaction Reporting and
Compliance Engine system (“TRACE”) and as further discussed in the Block Trade Study.

Referring to the distinction drawn in Section II below between “execution” level data and “allocation”
level data, the final rules should be clear that the determination of whether a transaction is a block trade
occurs at the execution level (in any event as a practical matter, for the reasons noted above, only the
execution level data may be available in real time to determine whether the transaction is a block trade).
Where a transaction is executed electronically, this may already be implied because the electronic
platform will not receive any allocation information and will therefore record the transaction at the
execution level. This clarification is therefore particularly applicable where the transaction is not executed
electronically.

end of day deadline to early the following trading day for trades executed late in the day. This approach is designed to ensure that
the vast majority of deferred trades are reported no later than the end of the trading day on which they are executed while still
providing protection for trades occurring late in the day.
6
For details of the commitment, please see the letter dated March 1, 2010, available on the website of the Federal Reserve Bank
of New York: http://www.newyorkfed.org/newsevents/news/markets/2010/100301_letter.pdf
7
For example as “on-the-run” products become “off-the-run”.

5
II. General Considerations

In this section we set out some general considerations that apply across the broad spectrum of points
relating to the Proposed Regulation.

(a) Consistency Between SEC and CFTC Rules and Overseas Regulators

Many market participants will likely be subject to parallel reporting requirements imposed by the
Commission, the CFTC and overseas regulators. To remove inefficiencies, simplify compliance
obligations and enhance regulatory agency capabilities, the Commission, the CFTC, and overseas
regulators should adopt consistent reporting requirements, including a common implementation effective
date, particularly where transactions in certain asset classes (such as credit derivatives) reported to the
relevant security-based swap data repository (“SSDR”) may be subject in some cases to the
Commission’s rules and in other cases to CFTC rules. Inconsistencies between the Proposed Regulation
and the CFTC Real-Time Reporting NPR and the CFTC’s Notice of Proposed Rulemaking on Swap Data
Recordkeeping and Reporting Requirements8 (the “CFTC Regulatory Reporting NPR”) should be
minimized to enhance compliance.

We have identified the following specific points that we think necessitate consistent ruling between the
Commission and the CFTC:

(i) The set of information to be publicly reported in real-time is quite different between the two
sets of proposed regulations. The CFTC Real-Time Reporting NPR is more specific in terms
of the set of information that is required, and also asks for a broader set of data elements.

(ii) In the lifecycle event model across asset classes, it is also critical to have consistency in the
regulatory approaches.

(iii) Within each separate product type, the Commission and the CFTC should harmonize rules to
define when the timeline for reporting a transaction will commence for that product. In
particular, the time at which a transaction becomes legally binding may not be the same for
all products. Where the reporting timeline is based on market activity such as “affirmation”,
“execution” and “confirmation”, the use of those terms should reflect long-standing market
conventions that differ according to the type of underlying reference asset. Harmonization of
use of such terms in the Commission's and CFTC's rules for a particular product type will
foster operational efficiency, lessen the incidence of errors, and place fewer burdens on
reporting parties. Further observations on the use of these terms and their application to
equity TRS, in particular, are set out below:

(A) In the CFTC Real-Time Reporting NPR, “affirmation” is proposed to be defined as

counterparties’ verifying that they agree on primary economic terms but not necessarily
all of the terms, as distinguished from confirmation and, in many cases, execution if

8
75 Fed. Reg. 76574 (December 8, 2010)

6
 execution does not occur when the parties affirm agreement to primary economic
terms. “Execution” is the agreement between the parties that legally binds them. 9

(B) The Proposed Regulation provides that the timeline for reporting begins at the “Time of
Execution”, defined as the point in time when counterparties become irrevocably bound
under applicable law, by creating an enforceable contract after having agreed to
material terms. Similar to CFTC-regulated swaps, for SBSs where primary terms are
not formed until the swap is confirmed, reporting should occur when the SBS is
confirmed.

(C) For certain equity TRSs, “affirmation” addresses initial steps undertaken in advance of
execution or confirmation; a swap order is initiated at the “affirmation” stage but is
neither executed nor confirmed at this time. Affirmation can occur at the time or
shortly after a trade is preliminarily discussed between two counterparties but occurs
before material terms such as price and quantity are determined and the swap is
executed or confirmed. Following affirmation, intra-day hedge transactions are
executed on a regulated exchange and reported in real-time, in connection with, but
separate from, the TRS which has yet to be executed or confirmed. Any hedge
transactions entered into in advance of the TRS transaction are executed and confirmed
independently of the TRS. In order for reporting to be meaningful, the material terms of
the TRS must be available to be reported. If price, a material term of the TRS, is not
arrived at until after the hedge is consummated, then the parties cannot confirm the
swap until such time. The legally enforceable TRS is made by way of swap transaction
confirmation, which is agreed upon after the time that preliminary swap terms were
affirmed and after independent hedge transactions are executed. For TRSs involving
material terms such as pricing, which occurs derivatively based on the price available
in the market end of day, the full terms of the TRS are not formed until end of day and
therefore the TRS is not executed and confirmed until end of day. In these
circumstances, after the TRS is confirmed by written trade confirmation, it may be
reported in real-time.

(b) Trade Allocations

It is common practice in the OTC derivatives markets for an asset manager to enter into a transaction with
a counterparty for a particular notional size for an agreed price (the “execution” level), and for the asset
manager to then allocate parts of that notional amount to multiple underlying funds (the “allocation”
level). Each fund is a separate legal entity, and so the agreement at the execution level will ultimately
result in several separate transactions at the allocation level.

As a result, we recommend the following:

9
As the CFTC points out, “execution can occur immediately following or simultaneous with (the pre-execution) affirmation; the
proposed definition of execution does not attempt to define what constitutes a legally enforceable contract, only that execution
occurs if and when the parties have formed a legally enforceable contract, which is a matter to be decided by applicable law.”
(See, CFTC Real Time Reporting NPR (75 Fed.Reg.76140 at page 76144).

7
 (i) For the purpose of public real time trade reporting, the objective of which is transparency,
participants should report the trade as executed by the desk. The reporting counterparty will
not need to receive the allocation information from the client for the purpose of meeting the
real time reporting obligations. Furthermore, this report will effectively reflect the pricing
and size of the trade. This is also consistent with reporting under TRACE.

(ii) For the purpose of trade reporting to the SSDR, by contrast, the allocation of the trade to the
respective counterparties will be essential to understanding the final dispersion of risk derived
from the initial trade. For transactions where the counterparty allocates to multiple funds (or
other entities), therefore, the requirement to report should be triggered from the time when
the reporting party receives the allocation from the customer - which is not typically within
the reporting counterparty’s control.

(c) Unique Identifiers

The Associations agree with the Commission’s view related to the importance of introducing unique
identifiers within the derivatives industry. We encourage the Commission, together with the CFTC and
other regulators, to explore current best in class models and mechanisms and adopt best practices for the
derivatives industry (e.g. DTCC gold standard). Industry utilities should be considered for assigning
unique IDs for transactions, products and legal entities/market participants. Furthermore, we encourage
the Commission to attempt to leverage existing market constructs used in the cash securities markets.

The Commission should consider adopting a convention for assigning unique IDs and incorporating a
pilot or early adopter program for certain products and participants that will allow for end-to-end testing
and a proof of concept. For example, a pilot program could consist exclusively of single name CDS
traded by security-based swap dealers (“SSDs”). The identifiers need to be universally adopted and the
industry is committed to use the standard identifiers as and when they become available but allowing for
an appropriate implementation period. A newly formed ISDA cross-product data working group, with
representatives from sell side and buy side institutions, will look at proposed solutions and the practical
implications of unique identifiers for the derivatives industry.

For legal entity identifiers (“LEIs”), we broadly support the principles set forth by the Office of Financial
Research 10. The solution needs to be international, the entity operating the LEI issuance should be not for
profit and operate on the principle of cost recovery. The industry should decide on the appropriate model
for cost recovery. Additional input is needed to decide the right key minimum elements and their
definition, which should also be determined by the industry. Key information about an entity (e.g. SSD in
an asset class or major swap participant in another, or a special entity) should at a minimum be required
fields.

ISDA is committed to provide product identifiers for OTC derivatives products that reflect the FpML
standard. For this process we will follow the same general principles laid out for LEI. In the first

10
OFR discussion paper: “Creating a linchpin for Financial Data: The Need for a Legal Entity Identifier”, December 10, 2010.

8
instance, this work will focus on product identifiers for cleared products. ISDA/FpML is currently
working on a pilot project with certain derivative clearing houses to provide a normalized electronic data
representation through a FpML document for each OTC product listed and/or cleared. This work will
include the assignment of unique product identifiers.

(d) Error Reporting

The Associations support the objective of prompt correction of errors by the reporting counterparty. We
however want to point out that most market participants rely upon systems that do not record the specific
reason for an amendment. As a result, we recommend that while such errors should promptly be adjusted
by market participants, the specific root cause of such amendments (for example a booking error or a
trade amendment between parties) could be omitted. In addition, we urge the Commission to clarify that
reporting parties are not responsible for data which is inaccurately transcribed or corrupted after it has
been submitted to a SSDR, and also have no duty to correct data errors of which they are unaware.

While the industry has done much to improve the speed at which trades are confirmed in recent years, it
has done so over time and without sacrificing accuracy. The time frames proposed by the Commission
are significantly more aggressive than what the industry has committed to in the past and it would be
unfortunate if this were to lead to an increase in errors. We recommend the Commission aim for an
appropriate balance between speed and accuracy in proposing time frames for regulatory reporting.

(e) Phase-in Implementation

It is difficult to comment on the appropriate phase-in periods for the rules contained in the Proposed
Regulation until the precise details of all reporting obligations are available in final form. However, in
general terms, the phase-in period should be sufficient to afford the industry the time needed to build the
technology infrastructure required to comply with regulations. In contrast to the view expressed in the
Proposed Regulation 11, we believe that virtually all existing systems would have to be significantly
overhauled to satisfy real-time reporting obligations of proposed Rule 901(c). The phase-in period should
take account of the work needed for market participants to establish connectivity to the SSDR for the
relevant asset classes once the final standards for data provision are known, including the determination
of unique identifiers, as well as the time needed for the SSDRs themselves to be properly established. We
expect that it will be technologically challenging to establish an SSDR in each asset class 12, however
given sufficient time, we do believe this will be achieved. Requiring compliance via non-electronic
methods is not recommended, as this would increase systemic risk with the industry. Similarly, for the

11
“Based on its discussions with market participants, the Commission understands that much of the infrastructure necessary to
support real-time reporting to a registered SDR may already be in place” - Proposed Regulation, (75 Fed. Reg. 75208 at page
75216).
12
ISDA has previously notified the Commission that the designation of a single registered SSDR per class of security-based
swap would provide the Commission and market participants with valuable efficiencies and expressed views regarding the
adoption of Financial Products Markup Language (“FpML”) as the protocol for reporting security-based swap transactions to a
SSDR or the Commission. We re-iterate those views in the context of the Proposed Regulation. Please see the letter from ISDA
to the Commission dated December 10, 2010 Re: File No. S7-28-10 - Interim Final Temporary Rule for Reporting Pre-Enactment
Security- Based Swap Transactions (75 Fed. Reg. 64643).

9
Commission to have to receive raw data from market participants would likely not be effective;
clarification of how this would work in practice is required.

The industry has worked successfully with regulators in recent years to develop an industry infrastructure
that has proved effective in reducing systemic risk and promoting regulatory goals, notably the process of
commitment letters delivered to the Federal Reserve Bank of New York and other regulators. The
Associations would welcome the opportunity to work further with the Commission and other regulators in
a similar framework to structure the necessary development in the most effective manner and monitor
progress towards established goals. For such an approach to be successful, the Associations would
suggest that implementing rules reflect the outcome of such work.

The definition of “security-based swap instrument” is used in the phase-in provisions contained in
Proposed Rule 910. We recommend that this definition should provide for more granular distinctions
between different types of transaction within a single asset class to avoid grouping together transactions
with quite different characteristics.

One aspect of phase-in that is not contemplated in the Proposed Regulation is a gradual phase-in of the
targeted timeframe for reporting information. By analogy with TRACE, the time required for reporting
when the system was first introduced was 75 minutes, and over a period of several years this was reduced
to 15 minutes as evidence was compiled that such reductions could be safely achieved technologically
and without adverse market impact. The reporting requirements for SBSs are significantly more complex
than for TRACE, therefore the phase-in should reflect this degree of complexity. Additionally, the Credit
Derivatives Trade Information Warehouse was implemented using a phase-in approach; new trades for
dealers were first sent to the warehouse 12 months after work commenced and phased implementations
over the following two years addressed on-boarding of clients and back-loading of trade populations.
Over time the population of credit derivatives included in the warehouse has increased and timeliness of
confirmation has improved through the industry commitment process outlined above. A similar approach
should be adopted for the implementation and development of SSDRs and reporting.

In addition, any concerns related to confidentiality of data should be addressed prior to the Proposed
Regulation being implemented. The fields to be publicly disseminated should be clearly defined in the
final rules.

III. Reporting of Trade Information

ISDA and SIFMA support the objective of real time reporting for SBS transactions contained in the
Dodd-Frank Act and the Proposed Regulation. Initial trades reported should carry a primary reference
number, and all amendments of that trade would then produce iterations of the original reference number.
Initially trades would be submitted with primary economic data. Upon receipt of additional information
pertaining to the original trade (e.g. trade specific allocations, partial or full termination), a subsequent
version of trade will be submitted reflecting associated amendments.

(a) Information to Report

10
We make the following specific recommendations regarding the set of information that has been
identified to be reported:

(i) In relation to the requirement to associate the execution time, to the second, with each of the
reported trades, the Commission indicates that “(...) proposed Rule 910(a) would not require
reporting parties to report any data elements (such as the time of execution) that were not
already available. Therefore, proposed Rule 910(a) would not require reporting parties to
search for or reconstruct any missing data elements.” We respectfully suggest that this is
incorrect in the case of voice trades, for which the entry time in the systems is typically
provided, but not the actual execution time of the trade. Providing the actual execution time
in the case of voice trades would then prove extremely challenging and invasive for the
marketplace.

(ii) We have two recommendations in relation to customized SBSs:

(A) We believe that real time reporting and public dissemination of information relating to
customized SBSs will add little to no price discovery value as their terms will not be
comparable with other SBSs. Furthermore, we believe that such reporting would
introduce the risk of providing price information that could potentially be
misunderstood by some market participants. As a result, we recommend that such
trades be excluded from the public dissemination of real time information.

(B) The marketplace experience in the development and usage of FpML as an electronic
algorithmic representation of OTC derivatives leads us to recommend a pragmatic
approach for the trade representation of such customized SBSs which would be limited
to a set of generic fields and be supplemented (potentially at a later point upon request)
by the actual confirmation (through a format such as PDF). This would be consistent
with the current approach for “Copper” records in credit derivatives and would
facilitate the support of all trades in an asset class within a single SSDR. Further, this
approach would facilitate the monitoring of customized SBSs and help direct efforts to
expand the population of fully supported trades.

(iii) The requirement to report on a Desk ID and Trader ID basis raises special concerns. First,
this information is not currently reported by any of the participants in the OTC derivative
markets, and may in some cases not be captured by existing systems. The industry will need
to develop standards and appropriate methodology to effectively report this information.
Furthermore, we are concerned that the requirement will create significant “noise” as a result
of booking restructuring events (due to either technical or desk reorganization
considerations). We therefore recommend that such information be either excluded, or that
participants report the Desk ID and Trader ID associated with the actual trade or lifecycle
events, but not those resulting from internal reorganization events.

11
 (iv) As a general matter, the Associations urge the Commission to limit real time reporting
requirements to new trading activity. Maintenance and lifecycle events should not fall within
this category. For example, transactions resulting from portfolio compression exercises do
not reflect trading activity and therefore contain no market information. As a result, we
recommend that these types of events be excluded from the real time reporting requirement
for price discovery purposes, but be included as part of the ongoing trade update reporting to
the SSDR (as they will impact trades that would have already been reported).

(v) We believe that, in the case of some asset classes, there is not a universal definition of the
notional amount of a trade. This is particularly the case where the notional is not confirmable
information. We therefore recommend that, as part of the Proposed Regulation, the
Commission provide guidelines for reporting the notional amount, such as those already
developed by the Federal Reserve Bank of New York13.

(vi) In response to question 39 in the Proposed Regulation, we recommend that the Commission
not require reporting of the purpose of the SBS transaction (such as market making,
directional trade or asset hedge), because a party’s reason for trading might reveal proprietary
information and the two parties to a trade will often, if not always, have several reasons for
executing a transaction.

(vii) The final rules should be clear that the information required to be publicly disseminated
cannot identify the participants to a SBS. 14 Such information would include the title and date
of any master agreement.

As noted in Section II, above, under “Phase-in Implementation”, compliance with the reporting
requirements under consideration will require development of substantial technology infrastructure across
a diverse range of asset classes. We therefore encourage the Commission to consider existing
confirmation models and their requirements regarding economic fields that should be matched to confirm
a transaction. Confirmation data can be relayed by clearing agencies, security-based swap execution
facilities (“SB SEFs”) and middleware providers. To promote successful implementation of the reporting
regime, we strongly believe the Commission should leverage and build upon investments made within the
industry over recent years. Specifically, the Commission should seek to pursue solutions based upon the
benefits seen in existing trade repositories such as the Credit Derivatives Trade Information Warehouse,
specifically that:

• leverage bi-laterally matched legally binding (“gold”) records,

• handle most if not all lifecycle events,

13
Guidelines are included under “Line Item Instructions for Derivatives and Off-Balance-Sheet Items Schedule HC-L” in the
Board of Governors of the Federal Reserve System’s “Instructions for Preparation of Consolidated Financial Statements for Bank
Holding Companies Reporting Form FR Y–9C”.
14
For example, Proposed Rule 902(a) in the Proposed Regulation refers to the information reported by the reporting party
pursuant to Proposed Rule 901, but not specifically to the information required by paragraph (c) of Proposed Rule 901, and
Proposed Rule 902(c)(3) refers to Proposed Rule 901(i) but not to Proposed Rule 901(d).

12
 • provide all participants with access to key operations controls and efficiencies such as central
settlement, credit event, re-organization and rename processing, and

• provide regulatory access to key market and industry data.

(b) Total Return Swap Transactions

There should be a general exemption from public dissemination of data with respect to TRSs and trades
otherwise designed to offer risks and returns proportional to a position in the security, securities or loan(s)
on which the TRS is based. TRS pricing information is of no value to the market because it is driven by
many considerations including the funding levels of the counterparties to the TRS and therefore may not
provide information about the underlying asset for the TRS.

Subject to the general point regarding TRSs above, we note that Proposed Rule 907(b)(2)(i) would
prevent an equity TRS from ever being a block trade, regardless of size. We believe that the Commission
is proposing to exclude equity TRSs from qualifying for a block exemption due to concerns that market
participants will go from trading equity on a transparent public exchange to trading equity TRS, which is
perceived to be less transparent than the current market practice if a block exemption concealed the
notional from the public. The Associations believe that even with a block trade exemption, equity TRS
would retain the high level of transparency that is seen today. For example, when an initiating party
wants to buy a $500mm TRS, the seller (usually a dealer), typically buys $500mm of shares or futures
that the TRS would reference on a public exchange. The securities and futures transactions are executed
on regulated exchanges, subject to full transparency and real-time reporting. The dealer then sells
$500mm TRS on the same equity exposure, leaving the dealer with zero net market risk after hedge
execution. This current practice is beneficial because market participants see a purchase of $500mm of
exposure, but the total size of one market participant is unknown to other market participants.

(c) Inter-affiliate transactions

Information relating to transactions undertaken within an organization to manage risk within the
organization should not be publicly disseminated. For example, if a counterparty chooses to enter into a
SBS with a particular entity within an organization, such as a U.S. subsidiary, although the non-U.S.
parent of the organization group is in a better economic position to incur the counterparty exposure from a
risk management standpoint, the inter-affiliate transaction entered into between the inter-company entities
(not with the counterparty) does not contain any additional price information beyond that contained in the
transaction with the customer. As a result, we recommend that such inter-affiliate transactions be
excluded from the scope of public real time reporting for price discovery purposes.

13
IV. Reporting of Collateral Information

(a) General comments regarding collateral in uncleared and cleared transactions.

Before offering specific comments on aspects of the Proposed Regulation relating to the reporting of
collateral information, we would stress a few general points of clarification regarding collateralization in
the OTC derivative market, distinguishing between uncleared and cleared transactions.

In relation to uncleared transactions, the following points are critical to defining correctly the set of data
fields in order to achieve the Commission's objectives for reporting and transparency. The Commission
may find it helpful to refer to two documents that were published in 2010: the Market Review of OTC
Derivative Bilateral Collateralization Practices published by ISDA (March 1, 2010) 15, which provides an
overview of the bilateral collateralization process and explains the use of collateral as a credit risk
mitigant and the Independent Amounts white paper published by ISDA, SIFMA and the Managed Funds
Association (March 1, 2010) 16, which describes the usage and purpose of Independent Amount (“IA”)
together with some of the risks and challenges associated with IA segregation.

Bilateral collateralization in the OTC derivatives market has several key distinguishing features that are
materially different from margin arrangements relating to futures, options and securities transactions. For
example:

• Collateral flows in both directions between the counterparties, according to the exposure that each
has to the other at different times

• The total collateral requirement comprises two elements, exposure collateral, which is present in
all agreements and IA, which is optional according to bilateral negotiation.

• Exposure collateral is always required to cover the net estimated mark-to-market value of the
portfolio of transactions between two parties at the time of a collateral call. 17 Importantly, this
calculation is performed at a netted portfolio level and cannot be broken down to the transaction
level - it is simply not possible to identify the specific exposure collateral or the “exposure”
associated with any particular transaction.

• IA is an optional additional amount of collateral that two counterparties may negotiate. Its
purpose is to protect the IA holder against adverse movement in the net mark-to-market value of
the portfolio that occurs before additional exposure collateral can be obtained to cover that
exposure. The calculation of IA generally takes into account the estimated period it would take to
unwind trades and/or portfolios along with the volatility of the positions in a portfolio. IA is

15
The full Market Review can be found on ISDA’s website: http://isda.org/c_and_a/pdf/Collateral-Market-Review.pdf
16
The full IA White Paper can be found on ISDA’s website: http://isda.org/c_and_a/pdf/Independent-Amount-WhitePaper-
Final.pdf
17
Specifically, the estimate (typically at mid-market) is of the amounts that would be payable between the parties if the
transaction(s) were terminated, and is typically referred to as the “Exposure” of the party that would be entitled to receive a
payment in the event of an early termination.

14
 roughly analogous to Initial Margin in the existing futures and options markets. IA can flow in
one direction, from one party to the other; it can also flow in opposite directions. If both parties
are required to post IA, the offsetting IA flows are netted, and only the net amount moves in
whichever direction is indicated by the netting calculation. Within a single collateral agreement,
IA may apply to all, some, or none of the transactions in the portfolio. If IA does apply to a
particular collateral agreement, it may be specified at transaction level, at portfolio level, at some
intermediate level (a combination of product type, currency and maturity, for instance), and
possibly a hybrid of all three. Therefore it may or may not be possible to identify the IA
associated with a particular transaction, but as a general matter this association cannot be reliably
made.

• Generally, SBS counterparties do not employ transaction-level collateral arrangements, instead

collateral arrangements are managed and processed at the portfolio level. In rare cases of a single
transaction with a specific collateral arrangement, this can be considered to be a special case of
portfolio collateralization, but for a portfolio of one trade.

In relation to cleared transactions, the situation is substantially simpler. We suggest that the most
pragmatic solution to creating transparency of valuation for collateral of cleared derivatives would be to
require the clearing agencies to report the positions, collateral, and valuations. We also suggest that in
particular, clearing agencies’ values should be used for all cleared transactions. Because of its clarity, we
would recommend this approach be adopted by the Commission.

(b) Specific comments in response to the Proposed Regulation

The remaining comments in relation to collateral information relate to specific provisions in the Proposed
Regulation, which are quoted, together with relevant footnotes from the Proposed Regulation, in italics
below:

(i) Required Collateral Agreement Information

Other Terms of the SBS: Proposed Rule 901(d) would require identification of the amount(s) and
currenc(ies) of any up-front payment(s) and a description of the terms and contingencies of the
payment streams of each counterparty to the other;62 the title of any master agreement, or any
other agreement governing the transaction (including the title of any document governing the
satisfaction of margin obligations), incorporated by reference and the date of any such
agreement; and the data elements necessary to calculate the market value of a transaction63. 18

62
For example, this would include, for a CDS, an indication of the counterparty
purchasing protection and the counterparty selling protection, and the terms and
contingencies of their payments to each other; and for other SBSs, an indication of which
counterparty is long and which is short. This information could be useful to regulators in
investigating suspicious trading activity.

18
Proposed Regulation (75 Fed. Reg. 75208 at page 75218)

15
 63
The Commission believes that these elements would include, for a SBS that is not
cleared, information related to the provision of collateral, such as the title and date of the
relevant collateral agreement.

We are interested in further clarification on the above requirements. For example, expanding on
the type of up-front payments the Commission would require, which contingencies would be
required, and whether they are related to collateral movements only (or not) is necessary. Further
clarification on the purpose for these data elements would also help us gauge the type of
information required and would allow us to assist the Commission in assessing whether the
provision of this data will advance the goals of the Proposed Rule. For example, we do not
believe that the title and date of the collateral agreement is necessary to calculate the market value
of a transaction.

(ii) Collateral Agreement Lifecycle Events

Section D. Reporting of Life Cycle Events: Proposed Rule 901(e) would require the reporting of
certain ‘‘life cycle event’’ information. Proposed Rule 900 would define a ‘‘life cycle event’’ to
mean, with respect to a SBS, any event that would result in a change in the information reported
to a registered SDR pursuant to proposed Rule 901, including a counterparty change resulting
from an assignment or novation; a partial or full termination of the SBS; a change in the cash
flows originally reported; for a SBS that is not cleared, any change to the collateral agreement;
or a corporate action affecting a security or securities on which the SBS is based (e.g., a merger,
dividend, stock split, or bankruptcy). 19

Under the proposed rule, for uncleared SBSs reportable changes to the collateral agreement
would include changes relating to haircuts, IA as defined at the portfolio level, eligible collateral,
etc. However, these electives rarely change during the life of the collateral agreement and any
such change to a collateral agreement would require extensive negotiation between the parties.
The cost of establishing the reporting mechanisms to detect such events and report them would
outweigh the usefulness of the rare instances of changes.

(iii) Regulatory Oversight

The Commission believes that each of these data elements would facilitate regulatory oversight of
counterparties and the SBS market generally by providing information concerning counterparty
obligations and risk exposures. For example, the reporting of data elements necessary to
calculate the market value of a transaction would allow regulators to value an entity’s SBS
positions and calculate the exposure resulting from those positions. The Commission
understands, based on discussions with industry participants, that market participants currently
provide this information regarding SBSs to data repositories. 20

19
Proposed Regulation (75 Fed. Reg. 75208 at page 75220)
20
Proposed Regulation (75 Fed. Reg. 75208 at page 75218)

16
 We agree with the underlying concept of monitoring such matters, but respectfully submit that
alternative approaches are available that will achieve the same objectives in a more cost-effective,
non-duplicative manner.

V. Reporting Responsibilities

(a) Reporting responsibilities

Today, certain SBS counterparties, clearing agencies and other third party vendors report SBS
information to trade information warehouses. However, OTC market participants, including the parties to
SBSs, do not currently have the operational capability to report SBSs with the granularity contemplated
by proposed Rule 901. The Associations expect that most SSDs and major security-based swap
participants (“MSSPs”) will expend the substantial development costs necessary to build the
technological functionality required to meet the reporting requirements. Other market participants,
however, may find those costs prohibitive, or will prefer to avoid them. The proposed rule allows these
parties to designate a third-party vendor to act as their agent, which we strongly support. While it is
difficult to anticipate the market structure that may develop in this area pending the promulgation of the
final rule requirements, SB SEFs, exchanges, clearing agencies, brokers, and stand-alone data reporting
vendors are all potential providers of this service, either across asset classes or for particular products or
transaction states (e.g., with respect to cleared trades). Consideration should also be given as to whether a
particular entity such as a SB SEF or a clearing agency will hold the authoritative record of a trade and
whether that information should be leveraged for reporting purposes. 21

The Associations consider a requirement that one or more entities other than a SBS counterparty, such as
a registered SB SEF, a national securities exchange, a clearing agency, or a broker, report SBSs to be
unnecessary in light of the likely prevalence of competition to provide reporting services and given the
ability of market participants to contract with the appropriate vendors to achieve the most efficient
allocation of reporting responsibilities.

In light of these considerations, it is highly likely that portions of the OTC derivative market will be
unable or unwilling to develop and support the sophisticated systems required to conform with the
reporting requirements set forth in the proposed rule, and will wholly rely on the reporting services of
third-party agents to meet their responsibilities. We therefore encourage the Commission to support the
use of third-party agents.

The delineation of reporting obligations in proposed Rule 901(a) are sufficiently clear. However, the
reporting of transaction data will often involve a trade-off between rapid reporting and the availability of
detailed information. Where trades are executed anonymously on a SB SEF or national securities
exchange, the market might elect to have such entity report the transaction as agent for the parties, as the
parties to the trade would not be in a position at the time of execution to ascertain which party had
reporting responsibilities under the proposed rule. However, with respect to trades submitted for clearing,

21
It should be noted that the authoritative record may transfer between entities at certain points during the life of a trade, for
example the authoritative record of a trade executed on a SB SEF and then cleared would initially reside at the SB SEF and then
move to the clearing agency.

17
for example, the SB SEF or national securities exchange may not itself have access to all of the
information required, such as whether the trade has been accepted for clearing. In such instances, the
relevant clearing agency could be tasked with supplying the missing data to the SB SEF or national
securities exchange for reporting, could report the missing data in parallel, or alternatively, could be
contracted to report the entirety of the trade. We believe a number of market-driven solutions are possible.

The issue of selection of a counterparty to report a transaction should only be relevant with respect to
uncleared trades which are not executed on a SB SEF or national securities exchange. The Associations
consider it likely that default market practices will quickly evolve in this area, consistent with other
existing OTC market conventions such as, for example, allocating responsibility for generating
confirmations for bilateral transactions. To the extent that particular inefficiencies are identified, the
Commission might consider adopting reporting presumptions to remove confusion and promote
consistent practices.

(b) Extraterritoriality

The Associations strongly urge the Commission to base its rulemakings on certain core principles related
to extraterritorial scope and international comity. We believe these core principles should be as follows:

• Section 752 of the Dodd-Frank Act requires the Commission “consult and coordinate with
foreign regulatory authorities on the establishment of consistent international standards with
respect to the regulation...of security-based swaps...and security-based swap entities...”.

• The Commission should consult with foreign regulators before establishing the extra-territorial
scope of the rules promulgated under Title VII. This is particularly important where deference to
substantially similar foreign regulation will serve similar policy interests to those of Title VII. In
any event, the Commission should seek to avoid the regulatory uncertainty and ambiguity (and
potential room for regulatory arbitrage) and additional expense that will ensue if market
participants are required to comply with inconsistent or redundant regulations. This is particularly
true where, as in the case of trade reporting, complex, novel, and expensive information
technology and operational systems must be developed over extended time periods.

• Resolving potential regulatory uncertainty and ambiguity between foreign and U.S. regulation
will facilitate the continued provision of capital, liquidity and risk management solutions to U.S.
corporations and institutional investors by foreign SSDs, thereby reducing the concentration of
risk and enhancing the strength of the U.S. capital markets.

• Many of the provisions of Title VII and the European Market Infrastructure Regulation
(“EMIR”), for instance, are conceptually similar but different in specific implementation.
Because market participants will have significant issues complying with both sets of regulations
if applied to the same transactions, we urge the Commission to seek international harmonization
in derivatives regulation through memoranda of understanding or other international cooperative
measures. We are concerned that without such international outreach there could be regulatory

18
 chaos as different regulators compete to regulate overlapping parts of the global derivatives
business.

• Jurisdictional boundaries are essential to implementation of Title VII. The Commission should
define the universe of transactions that they seek to regulate in a clear and unambiguous manner
so that the industry can implement the significant systems and operational changes necessary to
give effect to the regulations by the relevant effective dates. The jurisdictional boundaries should
also be tailored to promote and effectuate the public policy objectives underlying the specific rule
under consideration. To this end, the Commission should craft differing jurisdictional boundaries
that reflect the policy objectives of the rule in question as opposed to crafting a “one-size-fits-all”
framework. This approach will also help the Commission more precisely harmonize Title VII
with parallel international regulation. Ultimately, this will allow the Commission to manage their
scarce resources without sacrificing the important public policy considerations behind Title VII.

Applying these core principles to the proposed reporting and recordkeeping requirements, we urge the
Commission to work to reduce duplicative reporting, recordkeeping and other requirements in
overlapping regulations. Avoiding overlap is important with respect to reporting, particularly if the
overlapping data cannot be easily reconciled. For example, EMIR will also require reporting of OTC
derivative transactions likely resulting in some SBSs being reported more than once unless the
Commission works with its foreign counterparts. Absent international coordination to reduce redundant
reporting or, where unavoidable, establish standard data so that redundant records can be easily
reconciled, overlapping and inconsistent reporting regimes may serve to obfuscate rather than clarify the
true nature and size of the global SBS markets for international regulators. Instead of implementing SBS
reporting rules unilaterally, we request the Commission work with global regulators to devise systems
that efficiently operate together to which such global regulators have access to data relevant to the
performance of their responsibilities.

We do not believe that the Commission should require reporting of transactions between two non-U.S.
counterparties, nor is it clear that the Commission has the authority to do so. With respect to a transaction
between two non-U.S. persons that is cleared through a clearing agency having its principal place of
business in the U.S., the real time public reporting requirement should not apply to either of the two non-
U.S. persons, although the clearing agency can provide information for regulatory purposes. In addition,
we believe that the Commission should reach international agreements with other regulators before
requiring that all transactions with any U.S. person (even if entered into outside the U.S. or cleared with a
foreign clearing agency) be reported under Title VII for the reasons discussed above.

The Proposed Regulation requires that all transactions between a non-U.S. person and a U.S. person must
be reported by the U.S. person, even if the non-U.S. person is a foreign SSD. Given that end-users are
unlikely to have the internal systems and processes necessary to support this reporting, we are concerned
that the practical result would be an inadvertent exclusion of foreign SSDs from the U.S. market, which
could decrease liquidity, further concentrate the U.S. SBS market and thereby increase systemic risk.
Accordingly, we urge the Commission to reconsider this provision and follow the general precepts that
SSDs, even foreign SSDs, are responsible for reporting transactions with non-SSDs.

19
Lastly, we would ask the Commission to consider carefully and provide for consistency with, foreign
privacy laws, some of which carry criminal penalties for wrongful disclosure of information.
Alternatively, and at the very least, the requirements should be made subject to any such mandatory
restrictions on disclosure binding on the relevant parties. Failure to do so would create potentially
insurmountable challenges, both for foreign SSDs who wish to participate in the U.S. swaps market, with
concomitant decreases in liquidity and concentration of risk in the U.S. capital markets, and also for U.S.
SSDs who have entered into a transaction with a non-U.S. counterparty who is protected under such
privacy laws.
* * *

ISDA and SIFMA appreciate the opportunity to provide comments on the Proposed Regulation and looks
forward to working with the Commission as you continue the rulemaking process. Please feel free to
contact us or our staffs at your convenience.

Sincerely,

Robert Pickel
Executive Vice Chairman

Kenneth E. Bentsen, Jr.

Executive Vice President
Public Policy and Advocacy
SIFMA

cc: Honorable Mary L. Schapiro, Chairman

Honorable Kathleen L. Casey, Commissioner
Honorable Elisse B. Walter, Commissioner
Honorable Luis A. Aguilar, Commissioner
Honorable Troy A. Paredes, Commissioner

20
 ANNEX 1

The table below maps the comments in the different sections of this letter to related questions contained
in the Proposed Regulation.

Section of Letter Related Question Numbers

I. Block Trades - Appropriate Block Size 97-100, 104, 111-117, 123-128, 135, 200, 261-263
Threshold and Public Dissemination Delay

(Please also refer to the Block Trading Study)

II. General Considerations

(a) Consistency Between SEC and CFTC Rules and 195-197

Overseas Regulators

(b) Trade Allocations 31, 60-61, 76

(c) Unique Identifiers 49-50, 53-54, 70-72, 74, 85

(d) Error Reporting 142-144

(e) Phase-in Implementation 9-12, 30-31, 33, 35-36, 58-60, 86, 147, 173-175, 177,
181
III. Reporting of Trade Information

(a) Information to Report 14, 18, 26-28, 37-39, 45, 63-64, 68, 136-137, 147, 152,
154

(b) Total Return Swap Transactions 103, 122

(c) Inter-affiliate transactions 16, 151

IV. Reporting of Collateral Information

(a) General comments regarding collateral in 44

uncleared and cleared transactions.

(b) Specific comments in response to the Proposed 64

Regulation

V. Reporting Responsibilities

(a) Reporting responsibilities 1-6

(b) Extraterritoriality 7-8, 200

21
 ANNEX ANNEX 2

January 18, 2011

Block trade reporting

for over-the-counter
derivatives markets
Contents

Executive summary............................................................................................................. 1

1. Transparency and block trading .................................................................................... 3

1.1. Goals of transparency ...........................................................................................3
1.2. The cost of transparency – Illiquidity ...................................................................3
1.3. Block trade exemptions ........................................................................................5
1.4. Considerations for implementation.......................................................................6
2. Transparency in securities and futures markets ............................................................ 8
2.1. Trade reporting in the equity markets: the experience of the LSE .......................8
2.2. Trade reporting in the US futures markets............................................................9
2.3. Trade reporting in the corporate bond markets: the experience of TRACE .......11
3. The OTC derivatives markets ..................................................................................... 13
3.1. The rates markets ................................................................................................15
3.1.1. Interest rate swaps ...................................................................................15
3.1.2. Other OTC rates derivatives products .....................................................18
3.2. The credit derivatives markets ............................................................................20
4. Analysis of proposed rules .......................................................................................... 23
4.1. CFTC proposal ....................................................................................................23
4.2. SEC Proposal ......................................................................................................25
4.3. European proposals .............................................................................................27
5. Conclusion .................................................................................................................. 28

Appendix 1 ........................................................................................................................ 30
Appendix 2 ........................................................................................................................ 31
Appendix 3 ........................................................................................................................ 32
Executive summary

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank)
requires the Commodity Futures Trading Commission (CFTC) and the Securities and
Exchange Commission (SEC) to establish rules that provide for the real-time public
reporting of swaps 1 transactions, as well as exemptions to the real-time reporting rules for
large notional swap transactions and block trades (referred to collectively as “block
trades” throughout this paper).

A major challenge facing the CFTC and SEC is balancing the benefits of increased post-
trade transparency in over-the-counter (OTC) derivatives markets with potentially
adverse effects on market liquidity and pricing for end users. Both agencies have
proposed reporting rules that include exemptions for some large trades, though the CFTC
and SEC proposals differ substantially in how such block trades are treated.

The International Swaps and Derivatives Association (ISDA) and the Securities Industry
and Financial Markets Association (SIFMA) have jointly prepared this paper, with
support from Oliver Wyman, to help inform decisions about appropriate block trade
reporting rules for OTC markets. After reviewing the goals of transparency as well as the
importance of block trade reporting exemptions, the paper reviews and assesses trade
reporting regimes used in the securities and futures markets. Using trade-level data from
the interest rate and credit swap markets, it then illustrates distinctive market
characteristics that should inform an appropriate trade reporting approach for the OTC
derivatives markets. Finally, it assesses the CFTC and SEC proposals, identifying a
number of potential shortcomings and providing recommendations on how they could
be refined.

While not the primary focus of our research, one of the central conclusions of this paper
is that transparency can be increased in the OTC derivatives markets while preserving
liquidity. Other key findings include

 Special rules for block trades have been effectively used in equity, bond, and futures
markets to ensure that dealers are able to execute block trades on behalf of clients
without taking on unmanageable levels of risk, thus maximizing liquidity.
Introducing similar rules in the OTC derivatives markets will have an equally
beneficial effect

 Mechanisms used to balance the benefits and costs of transparency for large trades
include minimum block trade size thresholds, reporting delays, and limited disclosure
of block trading terms

1
“Swaps” is used throughout this paper to refer to OTC derivatives subject to regulation under Dodd-Frank by both the
CFTC and the SEC (which has authority to regulate “security-based swaps” in the legislation), unless otherwise noted.

1
 Trade reporting rules typically are developed and refined over time. TRACE, for
example, was phased in over three years for the US corporate, municipal, and agency
bond markets. Reporting rules for the London Stock Exchange experienced several
adjustments since 1986 to cope with changing market conditions. Trade reporting
rules for OTC derivatives should likewise be phased in, allowing regulators time to
test and refine preliminary standards

 Liquidity in OTC derivative markets is fragmented and varies considerably depending

on the specific product and terms of the contract (reference entity for CDS, maturity
for all products, etc.) traded, making a “one size fits all” approach to trade reporting
exemptions problematic

 The existing CFTC and SEC proposals for block trade reporting would likely increase
(rather than decrease) costs for end users, including institutional investors and
corporations, seeking to manage risk or raise capital

 The CFTC proposal establishes thresholds and reporting delays for block trades that
would have a significant adverse effect on trading in less liquid instruments. The
proposed rules would impose block minimum size requirements without appropriately
differentiating between instruments with very different levels of liquidity

 The SEC proposal, requiring full disclosure of notional trade size (albeit on a delayed
basis) for block trades, would likely impair liquidity for larger transactions in the
credit default swap (“CDS”) market, potentially leaving end users with significant
credit risk exposures

 TRACE-type volume dissemination caps should be employed for all OTC derivatives
products to ensure end users have sufficient sources of liquidity

Block trade rules should be set so that liquidity is not impaired, in order to preserve the
ability of investors and companies to hedge their risks in a cost-effective way. Rules
should be tailored to products – reporting rules for less liquid products should reflect
differences from more liquid products, for example. New rules for trade reporting should
be introduced using a phased approach. Reporting rules should be re-evaluated on a
regular basis to ensure they reflect the changing characteristics of the market.

2
1. Transparency and block trading

1.1. Goals of transparency

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) calls on
the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange
Commission (SEC) to adopt final rules for the public reporting of transaction and pricing
data for all “swap transactions” by July 15, 2011. Similar reforms are also being drafted
by regulators in Europe.

A major policy objective of Dodd-Frank is to bring greater transparency to the OTC

derivatives markets in the United States, while not adversely impacting liquidity in these
markets; in this regard, Dodd-Frank mandates that regulators take into account the impact
of liquidity when issuing rules regarding transparency. 2 The SEC and CFTC state in their
recent notices of proposed rulemaking 3 that the objectives of increased transparency are

 To provide regulators with access to comprehensive and timely market data,

facilitating the task of ensuring the safety and soundness of the financial system

 To promote lower transaction costs, greater competition, broader participation, and

improved liquidity through the public dissemination of trade data

These objectives are meant to be achieved, in part, through real-time, public reporting of
all OTC derivatives transactions (real-time is defined to be as soon as practicable).

1.2. The cost of transparency – Illiquidity

There is broad agreement that transparency can enhance market liquidity. However,
some forms of trade transparency can impair liquidity. Immediate reporting of large
trades will make hedging the risk in those trades more difficult as other market
participants anticipate the hedging trades that will be needed. These extra hedging costs
will be passed on to end users such as pension funds and companies. The result will be
higher costs for end users that rely on the OTC derivatives markets to manage risk.

2
See Dodd-Frank Sec. 727, which states that rules issued regarding the public availability of transaction and pricing
data for swaps shall contain provisions “that take into account whether the public disclosure will materially reduce
market liquidity.”
3
See Real-Time Public Reporting of Swap Transaction Data; Proposed Rule, Commodity Futures Trading
Commission, December 7, 2010 (http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-
29994a.pdf) (“CFTC proposal”) and Regulation SBSR – Reporting and Dissemination of Security-Based Swap
Information, Securities and Exchange Commission, November 19, 2010 (available at
http://www.gpo.gov/fdsys/pkg/FR-2010-12-02/pdf/2010-29710.pdf) (“SEC proposal”) for the detailed notices of
proposed rulemaking.

3
For example, when a corporation plans to raise a significant amount of capital by issuing
a fixed-rate bond, it is exposed to the risk that interest rates rise by the time it is ready to
issue the bond. The firm can hedge that risk by entering into an interest rate swap with a
market maker. The cost of the interest rate swap to the corporation will be directly
related to the price at which the market maker believes it can hedge the risk. If, however,
the terms of interest rate swap with the corporate end-user are reported in real time to the
market, then other potential counterparties will know that a market maker has executed a
large swap and needs to hedge the risk. As a result, these counterparties are likely to
adjust pricing (bid-offer spreads) in anticipation of the trade, increasing the risk of loss to
the market maker. 4 A rational market maker might react to this increased risk by (1)
refusing to enter into the large transaction with the corporate end-user (thereby reducing
liquidity), or (2) by increasing the price of the interest rate swap offered to the corporate
end-user (thereby increasing the firm's financing costs) to provide a buffer against the
increased risk. Either result is clearly detrimental to the end-user’s interests, and will
have a negative impact on that end-user’s ability to raise capital, damaging investment in
our economy. 5

Post-trade transparency in one transaction effectively leads to pre-trade signaling for

subsequent hedging related transactions. The knock-on negative effects – including
decreased liquidity, reduced ability to trade, and increased costs to hedge risks – will be
passed on to swaps end-users and those whose interests they represent. A reduced ability
to hedge risk or an increased cost to hedging risk will ultimately affect the economic
activity of companies and the savings and pensions of individuals.

The impact of transparency rules in major markets has been the subject of a number of
academic studies. 6 Several studies have found evidence of an adverse impact of
transparency in a range of markets. Madhavan, Porter and Weaver (2005), writing about
the Canadian stock markets, report “that the increase in transparency reduces liquidity.
In particular, execution costs and volatility increase after the limit order book is publicly
displayed.”

4
The size and direction of a transaction can be inferred before size is publicly disseminated based on the liquidity
premium in the reported price.
5
Similarly, a lender may wish to hedge a portion or all of a large new lending commitment to a corporation using credit
derivatives. If this new large hedging transaction is reported to the public before market makers can hedge their risk,
the cost and availability of the hedge will be negatively affected. This will then impact the lender’s ability to extend
credit or result in an increase in the cost of credit provided. Either event would, in turn, affect the corporation’s ability
to finance and expand its operations, and ultimately have a negative effect on the economy and job creation.
6
Bessembinder, H., Maxwell, W., Venkataraman, K., 2006. Market transparency, liquidity externalities, and
institutional trading costs in corporate bonds. Journal of Financial Economics 82, 251-288.
Edwards, A., Harris, L., Piwowar, M., 2007. Corporate bond market transaction costs and transparency. The Journal of
Finance 62, 1421–1451.
Madhavan, A., Porter, D., Weaver, D., 2005. Should securities markets be transparent?. Journal of Financial Markets 8,
265-287.

4
The same impact has been observed in other geographies. When the London Stock
Exchange (LSE) abolished fixed commissions in 1986, it initially required immediate
publication of prices. After experiencing a reduction in liquidity, the exchange allowed
the prices of trades exceeding £100,000 to be published after a 24-hour delay. In 1991,
the LSE changed its rules once again to introduce a 90-minute delay for trades that
exceeded a “social threshold” 7 of three times a normal market size trade. The LSE has
since changed the rules numerous times to achieve a better balance between transparency
and liquidity.

Futures exchanges have also recognized the impact of real-time reporting on liquidity of
listed futures and options. Some exchanges allow members to execute large transactions
bilaterally provided the terms are reported to the exchanges after a short delay. Chicago
Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) rules require reporting
within five minutes for interest rate products during regular trading hours and 15 minutes
at other times.

Futures are relatively simple, fungible instruments that trade in markets with thousands of
participants, including large numbers of individual investors. Contracts are of small size
and liquidity can run to hundreds of thousands of trades per day. Block trades are very
rare (less than one per day) for many products, as block minimum sizes are very high
relative to the average ticket size and the trading that can be executed during the short
delay periods. End users either execute transactions piecemeal, taking basis and market
risk, or rely on OTC markets to conduct large trades.

1.3. Block trade exemptions

To preserve a high level of liquidity, market regulators frequently allow reporting

exemptions for block trades. In defining block trade exemption rules, market governing
bodies have three general mechanisms at their disposal: (1) minimum block trade size
thresholds, (2) trade reporting delays, and (3) limited disclosure.

 Minimum trade size thresholds – By definition, block trade exemptions require

clear definitions of the criteria that qualify transactions as block trades subject to
special reporting requirements. This threshold or “minimum block size” is commonly
a function of the average trade size or the cumulative distribution of trades for a
specific instrument. Market regulators frequently target a percentage of transactions
that will qualify as block trades, but also take into consideration a wide range of
market factors (e.g. average daily trade volume).

 Reporting delays – Reporting delays of appropriate length allow market participants

to hedge the market risk of block trades during the delay period. The delay
mechanism is most effective when instruments or contracts are very liquid and either

7
Social thresholds are based on trade sizes that are representative of a particular product or asset class, which is usually
an average trade size for that product or asset class.

5
 fungible or highly standardized, 8 and minimum block sizes are set at reasonable
levels. If these requirements are met, participants are able to hedge entirely the
market risk of block trades during the reporting delay.

 Limited disclosure – Many products do not have sufficient liquidity to ensure that
risks from a block trade can be sufficiently hedged during a relatively short reporting
delay period. In many cases, markets permit participants in block trades to report
limited information regarding block trades. The most common form is a volume
dissemination cap – the market is informed that a transaction above the cap has
occurred, but not the exact size of the transaction. Markets may also grant volume
dissemination caps for more liquid products in cases where the block trade is a
multiple of the block minimum. The limited disclosure mechanism ensures that price
discovery remains intact for block trades while protecting post-block trade hedging
needs from being anticipated by other market participants.

1.4. Considerations for implementation

When establishing rules for block trade exemptions, market governing bodies should
consider a number of factors

 Block trade thresholds should be set so that disclosure of such trades does not
adversely impact liquidity. The purpose of block trade exemptions is to maximize
liquidity by allowing traders to efficiently cover the risks associated with the
execution of large trades.

 Rules should be tailored to products and assume one size does not fit all. The
OTC derivatives market contains a wide variety of products. Some products are
reasonably liquid and standardized, and block trading rules can be defined with some
degree of confidence as to their effect on liquidity. Other products may have much
less liquidity and a large percentage of this small volume may consist of block trades.

 Reporting rules for less liquid products should reflect differences from more
liquid products. Block minimum size for these illiquid products need to be smaller,
delays longer, and information less complete to ensure end users get the best
possible pricing.

 In some markets, the aggregate size of block trades represents a significant share
of overall turnover. For example, 45% of trading turnover on the LSE is subject to a
delay in trade reporting (but only 5% of the number of trades). This seems to be a

8
Standardized products are those for which market quotes are easily available. They include stocks, bonds and futures
contracts. In the OTC markets, credit default swaps and some credit indices have become highly standardized. Interest
rate swaps with spot start and 3- or 6-month LIBOR as the floating rate index also exhibit reasonably high levels of
standardization.

6
 natural consequence for many OTC derivatives products given their large average size
and low level of trading frequency.

 All market participants should be able to (cost effectively) hedge their risk.
Block trading rules should be designed to allow market makers to cover their risks,
and thereby provide efficient, low-cost liquidity to other market participants. In
liquid, standard instruments trading volumes need to be examined relative to
minimum block sizes and reporting delays. For illiquid and customized (non-
standard) products, market makers are not able to offset risk in short periods of time
and the disclosure of limited information may be the only viable alternative.

 For highly customized products, price transparency may be uninformative and

misleading. An OTC derivative contract can be customized to such a degree that its
transparency does not meaningfully inform the rest of the market. In fact, reporting
prices for such products can be misleading for market participants trading similar, but
different products.

 New rules for trade reporting should be introduced cautiously, as the impact on
market liquidity for OTC derivatives is unpredictable. Raising thresholds over
time does not risk damage to market liquidity in the same way that immediate
introduction of high thresholds would. Experience bears this out. The LSE initially
implemented real-time reporting, but soon had to introduce 24-hour reporting delays
for some trades given the initial impact on liquidity. Conversely, TRACE gradually
phased in shorter block trade reporting delays (moving from 75 to 15 minutes).

 Block trading formulas should be re-calibrated regularly and methodologies

reviewed periodically to ensure they both remain appropriate for
changing markets.

 Great care should be taken to ensure that the specificity of trade data reporting
does not compromise the anonymity of participants.

7
2. Transparency in securities and futures markets

Real-time post-trade reporting requirements have been introduced in a number of markets

in the US and Europe. Almost all efforts to implement real-time reporting have
recognized the need for block trading exemptions to preserve market liquidity.
Regulators and other market governing bodies have recognized that dealers will only
make markets when given the ability to hedge risk economically. Each of the
mechanisms described in Section 1 (minimum block trade size thresholds, reporting
delays, and limited disclosure of transaction data) are commonly used, often in
combination with one another, to balance transparency and liquidity.

Below we briefly review the evolution of trade reporting for UK equities on the LSE, the
trade reporting regime for US exchange-traded futures and the impact of the introduction
of the TRACE trade reporting system for US corporate, municipal and agency bonds.
Collectively and individually, these case studies demonstrate that inadequate block
trading exemptions impair liquidity and affect market structure. Indeed, the challenge is
to devise a post-trade transparency framework where the overall benefit of increased
transparency is maximized by preserving market liquidity.

2.1. Trade reporting in the equity markets: the experience of the LSE

The LSE trade reporting experience highlights the need for accommodating block trades
through exemptions to real-time reporting rules even in highly liquid markets. Rules
governing the trading of equity shares in the London markets were the subject of
sweeping changes on October 27, 1986, an event widely referred to as the “Big Bang.”
The changes included abolishing fixed commissions, eliminating most of the restrictions
on the ownership of brokers and introducing electronic trading.

As part of these changes, the LSE introduced a trade reporting regime designed to
promote total transparency. It required all trades in major stocks to be reported within
five minutes. It became apparent that near immediate and full transparency hurt liquidity
as market makers faced increased risks with their equity positions known virtually
instantaneously. 9 Real-time reporting rules were modified in early 1989, when the LSE
permitted trades in excess of £100,000 to be reported on a delay of up to 24 hours
after execution.

As illustrated in detail in Appendix 1, block trading rules continued to evolve, becoming

more flexible and detailed over time. Some of the first social thresholds (block size
thresholds defined as a multiple of normal trade sizes) were incorporated in the early
1990s. Current rules provide for reporting delays that vary from 60 minutes up to three
trading days for very large trades. Throughout this period, the LSE has set its size

9
Ganley, J., Holland, A., Saporta, V., Vila, A., 1998. Transparency and the design of securities markets. Financial
Stability Review 4, 8-17.

8
thresholds and reporting delay periods in a manner that enables dealers to offset risk
during the reporting delay period.

The current post-trade reporting delay regime has produced very interesting results. In
terms of the number of trades, almost 95% of trades are reported without any delay; in
terms of value, approximately 55% of trade value is reported without any delay, and a full
30% is reported at the end of the current trading day or later. 10 These data show that the
market still supports significant levels of block trading, albeit with a multi-tiered
reporting delay framework, a fact that might be difficult to ascertain from the assessment
of the LSE reporting delays contained in the CFTC’s December 7, 2010 proposal. 11

Table 1: Current LSE equity deferred publication framework10

End of End of End of End of
Delay band No delay 60 mins 180 mins day day 2 day 3 day 4
Value of trades 55.4% 7.7% 6.9% 17.0% 3.1% 6.5% 3.3%
Number of 94.8% 2.7% 0.9% 0.5% 0.3% 0.7% 0.1%
trades

The evolution of the LSE rules demonstrates that the right mix of real-time reporting and
block trading exemptions is a difficult balance to strike. A real-time reporting regime,
even in highly liquid securities, requires ongoing analysis and frequent review.

2.2. Trade reporting in the US futures markets

The unique characteristics of the US futures markets highlights the potential

consequences of block trade thresholds set well above normal trade sizes and should
guide the implementation of any trade reporting regime for OTC derivatives (where block
trades are more common and critical to market liquidity).

Futures markets are generally highly liquid and well-suited to central order books that
accommodate small trades and broad market participation. Futures trade in standardized,
small contracts (in contrast to the OTC markets, in which each contract is customized and
can be very large). Futures markets require reporting as soon as trades are executed.
Block trades are permitted with brief reporting delays that generally range from 5 to
15 minutes.

10
www.londonstockexchange.com TradElect parameters.
11
“The London Stock Exchange (“LSE”) allows the publication of the trade to be delayed, if requested, for a specified
period of time which is dependent on the volume of the trade compared to the average daily turnover, as published by
LSE, for that particular security. LSE rules require member firms to submit trade reports to LSE as ‘close to
instantaneously as technically possible and that the authorized limit of three minutes should only be used in exceptional
circumstances.’” (CFTC proposal, p. 76166)

9
The delay allowed for reporting futures block trades can be examined in light of the level
of trading for each product. Table 2 below provides block trading and other market
details for selected CME Group products. The table shows, for select futures contracts,
the potential number of block trades (e.g. 200 contracts for gold futures) that could be
completely offset over the course of a typical five-minute delay period. We calculate the
average number of contracts that are traded during the delay period (e.g. 2,196 for gold
futures) based on the year-to-date average daily volume, and then calculate how many
minimum block trades this would accommodate.

Table 2: Block trading details for selected CME Group futures products 12
Contracts
traded in
Minimum 5-minute Number of Average
block size delay block Average number of
(number of period trades trade size block
Futures contracts) 2010 YTD based on offset in (number of trades per
Contract (A) ADV (B) ADV (C) delay (C:A) contracts) day
Gold 200 171,277 2,196 11 2 <1
Silver 200 42,120 540 3 2 <1
Copper 100 40,842 524 5 2 <1
Natural Gas 100 246,663 3,162 32 2 10
Light "Sweet" 100 679,282 8,709 44 3 >50
Crude Oil
Ethanol 10 2,477 32 3 3 3
30-day Fed 2,000 52,009 667 0 50 <1
Funds
30-Year 3,000 326,481 4,186 1 10 <1
Treasury
Bonds
5-year 5,000 509,712 6,535 1 15 <1
Treasury
Notes

As shown in the table, most block trades in energy products and metals can be offset
during the delay. However, block trades in interest rate products cannot typically be
offset during the reporting delay despite significant activity in these contracts. The table
also shows that block trades are relatively rare in all the contracts in the table and are
virtually non-existent in the contracts where the delay provides the least opportunity to
offset risk.

A natural outgrowth of the high block trading thresholds is small average trades and a
scarcity of transactions of even modest size. Contracts for Natural Gas and US Treasury

12
Trading data for November 21, 2010, CME Group.

10
Notes futures illustrate this point, shown in Figure 4 and Figure 5 of Appendix 2. We
examined trading activity for both of these contracts on the CME on November 21, 2010.
98% of transactions in Natural Gas futures included less than ten contracts; likewise, 98%
of transactions in 5-year US Treasury Notes futures had an underlying principal of less
than $5 MM (with a single trade exceeding the $500 MM block minimum).

As a result of this market and reporting structure, participants that wish to buy relatively
large contracts (e.g. $200-300 MM of 5-year US Treasury Notes futures) need to split the
order into many smaller orders, thereby assuming aggregation risk as other market
participants infer from the initial trades that there are more trades to come. The aggregate
trade can easily become expensive, as it takes longer to execute and markets move
adversely. Practically, the futures market block trading rules have resulted in larger users
moving to other markets – primarily to US government securities markets themselves and
the OTC derivatives markets.

For a market such as OTC derivatives where the trade sizes are less concentrated in small
transactions (in fact, the SEC proposal acknowledges that for products with very low
trading frequencies most trades can actually be considered block trades, as each trade
makes up a significant portion of daily volume 13), it will be challenging for real-time
transparency to support active trading in the sizes that market participants require for
active risk management unless minimum block sizes are set appropriately.

2.3. Trade reporting in the corporate bond markets: the experience of TRACE

In 2002, The Trade Reporting and Compliance Engine (TRACE) mandated the public
dissemination of corporate, municipal, and agency bond trading data.

Similar to the OTC derivatives market, these bonds are traded over-the-counter on a
secondary basis. Market makers collectively hold inventory in thousands of different
bonds in order to meet the expected demand of the market and to support client activities.
The TRACE bond reporting system was introduced in phases, starting in 2002. It initially
applied only to 500 large investment grade securities and 50 high yield issues, and
instituted a 75-minute delay for block trades. TRACE was subsequently applied to about
4,650 debt securities in 2003, and the block reporting requirement reduced to 45 minutes.
This phased introduction allowed the market impact of the changes to be assessed.

The current TRACE reporting timeframe was introduced in 2005. Under these rules,
dealers are required to report trades within 15 minutes of their execution. Reporting
consists of the particular bond, time and date, price, yield, whether the bond was bought
or sold, and the size. Size is disclosed if a trade is less than $5 MM for investment grade

13
“For example, a single trade that is equivalent in size to a full- or half-day’s average volume may be considered out-
sized. On the other hand, if a particular SBS trades only once or twice per day then every trade would be equivalent to a
full or half-day’s average size.” (SEC Proposal, p. 75231)

11
bonds, and if less than $1 MM for non-investment grade bonds; otherwise, size is
reported as being above those thresholds.

There is a significant body of research on the effects of TRACE on market practices

including research that addresses TRACE’s impact on liquidity. Bessembinder and
Maxwell (2008) 14 present a number of interesting findings. The authors find that trading
costs decreased for smaller trades following the introduction of TRACE. This occurred
because less-active market participants that typically trade in smaller sizes now had a
better informed view of market prices, which improved their bargaining position. This
conclusion was arrived at independently by several studies. 15

With an average trade size of $2.7 MM for institutional corporate bond trades in the OTC
market and 85% of trades greater than $1 MM, 16 it is clear that a block level of $5 MM
for investment grade bonds and $1 MM for non-investment grade bonds is indeed
relatively low. This exemption provides for real-time transparency for the majority of
trades, but at the same time limits the disclosure of trade size for the significant portion of
trades that qualify as block trades. The framework provides transparency, and also
accommodates trading in large sizes.

TRACE’s introduction has achieved one of its primary objectives – to better inform
smaller investors about recent bond trading prices and has done so while allowing block
trades to continue.

14
Bessembinder, H., Maxwell, W., 2008. Transparency and the corporate bond market. Journal of Economic
Perspectives 22, 217-234.
15
Bessembinder, Maxwell, and Venkataraman (2006); Edwards, Harris, and Piwowar (2007); and Goldstein, M.,
Hotchkiss, E., Sirri, E., 2007. Transparency and liquidity: A controlled experiment on corporate bonds. Review of
Financial Studies 20, 235-273.
16
Bessembinder, H., Kahle, K., Maxwell, W., and Xu, D., 2009, Measuring abnormal bond performance. Review of
Financial Studies 22, 4219-4258.

12
3. The OTC derivatives markets

The over-the-counter (OTC) derivatives market emerged in the early 1980s in response to
inefficiencies in the global debt markets. Some borrowers were able to raise debt in the
floating rate markets at comparatively lower rates than the fixed rate markets, and vice
versa. Early interest rate swaps allowed borrowers to "swap" fixed versus floating rate
payments on a common notional amount, resulting in lower financing costs for
both parties.

Swaps proved to be extremely flexible risk management tools, allowing end users to
manage a wide range of interest rate and currency risk 17 as well as lower financing costs.
However, matching counterparties with perfectly offsetting requirements was often
impossible and hampered the growth of the market. Interest rate swaps only became
commonplace when financial intermediaries began taking the other side of contracts,
warehousing and hedging risk on a portfolio basis without actually matching offsetting
client positions. By the early 1990s, these contracts became the instrument of choice for
end users to manage interest rate and currency risk. Soon thereafter, a comparable
derivatives market for the management of corporate, sovereign, and other credit risk
emerged (though it pales in comparison to the size of the interest rate swaps market).

From its inception, the OTC derivatives market has been an institutional market with
almost no retail participation. Indeed, it is illegal for most individual investors to trade
OTC derivative contracts. The first users of the market were large borrowers –
corporations, banks, securities firms, sovereigns and supranational agencies, such as the
World Bank and the European Investment Bank – who used swaps to adjust the risk
profile of their liabilities. Institutional investors, mutual funds, hedge funds and
insurance companies subsequently emerged as key users (and, in some cases, providers)
of derivatives, employing them to implement a variety of investment strategies.

The OTC derivatives markets evolved to maximize the flexibility of instruments for end
users. Market participants made use of the flexibility of OTC contracts to disaggregate
and manage a range of complex risks in a very precise manner. This has produced a
number of unique attributes that distinguish OTC derivatives markets considerably from
securities and standardized futures and options

 Limited market activity – Despite the hundreds of trillions of dollars in notional

outstanding OTC rates derivatives contracts, there is actually limited trading activity in
the market. Roughly 5,500 contracts are executed each day across interest rates swaps,
caps, floors, swaptions and other debt-related products in over 20 currencies. 18 Even if
products are categorized into multi-year maturity buckets, the most liquid contracts
17
Interest rate swaps can be customized to nearly any underlying reference interest rate, currency, and starting and
ending dates; thus, users are able to offset unwanted risks very precisely by engaging in the OTC derivatives markets.
18
TriOptima trade-level interest rate swap repository data over a 45-trading day period from August 1 to September 31,
2010.

13
 with maturities between five and ten years only trade 500 times per day (or less than
one per minute globally assuming a 12-hour trading day). The global universe of
outstanding OTC interest rate products, approximately five million transactions,
consists of the same number of trades as conducted in exchange traded interest rate
products on the CBOT and CME over the course of just 15-20 days. 19, 20

 Large individual transactions – The OTC derivatives marketplace primarily serves

large institutions with the need for large transactions. Individual trades by large
institutions may well represent activity for hundreds or thousands of distinct accounts
managed on behalf of small institutions and retail investors. The average size of a ten-
year USD interest rate swap was $75 MM during 2010, 21 whereas comparable
transactions in futures and securities markets are substantially smaller ($2 MM for ten-
year US Treasury Notes futures 22 and $3 MM for US corporate bonds, 23 respectively).
Other OTC products also tend to have substantially larger average transaction sizes
than their futures and cash counterparts. In many markets, OTC derivatives markets
have been the preferred (or only viable) venue for block trades.

 Limited participation – The OTC derivatives market is an institutional marketplace

with a relatively small number of active participants. JP Morgan estimates that there
are only 500 active participants in USD interest rate swaps and less than 250 in the
credit derivatives markets. 24 Active participants tend to be large institutions, banks,
securities firms, insurance companies, asset management firms (which represent a
number of smaller investors) and major corporations – this is due largely to balance
sheet requirements for trading in these markets. By contrast, the number of active
participants in the most liquid futures contracts (e.g. WTI Crude, S&P Index contracts)
is in the tens of thousands and includes a significant number of retail investors.

 Customization – There is no theoretical limit to the number of unique contracts that

can be executed in the OTC derivatives marketplace. In vanilla interest rate swaps
alone, there are more than 100,000 discrete instruments, 25 differentiated by underlying
currency, maturity and floating rate indices; in the credit default swaps market, there
are hundreds of thousands of discrete single-name contracts, differentiated by coupons

19
As measured by the TriOptima Trade Repository Report as of December 17, 2010, available at
http://www.trioptima.com/repository/historical-reports.html.
20
CME Group Exchange ADV Report, October 2010; CME Group daily trading activity for January 10, 2011.
21
TriOptima trade-level interest rate swap repository data over a 45-trading day period from August 1 to September 31,
2010.
22
Trading data for November 21, 2010, CME Group.
23
Bessembinder, H., Kahle, K., Maxwell, W., and Xu, D., 2009, Measuring abnormal bond performance. Review of
Financial Studies 22, 4219-4258.
24
Active market participants are defined as those trading at least five times per year in that product; the number of
actual users is much greater.
25
J.P. Morgan internal research and analysis.

14
 (at least two per entity) and maturities (40 quarterly maturities out to ten years) on
thousands of unique reference entities.

 Privately negotiated transactions – Because a significant share of trades are

customized and liquidity is provided by a relatively small number of participants, the
OTC derivatives market has not naturally evolved into an exchange-traded market with
thousands of participants like other instruments.

 Professional risk intermediation – Dealers offer OTC derivative contracts with terms
that are difficult to perfectly match on a consistent basis. Because of this and the long
duration of most contracts, dealers need to manage large portfolios of outstanding
contracts with significantly different risk profiles. This activity requires a substantial
investment in specialized staff, advanced technology and capital resources. Roughly
15 to 20 bank dealers are major market makers and competition for client business is
extremely strong among this group.

Many of the key differences between OTC and exchange traded derivatives markets are
briefly summarized in the table below.

Table 3: OTC derivatives and exchange traded derivatives market size and
participation 26
Ratio of market Average
Active Total participants to number of
Product participants Instruments instruments trades per day
Exchange traded markets
WTI futures >20,000 70 >300 >250,000
S&P e-Minis >150,000 5 >30,000 >200,000
OTC derivatives markets
Single-name CDS 200 75,000+ <0.003 4,000
Index CDS 200 100 2.0 2,000
Vanilla interest rate swaps 500 100,000+ <0.005 1,000

3.1. The rates markets

3.1.1. Interest rate swaps

The OTC rates derivatives market is one of the largest and most important financial
markets in the world today, yet only several thousand transactions are executed daily
across a wide range of currencies, reference rates, and maturities.

26
J.P. Morgan internal research and analysis.

15
Liquidity in rates derivatives is highly fragmented. The interest rate swaps market (the
most liquid segment of the market) is generally characterized by

 Low volumes in specific buckets (currency, maturity, etc.)

 Highly volatile daily trading volumes within specific contracts
 Relatively large transaction sizes and concentrated trading volumes

Approximately 4,000 27 interest rate swap transactions across all currencies and maturities
are executed per day by the 14 largest dealers. 28 Of those, approximately 1,500 trades are
in USD contracts with 500 trades per day in the 5-10 year maturity range. The number of
transactions executed in specific maturity buckets is much smaller: on average fewer than
100 seven-year USD interest rate swaps are completed on a typical trading day. 29 USD
and Euro interest rate swaps are the most commonly traded OTC interest rate derivatives.
Trading in other currencies is significantly lower.

Liquidity (as measured by trading volume) fluctuates considerably over time. Figure 1
shows the daily trading activity for the 14 largest derivatives dealers in USD interest rate
swaps with 5-10 year maturities, the most common maturity range, from August to
September 2010. Trading volume across this broad set of contracts ranged from 300 to
1,000 contracts per day, with significant spikes in activity driving up the average daily
volume. Volatility within specific maturity buckets is even greater.

27
Compared to the 1,000 trades per day listed in Table 3, the estimate of 4,000 trades per day for all interest rate swaps
includes non-vanilla interest rate swaps with odd maturities, non-spot starts, and non-major currencies.
28
ISDA estimates that the 14 largest dealers hold approximately 80% of OTC interest rate derivatives contracts
outstanding (Mid-Year 2010 Market Survey Results).
29
TriOptima trade-level interest rate swap repository data over a 45-trading day period from August 1 to September 31,
2010.

16
Figure 1: Daily trading activity in USD 3-month Libor interest rate swaps at
5-10 year maturity30

1500
# of trades per day

1000

500

0
8/2/10text
Blank August 2010 9/2/10text
Blank September 2010

The average transaction size for US$ interest rate swaps in the 5-10 year maturity bucket
is $75 MM with a significant number of transactions in excess of $200 MM. This is in
stark contrast with the futures markets where trade sizes are much smaller and 95% of the
trades in five-year Treasury Notes futures are less than $5 MM in size. The distribution of
transaction sizes for comparable contracts in the OTC and futures markets is provided in
Figures 2 and 3 below.

Figure 2: Trade size distribution in USD 3-month Libor interest rate swaps at 5-10
year maturity 30

7000

6000

95th
5000 percentile of
trading
# of trades

4000 activity ≈
$250 MM
5 times the
3000
average trade
size ≈ $375
2000 MM

1000

0
0 100 200 300 400 500+
Trade size ($MM notional)

30
TriOptima trade-level interest rate swap repository data over a 45-trading day period from August 1 to September 31,
2010.

17
Figure 3: Trade size distribution for Dec 10 5-year US Treasury Note futures
product for November 21, 2010 31

7500

95% of trades
are for less
than $5 MM
5000
Number of trades

notional
Only ~1 block
trade ($500
MM notional
2500 size) per day

0
0 10 20 30 40 50 60 70 80 90 100 500+
Notional trade size ($MM)

Figure 2 also shows thresholds derived from the CFTC proposed rules on minimum block
size trades – $250 MM (95th percentile) and $375 MM (five times the average trade size).
The CFTC proposal would require real-time reporting for over 98% of the market.

One of the stated goals of real-time reporting regulation is to tighten pricing spreads in
the OTC markets. In a recent blind test conducted by Atrevida Partners, 32 three large
investment firms each solicited executable price quotes from dealers on five separate IRS
transactions. For each transaction, three quotes were requested The dealer quotes were
compared to Bloomberg screen pricing as well as to one another. The best quotes
averaged 0.001% (one-tenth of a basis point) from the mid-market yield on Bloomberg.
The average spread between the best and worst quote (of the three total quotes) was
0.0038% (0.38 basis points) and as a percentage of the average quote this spread was
0.30%. The test indicates that pricing in the interest rate swap market is very competitive
despite the low volume of trades done each day by dealers. In addition, the close
relationship between Bloomberg and dealer quotes indicates that pricing is highly
transparent for customers.

3.1.2. Other OTC rates derivatives products

In addition to interest rate swaps, the OTC rates derivatives products consist of many
other product categories. The largest of these include forward rate agreements (“FRAs”),

31
Trading data for November 21, 2010, CME Group.
32
“Interest Rate Swap Liquidity Test” - a report sponsored by ISDA and conducted by Atrevida Partners in conjunction
with market participants in November 2010.

18
swaptions, caps and floors, and basis swaps. In all, these products represent
approximately 27% of outstanding notional and 20% of outstanding contracts. 33 (Both of
these figures may overstate the relative percentage of actual activity in these products as
interest rate swaps undergo regular “compression” cycles in which contracts are torn up.)

TriOptima lists 12 distinct categories of rates products. A snapshot of each product and
key market data is presented below.

Table 4: Overall “snapshot in time” trade summary by product type33

Notional Trade Count Average Trade Size
($TN) (’000s) ($MM)
Interest rate swaps 291 3,030 96
Overnight index swaps 57 96 531
(OIS)
Sub total 342 3,116 110
FRAs 51 145 351
Swaptions 28 193 143
Basis swaps 20 89 223
Caps/floors 12 78 151
Cross currency swaps 8 115 72
Exotic IRS 6 78 76
Other products 5 76 65
Sub total 129 774 167
Total 471 3,890 121

TriOptima data is for the 14 largest dealers, which skews the average trade size data
considerably as does the methodology for double counting cleared transactions (primarily
interest rate swaps and OIS interest rate swaps). But the data is clear with respect to the
non-interest rate swap products – trade size also varies considerably. These variations
along with differences in trade frequency and risk characteristics require that the products
should be examined independently with respect to block minimums, reporting delays and
disclosure requirements.

The TriOptima data indicates that the 14 largest dealers have approximately four million
outstanding contracts. These dealers represent an estimated 80% of the total notional,
implying that approximately five million OTC rate contracts are outstanding globally. By
contrast, the CME Group trades approximately 300,000 tickets per day in the US
government and Eurodollar futures contracts. The entire population of OTC interest rate
trades represents slightly more than the 15 days of activity in the interest rate futures
market of the CME Group. Approximately 5,500 OTC interest rate derivative
33
As measured by the TriOptima Trade Repository Report as of December 17, 2010, available at
http://www.trioptima.com/repository/historical-reports.html.

19
transactions are executed globally each day, equal to just 2% of the number of trades
conducted in the corresponding CME Group futures contracts. US$ trades are less than
1% of the daily volume in corresponding futures markets.

3.2. The credit derivatives markets

Like other OTC derivatives markets, the OTC credit derivatives markets are marked by
low volumes and large transaction sizes. The market is composed of approximately 4,000
single-name reference entities, on which protection is written (sold) or purchased, and
100 indices comprised of single-name reference entities. Volume and size characteristics
of the CDS market are summarized on the following page (graphs containing additional
CDS market data are contained in Appendix 3).

Overall average daily volume is approximately 6,500 contracts, of which 4,500 are
single-name reference entities and 2,000 are credit indices. Approximately 1,000 single
name reference entities are traded more frequently and consistently. They include
approximately 930 corporate and 65 sovereign entities. In all, average daily trading
volume for these 1,000 names amounts to approximately three trades per day for each
reference entity. Each reference entity will have at least 80 quotable contracts: 40
different maturities and two different coupons. In all, there are over 80,000 individual
contracts for these 1,000 names. The vast majority of individual contracts trade
very infrequently.

Table 5: Summary of CDS trading behavior 34,35

Daily Trading Activity Trade Size
Number
of Average % of RE % of RE
90th
reference daily with <5 with >20 80th
entities trades trades trades Mean percentile percentile
(RE) per RE per day per day ($MM) ($MM) ($MM)
Single-name
Corporates 935 3 79% <1% 8 7 10
Sovereigns 65 8 56% 11% 13 16 24
Total 1000 3 77% 1% 8 8 11
Indices
High Grade 80 15 79% 14% 15 100 150
High Yield 35 20 65% 16% 20 30 55
Total 115 17 75% 15% 16 80 120

34
DTCC Credit Default Swap (CDS) trade repository for all trades from March-June 2010
35
Trade size distribution determined by number of transactions (e.g. for a sample of 100 trades, the 80th percentile
represents the threshold, in $MM, that separates the smallest 80 trades and the 20 largest trades)

20
Of the corporate reference entities, nearly 80% trade less than five contracts per day, with
many names that average less than one trade per day. The table above shows that only
two corporate reference entities traded 20 or more times per day (across all contracts
outstanding on a given reference entity) over the three-month period. In a 12-hour
trading day, this represents one trade done globally every 36 minutes.

It should also be noted that the table is a snapshot of the entire market on an average day.
This means that a reference entity that trades 20 times on a given day may trade less than
20 times on a subsequent day. Average trade size for corporate reference entities is
$8 MM and more than 90% of trades are for less than $10 MM

Of the sovereign names, approximately 55% trade less than five times per day. The table
shows that seven sovereign reference entities trade 20 or more times per day. Average
size for a sovereign name is $13 MM and 90% of trades are for less than $25 MM.

To show an example of trading in the sovereign CDS market, Figure 3 shows daily
trading activity for the Kingdom of Spain, one of the most frequently traded single-name
reference entities. Daily trade volumes have varied over a three-month period from fewer
than 10 contracts to as many as 125. The average number of contracts traded is 35 per
day and the average turnover of the “on-the-run” five-year contract is 21 trades per day.
This trading volume is in stark contrast to that of equity and liquid futures contracts.

Figure 3: Most actively traded sovereign CDS daily trading activity 36

150

100

50

March April May June

Kingdom of Spain

It is useful to compare the TRACE process with what might be appropriate for the CDS
market. TRACE took three years to implement and ended up with volume dissemination
caps of $5 MM for investment grade bonds and $1 MM for high yield. The average size

36
DTCC OTC CDS trade repository; 3 month data set of CDS trades from March to June, 2010.

21
trade in single name corporate CDS ($7 MM) is higher than the average investment grade
corporate bond trade ($2.7 MM) and trading activity is much lower in CDS and dealers
often take weeks or more to close out large positions. 37 We believe that trade reporting
requirements for CDS products should be phased in and adjusted over time, as was the
case with TRACE, both with respect to mechanics as well as volume dissemination cap
sizes.

There are far fewer credit indices traded compared to single-name reference entities.
Analyzing the aggregate trading in each index, we find there are about 100 liquid indices.
The ten most active indices make up 75% of the total daily volumes; the four most active
indices make up 50% of the market's total trading volume. Each of the top four indices
trades more than 100 times per day, whereas 75% of the remaining indices trade less than
ten times per day. The average contract size is approximately $75 MM for investment
grade indices and $30 MM for high yield indices. 38 We believe a process similar to
TRACE can be developed as well for credit indices, differentiating investment grade from
high yield instruments, and setting the volume dissemination caps at relatively low initial
levels to ensure liquidity remains in the market.

The OTC credit derivatives markets illustrate well a common feature of swaps markets in
general – the market is fragmented across a wide range of instruments. This market
fragmentation means that individual instruments trade infrequently, even in asset classes
considered to be relatively liquid. For example, CDS contracts on most reference entities
trade less than five times per day, and there are dozens of contracts per reference entity.
This distinctive level of trading frequency should directly inform the development of an
effective block trade reporting approach.

37
Bessembinder, H., Kahle, K., Maxwell, W., and Xu, D., 2009, Measuring abnormal bond performance. Review of
Financial Studies 22, 4219-4258.
38
DTCC OTC CDS trade repository; 3 month data set of CDS trades from March to June, 2010.

22
4. Analysis of proposed rules

4.1. CFTC proposal

Dodd-Frank has designated the CFTC as the primary market regulator for certain OTC
swaps contracts. It includes certain swaps tied to interest rates, currencies, commodities,
baskets or broad-based indices of equities and indices of indebtedness of groups of
reference entities (credit indices). The legislation requires real-time reporting (as soon as
practically possible) for certain swaps, but assigns regulators the task of developing
reporting rules that reflect the effects of real-time reporting on market liquidity. The
CFTC published its proposed rules on real-time reporting in the Federal Register on
December 7, 2010. In this section of the paper, we examine the proposed rules with
respect to interest rate and credit index swaps.

The proposed rules require that all swaps be reported in real time unless a transaction
meets the minimum block trading size, in which case the transaction is subject to a
15-minute delay in reporting. All transactions, whether executed on a swap exchange or
bilaterally, are subject to real-time reporting and subject to the same minimum trading
sizes in order to qualify for the 15-minute delay.

Minimum block trading sizes are determined generally by Swap Data Repositories
(SDRs). SDRs aggregate swap products within asset classes into smaller groups called
Swap Instruments. The rule itself defines a Swap Instrument as “a grouping of swaps in
the same asset class with the same or similar characteristics.” In the explanation of the
proposed rules, the CFTC “believes that it is appropriate to group particular swap
contracts into various broad (emphasis added) categories of swap instruments.” It goes
on to state, “the Commission believes that within each asset class there should be certain
criteria that are used to determine a category of swap instrument. For example, swaps in
the interest rate swap asset class may be considered the same swap instrument if they are
denominated in the same major currency (or denominated in any non-major currency
considered in the aggregate) and if they have the same general tenor.” Additionally, “... a
single category of swap instrument may be ‘US dollar interest rate swaps in a short
maturity bucket, including swaps, swaptions, inflation-linked swaps, etc. and all
underlying reference rates.’” With respect to credit indices, they all are presumed to be
the same Swap Instrument. 39

Public dissemination of the notional amounts of transactions is subject to a rounding

convention. This convention provides, among other things, that notional principal of
contracts in excess of $250 MM be reported as $250 MM+. The explanation of the
proposed rules cites the rounding convention as providing a degree of anonymity. As
discussed below, this is an important element in preserving the availability of block
trading.

39
CFTC proposal, pp. 76153, 76172.

23
The minimum block trading sizes are then subject to a two-part test. The first part, called
the Distribution Test, is the notional amount that is greater than 95% of the transactions of
a Swap Instrument, where the rounding convention has first been applied. The second
part, called the Multiple Test, is the result of multiplying a block multiple by the social
size of the Swap Instrument. The block multiple is proposed to be five and the social size
is the largest of the Swap Instrument's mode, median or mean. The minimum block
trading size is then simply the higher of the results produced by the Distribution Test and
the Multiple Test.

Analysis of the CFTC proposed rules

As proposed, we see three significant areas where improvements might be made to the
current CFTC proposal

 Narrower definition of swap instruments with appropriately tailored rules –

We believe the definition of Swap Instrument contained in the proposed rules is
excessively broad. For example, it classifies a two-year plain vanilla interest rate
swap and a three-year Bermuda options contract as the same Swap Instrument. The
liquidity of each of these products is vastly different and disclosure of a $250 MM
trade in each product will have a different impact on market liquidity for each one.
For interest rate products, it would be more advisable to retain the critical tenor
division but also allow for additional Swap Instruments in the interest rate product
market. For example, fixed rate interest rate swaps against major floating reference
bases might be grouped into three Swap Instruments (short, medium and long term).
Similarly, swaptions, caps and floors with European or American exercise provisions
could be another group of three Swap Instruments. Another grouping might apply to
liquid basis swaps and all other products might comprise one or more additional
groupings.

 Broader application of rounding convention – A second issue relates to the

rounding convention as its use mitigates the very short delay of 15 minutes. Many
large transactions, whether they are OTC derivatives, equities or corporate bonds,
cannot be offset within a relatively short reporting delay. This has been the
motivation for equity exchanges to permit long, multi-day delays while other markets
such as the corporate bond market have used volume dissemination caps. TRACE
uses such caps of $5 MM and $1 MM for investment grade and non-investment grade
bonds, respectively, in conjunction with a reporting requirement of 15 minutes. As
written, the rounding convention would permit the most liquid interest rate derivatives
products to be executed in very large size (e.g. $1 BN or more) and dealers would be
able to offset risk, confident that the market only knows of a $250 MM+ trade. The
rounding convention will not, however, provide similar protection to other swaps
products that may be less liquid. We believe it would be most useful to adopt
rounding conventions for each of the expanded set of Swap Instruments
recommended above, and that such rounding conventions reflect the liquidity
characteristics of the specific Swap Instruments.

24
 Broader test of block trading to account for average daily volume – The two-part
test used to define “block trades” may fail to capture the full breadth of block trading
activity. The example provided in the CFTC proposed rules provides an illustration
of a swap instrument with all transactions between $50-60 MM in notional size. 40
However, the “social size” for the instrument is $55 MM, yielding a minimum block
size of $275 MM. This text neglects to specify that the average daily volume was
$1,375 MM, placing the block size threshold at approximately 20% of daily trading
volume for the instrument. As a general matter, we believe block minimums for
single trades should be established at levels well below 20% of average daily volume.
Both the Distribution Test and the Multiple Test should be bounded by a percentage
well below 20% of average daily volume. We also believe that aggregate block
trading activity should not have a pre-determined limit. As noted in Section 2.1, LSE
block trading activity, amounts to 45% of aggregate trading volume without damaging
the transparency of overall prices.

 Initial reporting delay of greater than 15 minutes – The CFTC’s proposed delay
period is inadequate to allow market participants to hedge risks from large trades or
trades in illiquid instruments. The changes described above might eliminate the need
for longer reporting delays but longer reporting delays for blocks should also clearly
be considered.

4.2. SEC Proposal

Dodd-Frank has designated the SEC as the primary market regulator for security-based
swaps. These include swaps tied to equities of single entities as well as single-name CDS
and narrow-based baskets or indices of securities. The SEC published proposed rules on
November 19, 2010. In this section, we will examine the proposed rules with respect to
single-name CDS.

The proposed rules require that all security-based swaps be reported in real time unless a
transaction meets minimum block trading size. The proposed rules specify general
guidelines for setting block trading thresholds but do not set specific levels. The
proposed general guidelines appear to be less certain than the proposed rules for real-time
reporting from the CFTC. However, the SEC states that it will assess the distribution of
single-name CDS trades and determine some size cut-off which will be the block trading
minimum. The example used by the SEC suggests that the minimum block trade size will
be $15 MM to $30 MM. The minimum will not vary by maturity of the instrument or by
the type or liquidity of the reference entity.

Block trades will still require real-time reporting of execution and pricing but the notional
size will be suppressed for a minimum of eight hours and a maximum of 26 hours, based
strictly on the time of day a transaction is executed.

40
CFTC proposal, p. 76162.

25
Analysis of the SEC proposed rules

The SEC is proposing a methodology that differs substantially from the TRACE reporting
system. TRACE requires 15-minute reporting of all trades but has a volume
dissemination cap of $5 MM for investment grade securities and $1 MM for
non-investment grade securities. Trades larger than the caps are merely noted as such.
There is no second wave of transaction reporting that includes actual notional size. By
contrast, the SEC proposes reporting complete notional size transaction data (albeit with
substantial reporting delays).

We believe that this reporting of actual block trading notional amounts will impede the
execution of very large trades. This is problematic because the CDS market is
characterized by a significant number of very large trades relative to the cash corporate
bond market. This is due in part to the fact that corporate bond trades involve securities
of modest size, while the CDS market references an entity's entire stock of debt with the
same seniority. We agree that the CDS block sizes should be larger than TRACE's
volume dissemination caps, but we believe the CDS market is better suited for large
trades and does not have the same protection under the current proposal as does the
market of smaller trades (corporate bonds).

As noted in Section 4.3 below, another approach towards single-name CDS reporting has
been proposed by the Committee of European Securities Regulators (CESR). CESR will
require immediate reporting of transactions under the “social threshold” (€5 MM or
lower). Transactions greater than €5 MM and less than €10 MM will require end of day
trade size and price information. Trades in excess of €10 MM will be disclosed at the end
of the trading day without actual size data. This multi-tiered reporting system is more
appropriate for very large trades than the system proposed by the SEC. The disclosure of
very large trade sizes in relatively illiquid markets may impact liquidity and prices for
extended periods.

As we have noted, one product (corporate bonds) will have a more favorable reporting
environment for block trading than another (single-name CDS) if the SEC's proposal
becomes final. Another jurisdiction (Europe) is considering a second reporting
environment that also provides more protection to block trading than the SEC. We
believe that reporting of actual size trades, albeit with a delay, will reduce the number of
block trades and most likely the aggregate volume of single-name CDS trading. We do
not think a goal of the process of establishing minimum block trade sizes is to reduce the
actual number of block trades. Instead, the goal should be to balance the need for
transparency with its effect on liquidity.

The single-name CDS market is much different than the markets for much more liquid
instruments. Dealers are apt to have single-name CDS positions on their books for days,
if not weeks or months. Market knowledge of the existence of these positions will impact
prices for considerable periods of time. Both the TRACE process and the

26
recommendations of CESR contain volume dissemination caps. We believe these should
also be part of the block trading rules for CDS products.

4.3. European proposals

The rulemaking process regarding trade transparency in Europe started shortly after the
Markets in Financial Instruments Directive (MiFID) introduction in 2007, and the
rulemaking process continues (e.g. MiFID II). The directive brought significant changes
to the European regulatory framework for secondary markets. Already, CESR assessed
the impact of these changes for corporate bonds, structured finance products, and credit
derivatives markets, but since other OTC derivatives markets were not studied originally,
CESR is now considering a post-trade transparency regime for the following financial
instruments: interest rate derivatives, equity derivatives, foreign exchange derivatives and
commodity derivatives.

The general framework used by CESR (for CDS products) has been one of tiered trade
size buckets by asset class, with varying levels of transparency for each. In the lowest
bucket, price and volume reporting is proposed to be in real time, or as close to real time
as possible. In the middle bucket, price and volume reporting is proposed to be at the end
of the trading day. In the highest bucket, price reporting without actual volume (but with
an indicator that the trade is indeed in this highest bucket) is proposed to be at the end of
the trading day.

CESR recommends that the calibration of block thresholds and time delays for the
proposed regime should ideally be based on the liquidity of the instrument in question.
However, due to the nature of these OTC markets, there is currently an absence of trading
data which can reliably be used to calibrate a transparency regime. CESR therefore
recommends that initial calibration be based on the average trading size of each of the
markets in question. Once the regime is implemented this information will quickly
become available for regulators to further study the market and refine the proposed
framework. At the core of CESR’s recommendations is the need to undertake a post-
implementation review for all asset classes, with plans to reach conclusions one year after
introducing the new transparency obligations.

27
5. Conclusion

The foregoing discussion clearly demonstrates that a very high degree of transparency can
be introduced to the OTC derivatives market while preserving its liquidity. Building an
effective trade reporting system for the OTC derivatives market, however, is a significant
challenge, partly because there is no established framework for real-time public reporting
in OTC derivatives today. Models that function well in securities or futures markets are
poorly suited to OTC derivatives, which are characterized by a diversity of instruments,
low trade frequency but large transaction sizes for many instruments, and a relatively
small number of large, sophisticated participants. Regulators will need to walk a fine line
to effectively balance market transparency with liquidity.

The proposed rules of the CFTC and SEC recognize this goal, but are more appropriate
for transactions in cash securities or futures than for transactions in OTC derivatives. If
established, they could pose a significant risk of impairing market liquidity or
dramatically increasing execution costs.

Drawing on the lessons from three trade reporting regimes and market data on interest
rate and credit derivatives, we propose several considerations that an effective trade
reporting regime for OTC derivatives should reflect

 Block trade thresholds should be set so that liquidity is not impaired, in order to
preserve the ability of investors and companies to hedge their risks in a
cost-effective way

 Rules should be tailored to products and markets. Rules for less liquid products
should be different from rules for more liquid products. One size does not fit all

 New rules for trade reporting should be phased in and refined over time. Rules
should be re-calibrated and methodologies re-assessed in light of experience and
market changes

 Block trades may constitute a significant amount of trading volume for

certain products

 For highly customized products, price transparency may be uninformative

and misleading

 Volume dissemination caps such as those found in TRACE are important means of
mitigating the effects on liquidity of real time reporting for all OTC derivatives
products

The proposed rules by the CFTC and SEC should be modified with these considerations
in mind. Most importantly, rules should calibrate block trade thresholds to reflect trade

28
volume and liquidity for specific instruments and limit disclosure for certain large
block trades.

29
Appendix 1

Table 6: LSE experience with post-trade transparency regimes 41

Time Period Rule Reason for change
42
Oct ’86 – Feb ’89 All trades in actively traded stocks in 5 LSE considers transparency as an
43
minutes important feature of the new
trading system
Feb ’89 – Jan ’90 Prices in trades >£100,000 in actively To help increase low volumes and
traded stocks in 24 hours. Other trades mitigate losses made by market
as before makers
Jan ’90 – Jan ’91 Trades >£100,000 in actively traded To increase transparency
stocks same as before. Other trades in
actively traded stocks in 3 minutes
44
Jan 91 – Dec 93 Trades >3x NMS in 90 minutes. Other OFT report (1990) stated that
trades in 3 minutes current regime was uncompetitive
Dec 93 – Jan 96 Trades >75x NMS within 5 days or until These trades were viewed as
90 per cent unwound, whichever is the particularly informative and
earliest. 3x NMS - 75x NMS in 60 immediate publication would harm
minutes. Other trades in 3 minutes liquidity
Jan 96 – Dec 99 Trades >6x NMS within 60 minutes. OFT Report (1994) reiterated the
Trades >75x NMS as before. Inter-dealer conclusions of the 1990 report
trades excluded from publication delay. based on the empirical evidence
Other trades in 3 minutes of Gemmill (1996). Also, a SIB
report (1995) recognised the
possibility of a trade-off between
transparency and liquidity
… … …
45
Present day 4 average daily trading (ADT) bands To distinguish between different
created for each currency, with greater levels of trading across products
delays (60 minutes up to 3 trading days
after trade) allowed for transactions of
increasing size within each band

41
Ganley, J., Holland, A., Saporta, V., Vila, A., 1998. Transparency and the design of securities markets. Financial
Stability Review 4, 8-17.
42
The most actively traded securities in the Stock Exchange Automated Quotations System (SEAQ). About 100
securities came into this category when it was in official use by the London Stock Exchange. These were shares of
companies with high turnover and high market capitalization.
43
Publication refers to date, time and the name of the stock, whether the trade was a buy or a sell, its price and volume.
Until 1991, publication delays referred to price only. Subsequently, publication delays referred to both price and
volume.
44
NMS (Normal Market Size) is given by (2.5%/250x(customer turnover in the past 12 months)/(closing mid-price on
last day of quarter)).
45
www.londonstockexchange.com TradElect parameters.

30
Appendix 2

Figure 4: Trade size distribution for Dec 10 natural gas futures product for
November 21, 2010 46

20000

98% of trades
15000 are for less
than 10
Number of trades

contracts

10000
Only ~10
block trades
(100
5000 contracts)
occur per day

0
0 25 50 75 100+
Contracts per trade

Figure 5: Trade size distribution for Dec 10 5-year US Treasury Note futures
product for November 21, 201046

7500

95% of trades
are for less
than $5 MM
5000
Number of trades

notional
Only ~1 block
trade ($500
MM notional
2500 size) per day

0
0 10 20 30 40 50 60 70 80 90 100 500+
Notional trade size ($MM)

46
Trading data for November 21, 2010, CME Group.

31
Appendix 3

Figure 6: Trade frequency distribution of the 930 most actively traded single-name
corporate reference entities (all coupons and maturities) 47
50%

40%
% of corporate entities

30%

20%

10%

0%
0-2 3-5 6-8 9-11 12-14 15-17 18-20 20+
# of trades per day
Corporate CDS

Figure 7: Trade frequency distribution of the 65 most actively traded single-name

sovereign reference entities (all coupons and maturities)47
40%
% of sovereign entities

30%

20%

10%

0%
0-2 3-5 6-8 9-11 12-14 15-17 18-20 20+
# of trades per day
Sovereign CDS

47
DTCC OTC CDS trade repository; 3 month data set of CDS trades from March to June, 2010.

32
Figure 8: Trade size distribution of 5Y USD based single-name corporate CDS
reference entities 48
30%

20%
% of trades

10%

0%
0-2 2-4 4-6 6-8 8-10 10-12 12-14 14-16 16-18 18-20 20-22 22-24 24-26 26-28 28-30 30+
Trade size ($ MM)
% of 5Y Corporate CDS

Figure 9: Trade size distribution of 5Y USD based single-name sovereign CDS

reference entities48
30%

20%
% of trades

10%

0%
0-2 2-4 4-6 6-8 8-10 10-12 12-14 14-16 16-18 18-20 20-22 22-24 24-26 26-28 28-30 30+
Trade size ($ MM)
% of 5Y Sovereign CDS

48
DTCC OTC CDS trade repository; 3 month data set of CDS trades from March to June, 2010.

33
Figure 10: Trade frequency distribution for index based CDS contracts 49
50
•22 entities trade 10+
Number of index reference entities in
times/day

•10 trade 50+ times/day

bucket

•5 trade 100+ times/day

25

0
0 1 2 3 4 5 6 7 8 9 10+
Average num ber of daily trades

Figure 11: Trade size distribution of investment grade USD based index CDS
reference entities49
20%
% of investment grade USD
index CDS trades

10%

0%
0-10 50-60 100-110 150-160 200-210 250+
Trade size bucket ($MM notional)

49
DTCC OTC CDS trade repository; 3 month data set of CDS trades from March to June, 2010.

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Figure 12: Trade size distribution of high yield USD based index CDS
reference entities50

% of high-yield USD index CDS 40%

30%
trades

20%

10%

0%
0-10 50-60 100-110 150-160 200-210 250+
Trade size bucket ($MM notional)

50
DTCC OTC CDS trade repository; 3 month data set of CDS trades from March to June, 2010.

35