July 18, 2016
Mr. Christopher J. Kirkpatrick
Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street NW
Washington, DC 20581

Re:

Clearing Requirement Determination for Certain Interest Rate Swaps(RIN 3038–AE20)

Dear Mr. Kirkpatrick:
Citadel LLC 1 (“Citadel”) appreciates the opportunity to provide comments to the Commodity
Futures Trading Commission (the “Commission”) on its proposal to establish a clearing
requirement for certain additional interest rate swaps (the “Additional IRS Instruments”). 2
As a significant participant in the OTC derivatives markets, we applaud the Commission forrecognizing the important role of central clearing in achieving the Dodd-Frank Act objectives of
reducing interconnectedness, mitigating systemic risk, increasing transparency, and promoting
competition in these markets. We fully support the Commission’s proposal to establish a clearing
requirement for the Additional IRS Instruments.
Central clearing is a fundamental cornerstone to open, efficient and transparent markets. In acentrally cleared market, participants all face the clearinghouse and bilateral counterparty credit
exposure to other participants is eliminated, thereby reducing interconnectedness and systemicrisk. In addition, market participants benefit from the safeguards in the risk management anddefault management frameworks of the clearinghouse, including with respect to margin collection,robust end-of-day pricing, and guaranty fund contributions.
The elimination of bilateral counterparty credit exposure through central clearing alsotransforms how OTC derivatives can be traded, increasing competition and providing new sourcesof liquidity for market participants. Since market participants no longer face each other when
executing a cleared OTC derivative, complex bilateral trading documentation can be eliminatedand a wider range of execution counterparties can be accessed. This leveling of the playing fieldwith respect to execution spurs price competition and yields a number of benefits to market
1
Citadel is a global financial firm built around world-class talent, sound risk management, and innovative marketleading technology. For more than a quarter of a century, Citadel’s hedge funds and capital markets platforms havedelivered meaningful and measurable results to top-tier investors and clients around the world. Citadel operates inall major asset classes and financial markets, with offices in the world’s leading financial centers, including
Chicago, New York, San Francisco, Boston, London, Hong Kong, and Shanghai.
2

81 Fed. Reg. 39506 (June 16, 2016) (“Proposed Clearing Determination”).

1participants, including narrower bid-ask spreads, improved access to best execution, and increased
market depth and liquidity. In addition, the elimination of bilateral counterparty credit exposureand complex bilateral trading documentation can spur further market structure innovations, suchas trading solutions that allow investors to transact directly with other investors without the use ofintermediaries.
The U.S. has been a global leader in implementing clearing for OTC derivatives markets. As
recently highlighted by Chairman Massad, more than 75% of index credit default swap and interest
rate swap transactions (measured by notional value) are now being cleared in the U.S., compared
to only about 15% in 2007. 3 Importantly, this transition to clearing has been successfully
implemented across the market, including trading activity by both dealers and end investors. Eachof the largest derivatives clearing organizations (“DCOs”) registered with the Commission has
now successfully cleared trillions of dollars of outstanding OTC derivatives transactions for end
investors following the Commission’s first mandatory clearing determination in 2013. 4
As other jurisdictions continue to implement the G20 reforms for the OTC derivatives markets
and require mandatory clearing of additional instruments, we support Commission efforts to
update the scope of U.S. rules in order to harmonize the set of products subject to mandatory
clearing globally. This will ensure a level playing field and deter regulatory arbitrage, while
enhancing liquidity in cleared instruments to the benefit of end investors.
I. The Additional IRS Instruments Are Suitable for Mandatory Clearing
Under the Commodity Exchange Act, the Commission must take into account five factors
when making a clearing requirement determination. 5 We agree with the Commission that market
data and the existing DCO clearing offerings support a finding that each of these factors is met
with respect to the Additional IRS Instruments. We briefly comment on each of the five factors
below.
A. Outstanding notional exposures, trading liquidity, and pricing data
As stated by the Commission in the Proposed Clearing Determination, the OTC derivatives
market is a global market. 6 Therefore, we applaud the Commission for taking into accountmultiple sources of available data when assessing the liquidity characteristics of the Additional
IRS Instruments, including data from swap data repositories, DCOs, the Bank for International

3

See Remarks of Chairman Timothy Massad before the CCP12 Founding Conference and CCP Forum, Shanghai,
China, June 7, 2016, available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-46. See also
http://www.swapsinfo.org/.
4

See LCH Daily Volumes – SwapClear Global, available at: http://www.lch.com/en/asset-classes/otc-interest-ratederivatives/volumes/daily-volumes-swapclear-global; CME Open Volume Tracker, available at:
http://www.cmegroup.com/education/cme-volume-oi-records.html; ICE Clear Credit, available at:https://www.theice.com/clear-credit
5

Section 2(h)(2)(D)(ii) of the Commodity Exchange Act.

6

See Proposed Clearing Determination at 39513.

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Settlements, and industry organizations. 7 Together, these data sources provide a more holistic
view of the market for any particular OTC derivative and are indicative of the various sources ofpricing data that DCOs have access to for purposes of their risk management and default
management frameworks.
In assessing the available data, we agree with the Commission that there are significant
outstanding notional exposures and robust trading liquidity in the Additional IRS Instruments. As
a result, DCOs have access to adequate pricing data in order to appropriately risk manage these
instruments. These conclusions are further supported by the fact that DCOs already have approved
clearing offerings for each of the Additional IRS Instruments and market participants havevoluntarily decided to clear significant volumes in these instruments prior to the introduction of aclearing mandate. 8
B. Availability of a rule framework, capacity, operational expertise and resources, and credit
support infrastructure
As noted above, all of the Additional IRS Instruments are currently being cleared by DCOs inmaterial volumes, demonstrating the infrastructure and operational expertise that already exists to
support a clearing mandate. Furthermore, no material changes are required to the current DCO
rule frameworks and credit support infrastructures in order to implement a clearing mandate for
the Additional IRS Instruments. The existence of significant voluntary clearing demonstrates theconfidence that market participants have in these aspects of the current DCO clearing offerings.
C. Effect on the mitigation of systemic risk
We strongly agree with the Commission that central clearing provides greater systemic risk
mitigation than bilateral margining for uncleared swaps. 9 While bilateral margining may help
reduce the market impact of a counterparty default, central clearing eliminates the complex webof interconnected bilateral counterparty credit exposures. These interconnected bilateral exposures
are replaced not only with a margin framework applied by the DCO, but also centralized risk
management and default management frameworks that are specifically designed to manage andmitigate the potential systemic impact of unexpected market events, including a counterparty
default.
DCOs operate in accordance with an ongoing set of regulatory requirements andresponsibilities, including with respect to financial resources, stress testing, and model backtesting, that serve to distinguish the risk management of cleared positions from uncleared positions.
In addition, DCOs facilitate multilateral netting and compression, increase efficiency with respect
to collateral management and trade reconciliation, and provide market participants with increasedtransparency around end-of-day pricing. Finally, more market participants are able to becomeliquidity providers in cleared instruments as a result of the elimination of bilateral counterparty
credit exposure and complex bilateral trading documentation, increasing market diversification
7

Id.

8

Id. at 39530.

9

Id. at 39523.

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and the resiliency of liquidity during times of market stress. All of these benefits of central clearing
ultimately serve to mitigate systemic risk by enhancing the risk management of OTC derivatives
and reducing the prospect of firms becoming too interconnected-to-fail due to bilateral uncleared
positions.
D. Effect on competition
As discussed above, the elimination of bilateral counterparty credit exposure and complex
bilateral trading documentation as a result of central clearing enables market participants to accessa wider range of execution counterparties and encourages the entry of new liquidity providers.
This spurs increased price competition, lowering execution costs for investors and enhancing
overall market liquidity.
We have already witnessed these benefits start to accrue to investors in those OTC derivatives
that are subject to mandatory clearing. New liquidity providers have entered both the index credit
default swap and interest rate swap markets directly as a result of the Commission’s existing
clearing mandates, bringing innovations such as firm pricing and faster response times. 10 In
addition, market research confirms the link between central clearing and improved liquidity. A
recent study of the index credit default swap market found that “the reduced counterparty risk andincreased post-trade transparency associated with central clearing have beneficial effects on
liquidity.” 11 Separately, recent Bank of England research found that the implementation of theCommission’s clearing and trading reforms in the USD interest rate swap market led to asignificant improvement in liquidity and a significant reduction in execution costs, with market
participants saving as much as $20 million - $40 million per day, of which $7 million - $13 million
was being saved by market end-users alone per day. 12
Importantly, the increased competition among execution counterparties resulting from central
clearing is not dependent on there being a certain number of DCO clearing offerings per
instrument. While competition across DCOs can be positive for market participants, and morethan one DCO offers to clear most all of the Additional IRS Instruments, we do not believe there
should be a strict requirement that multiple DCOs clear a given instrument in order to implementa clearing mandate. In many cases, market participants prefer to consolidate their cleared positions
at a single DCO in order to maximize netting, compression, and margin offset opportunities,
thereby reducing overall clearing costs. In addition, in the context of assessing the fees and charges
applied to clearing as required by the Commodity Exchange Act, the Commission should note thatclearing costs for many market participants are primarily driven by the fees charged by their10

See, e.g., New players break into credit derivatives, FT (Nov. 17, 2015), available at:
http://www.ft.com/intl/cms/s/0/22b83fa4-8c6e-11e5-8be4-3506bf20cc2b.html#axzz3rj5MtwiI; and Dealer algos
strike back in swaps market showdown, Risk.net (Feb. 24, 2016), available at: http://www.risk.net/riskmagazine/feature/2446836/dealer-algos-strike-back-in-swaps-market-showdown.
11
See Loon, Y. C., Zhong, Z. K. Does Dodd-Frank affect OTC transaction costs and liquidity? Evidence from realtime CDS trade reports. Journal of Financial Economics, 119 (3), 645–672 (2016) at page 4, available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2443654.
12
See Staff Working Paper No. 580 “Centralized trading, transparency and interest rate swap market liquidity:
evidence from the implementation of the Dodd-Frank Act”, Bank of England (January 2016), available at:
http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp580.pdf.

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clearing FCM (and not the DCO). As FCM clearing fees are based primarily on the portfolio being
cleared rather than the number of different DCO clearing offerings, competition among FCMs ismore relevant to ensuring that the overall fees and charges applied to clearing are set at areasonable level. Finally, it is worth noting that the imposition of a clearing mandate may itself
create the commercial rationale for another DCO or FCM to launch or expand its clearing offering
given the expected increase in overall cleared volumes.
Based on the above and market experience with the prior clearing mandates, we agree with theCommission that the Proposed Clearing Determination will enhance market competition withrespect to the Additional IRS Instruments.
E. Reasonable legal certainty in the event of insolvency
We agree with the Commission that reasonable legal certainty exists in the event of an
insolvency of a DCO or one or more of its clearing members when clearing the Additional IRS
Instruments. The regulatory framework governing the treatment of customer and swap
counterparty positions, funds, and property is set forth in the U.S. Bankruptcy Code, theCommodity Exchange Act and Commission regulations, and this long-standing framework has
only been strengthened following the implementation of the Dodd-Frank Act. Furthermore, as theregulatory framework applies equally to all instruments cleared by a DCO, the Commission should
leverage the analysis included in prior clearing determinations.
II. Implementation Timing
We agree with the Commission that most market participants that would be subject to the
proposed clearing mandate for the Additional IRS Instruments are already clearing USD, EUR,
GBP, or JPY interest rate swaps pursuant to the existing clearing mandates. Therefore, we believe
the Commission’s proposal to require compliance 60 days after publication of the expanded
clearing mandate is realistic, as the mandate should not be expected to require the establishmentof a material number of new clearing arrangements. This conclusion is further supported by thesignificant amount of voluntary clearing that is already occurring in the Additional IRS
Instruments, suggesting that most market participants are already prepared for the clearing
mandate and the necessary infrastructure is in place. 13
Notwithstanding the above, we are also supportive of the second implementation option, to theextent the Commission believes that it is preferable on the basis of international comity. This
option would require compliance with the expanded clearing mandate on a currency-by-currency
basis 60 days after the effective date of a corresponding foreign clearing mandate. In the event theCommission does select this option, it should clarify that the relevant effective date of a foreign
clearing mandate is the first date on which an instrument in such currency is required to be cleared,
as otherwise the presence of a phased-in compliance schedule in the non-U.S. jurisdiction may
create ambiguity. In addition, the Commission should clarify that the reference to an “analogous
clearing requirement” in a non-U.S. jurisdiction refers to the product set and not the scope ofentities covered, as a foreign clearing mandate may not cover the exact same type of entities as the13

See Proposed Clearing Determination at 39530.

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U.S. clearing mandate. The Commission should not attempt to precisely replicate the entity scopeof foreign clearing mandates, as otherwise the U.S. framework will become a confusing patchworkof foreign regulation, compelling U.S. market participants to apply different criteria on a currencyby-currency basis to determine whether (and when) they are in-scope. Finally, it is important toretain an outer bound of two years for when the final Commission rule may become effective inorder to provide certainty to market participants regarding implementation.
In either implementation scenario, we agree with the Commission that there should not be any
additional phase-in by counterparty type. The Commission provided a 270 day phase-in as part ofits first clearing mandate in order to allow market participants time to establish clearing
arrangements and become familiar with DCO clearing offerings and the associated workflows.
With most market participants that would be subject to this proposed clearing mandate alreadyclearing USD, EUR, GBP, or JPY interest rate swaps, and in many cases voluntarily clearing the
Additional IRS Instruments, this type of phase-in is no longer necessary. Non-U.S. jurisdictions
may implement phase-ins by counterparty type for these currencies given that, in many cases, itwill be the first clearing mandate implemented in that jurisdiction. However, the Commission
should avoid unnecessarily complicating and delaying the implementation of any expanded
clearing mandate in the U.S. by seeking to replicate any such phase-in when it is not warranted for
U.S. market participants.
Finally, we urge the Commission to proceed with finalizing the expanded clearing mandate
notwithstanding ongoing discussions regarding potential amendments to the Commission’s trading
rules and made available to trade (“MAT”) process. An assessment of whether an instrument may
potentially become subject to mandatory SEF trading in the future is not part of the criteria for
determining whether OTC derivatives are suitable for mandatory clearing. In addition, even under
the current MAT process, only a subset of instruments subject to mandatory clearing are also
subject to mandatory SEF trading. Market experience has shown that those instruments currently
subject to mandatory SEF trading are actively traded, highly liquid, and suitable for SEF trading.
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We commend the Commission for recognizing the critical role of central clearing in reducing
interconnectedness and mitigating systemic risk. We support the Commission updating U.S.
clearing rules in order to harmonize the set of products subject to mandatory clearing globally,
thereby bringing increased transparency, more competition, and better pricing to a wider range of
OTC derivatives.

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We appreciate the opportunity to provide comments on the Commission’s mandatory clearing
requirements. Please feel free to call the undersigned at (312) 395-3100 with any questions
regarding these comments.
Respectfully,/s/ Adam C. Cooper
Senior Managing Director and Chief Legal Officer7