5 MA SWAPS & DERIVATIVES MARKET ASSOCIATION 

April 19, 2011 

David A. Stawick, Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21 st Street, NW 

Washington DC 20581 

Elizabeth Murphy, Secretary 

Securities and Exchange Commission 

100 F Street, NE 

Washington, DC 20549 

Re:	 OTC Derivative Market Integrity & Real-timeTrade Processing 

Requirements for Processing, Clearing, and Transfer of 

Customer Positions 17 CFR Parts 23,37,38 and 39, RIN 3038-AC98 

Dear Mr. Stawick and Ms. Murphy: 

The Swaps & Derivatives Market Association ("SDMA") appreciates the opportunity to provide 

comments to the Commodity Futures Trading Commission (the "CFTC") and the Securities and 

Exchange Commission ("SEC") (CFTC and SEC collectively the "Commissions") on the CFTC's 

Notice of Proposed Rulemaking regarding Parts 23, 37, 38 and 39 of Title 17 of the Code of 

Federal Regulation entitled "Requirements for Processing, Clearing, and Transfer of Customer 

Positions". 

The SDMA is a non-profit financial markets trade group of US and internationally based brokerdealers, investment banks, futures commission merchants and asset managers participating in 

all segments of the exchange-traded and over-the-counter derivatives and securities markets. 
D. Stawick 

E. Murphy 

April 19, 2011 

Page 2 

The immediate real-time clearing of swaps1 is critical to accomplishing the goals of the Title VII 

of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank Act") to: (1) 

reduce systemic risk, (2) increase trade integrity and (3) promote market stability. 

The SDMA supports the amendments to proposed rules 23.506 "Swap Processing and 

Clearing"; 37.702 "General Financial Integrity", 38.61 "Mandatory Clearing" and 39.12 

"Participant and Product Eligibility". Specifically, we support them because these amendments 

certify a regulatory framework that provides for real-time clearing of swaps traded on swap 

execution facilities ("SEFs") or designated contract markets ("DCMs") that are listed for clearing 

by central counterparty clearing houses ("CCPs"/' 

The SDMA believes that in order to have successful clearing and SEF-based execution of OTC 

derivatives, it is critical that there be certainty of execution and trade settlement. Such certainty 

is clearly a function of pre-trade and post-trade trade integrity. For the reasons stated below, 

the SDMA recommends that the Commissions mandate the use of existing and commonly 

available financial technology and symmetrical workflow that brings: (1) post-trade trade 

integrity through immediate real-time clearing, and (2) the pre-trade trade integrity through 

immediate and real-time pre-trade margin checks. Both are necessary complimentary 

components to ensure that market integrity in the cleared swaps market created by the Dodd 

Frank Act is achieved. 

I. Post-Trade Trade Integrity 

The buyer and seller must know immediately whether their trade has been accepted for 

clearing. Trade uncertainty, caused by the time delay between the time of trade execution and 

1 Throughout this letter all references to "swaps" refers to swaps and security-based swaps that are required to be 

cleared by Sections 723 and 763, respectively, of the Dodd Frank Act. 

2 The CFTC refers to the clearing house as derivatives clearing organization or "DCO", and their clearing members as 

Futures Commission Merchants or "FCMs". The SEC refers to the clearing house as a Security-Based Swap 

Clearing Agency and their clearing members as Clearing Agency Participants. For the purposes of this letter we will 

refer to the clearing house as the central counterparty clearing house or "CCP" and their members/participants as 

clearing firms. 
D. Stawick 

E. Murphy 

April 19, 2011 

Page 3 

the time of trade acceptance into c1earing3

, destroys market integrity in the post-trade work 

process. It also directly impedes liquidity, efficiency, and more stable markets. The SDMA 

recommends two solutions to promote post-trade trade integrity and prevent such trade 

uncertainty. 

Certain Cleared Listed Markets: FCMs Guarantee Customer Trades 

First, the SDMA believes that for cleared OTC derivatives markets, the Commissions should 

follow the construct of certain futures markets where "perfect settlement" of a trade is assumed 

unless the trade is rejected. In these futures markets, clearing member firms, or Futures 

Commission Merchants ("FCMs"), guarantee their customer trades. That is to say, the trade is 

executed and is automatically confirmed unless the clearing member has given prior notice to 

reject such a trade. Trade integrity is assured and settlement risk minimized because the trade 

counterparty can look to the customer's FCM to be made whole if that customer cannot pay. 

Such an optimal approach works well in the futures markets because the onus falls on the entity 

best positioned to monitor a market participant's ability to pay for its trade - the participants' 

FCM. The FCM strictly and proactively monitors its customer's margin and trading parameters 

to protect itself and, by extension, trade counterparties from a rejected trade where economic 

loss could be experienced. Similarly, if the FCM seeks to limit the trading of its customer, the 

FCM is required to inform the execution broker or trade venue of such a restriction in advance. 

Because it holds the customer's margin account, the FCM is best positioned to inform trade 

venues to limit a customer's trading. FCMs are also optimally positioned to require additional 

funds or liquidate a position in order to cover any breakage amounts or cover any expenses it 

may have incurred from a customer's rejected trade. 

Because this approach has worked well for many years, it provides a good example for similarly 

structuring the cleared swaps market created by the Dodd Frank Act. 

3 Currently in the OTC market the time delay between trade execution and clearing can be anywhere from several 

hours and a week. 
O. Stawick 

E. Murphy 

April 19, 2011 

Page 4 

Cleared OTC Derivative Market: The "Last Look" Option and its Remedy 

Currently in the fledgling cleared OTC swaps market, clearing members do not guarantee 

trades and thus such workflow requires that a trade be "accepted" post execution before it is 

confirmed for clearing. It is foreseeable that, although clearing firms expect to routinely accept 

customer trades, such an option to reject a customer trade post execution represents a "last 

look" option that may lessen trade integrity if not addressed. 

The SOMA recommends that if the "last look" option is to become the market standard in the 

cleared OTC swaps market, then the only remedy for a rejected trade is that the trade be 

broken - that is, there is no trade. 

Breaking a rejected trade in the OTC swaps market should not be viewed as negative. Rather, 

it is the optimal solution preferred by many buyside and dealer participants, if "no trade" is 

coupled with "real time" or immediate notification to the trade counterparties. If the parties are 

notified in real time, economic loss is minimized as it is assumed that the market may have 

moved little and thus "breakage" or the cost of executing a new trade to replace the rejected 

trade is minimized. "Good" trade counterparties can re-enter the market immediately to execute 

new trades with solvent counterparties that are accepted into clearing. In contrast, "bad" trade 

counterparties are restricted by both the SEF and their clearing firm from executing further 

trades. 

To ensure post-trade trade integrity, the SOMA strongly urges that the Commissions require that 

SEFs, CCPs and clearing members utilize current and available technology and symmetrical 

workflow to ensure real-time trade confirmation. Regulators should require that (1) all SEFs 

deliver both sides of the trade simultaneously to the CCP in real time; (2) CCPs respond with 

the trade acceptance or rejection in real-time back to the SEF, such that the SEF can in turn 

immediately notify the trade counterparties; and (3) CCPs work with their member clearing firms 

to ensure that it provide and maintain the internal workflow and technological infrastructure 

necessary to make certain that the CCP can respond to the SEF in real time. 
D. Stawick 

E. Murphy 

April 19, 2011 

Page 5 

Importantly, swap CCPs should be cognizant that their swap workflows might actually impede 

real-time confirmation. Certain CCPs do not offer a direct application program interface ("API") 

connectivity through which a SEF can directly connect to confirm trades. Instead, these swap 

CCPs offer connectivity and trade confirmation only via third party middleware systems. By 

adding extra steps, these CCPs may be increasing communication latency which could add 

trade uncertainty if not addressed. 

The SOMA's solution that views rejected trades in real-time as "no trades" recognizes a 

practical construct that has existed in the cleared derivatives market since its inception. It 

recognizes that clearing houses (and their clearing members) should work in concert with 

execution venues to optimize trade and settlement integrity. SEFs and CCPs should seek to 

bring execution closer to clearing by lessening trade confirmation latency to the point of realtime settlement in the workflow. It is important to note, that certain applicant SEFs and forward 

thinking OTC swap clearing houses either offer now or expect to offer such real time, low 

latency connectivity as the Dodd Frank Act becomes effective in the coming months. 

II. Pre-Trade Trade Integrity 

During the course of trading, buyers and sellers may knowingly or unknowingly exceed their 

margin parameters (set by their clearing broker) which may result in a trade being rejected for 

clearing. The uncertainty that a buyer or seller may have exceeded its margin parameters, and 

potentially cause a trade to be rejected for clearing, has an adverse impact on pre-trade trade 

integrity and increases settlement risk. 

To further mitigate such risk, the SOMA recommends that the Commissions compel market 

participants to take a definitive, proactive approach to enhancing trade integrity on a pre-trade 

basis. The Commissions should require that pre-trade customer margin checks occur at the 

SEF to protect the market from a customer who either knowingly or unknowingly violates margin 

parameters by initiating a trade that will be rejected. 

Specifically, regulators should require clearing firms to share customer margin information via 

CCP connectivity with SEFs on an immediate or real-time basis. To avoid building additional 
D. Stawick 

E. Murphy 

April 19, 2011 

Page 6 

connectivity directly between multiple SEFs and multiple clearing brokers, it is optimal that the 

CCP be the central nexus where such information is exchanged. SEFs, which operate in a 

neutral capacity for the customer, can transmit such information back to the customer so that it 

does not knowingly breach its own trading parameters within a given clearing house. 

Importantly, through such workflow customer anonymity is preserved as customers see only 

their own margin information. 

To further promote pre-trade trade integrity, regulators should require SEFs to monitor such 

customer margin parameters to prevent a customer from either knowingly or unknowingly 

trading beyond its limit by restricting the customer's execution ability before an offending trade 

occurs. 

By linking execution venues with customer spending power on a real-time pre-trade basis, 

customers are precluded from executing trades that would ultimately be rejected. SEFs and 

clearing firms can communicate real-time on their customers via CCPs such that the customer's 

trading experience dramatically improves. As trade rejection frequency diminishes, so too does 

settlement risk. Importantly, trade certainty and marketplace integrity increase, though not at 

the expense of customer anonymity. 

To act as a deterrent, SEFs and CCPs should be allowed to impose sanctions and fines on 

customers who knowingly breach their limits. At a higher level, regulators should also look to 

impose fines or take more punitive action on such customers for such careless activity. 

It is important to note, that the technology needed to support pre-trade margin checks exists 

today and is being deployed by certain CCPs and SEF execution venues. 

III. Alternative Documentation and Workflow Proposals 

Some have suggested that trade integrity and settlement risk can be mitigated through 

documentation or asymmetric workflow. Specifically, certain parties have suggested that if a 

trade is rejected from clearing, the trade is still "good" because it can become a non-cleared, 
D. Stawick 

E. Murphy 

April 19, 2011 

Page 7 

bilateral trade governed by a traditional ISDA Master Agreement ("ISDA Agreement") signed by 

the buyer and the seller. 

The SOMA adamantly believes that this solution is unworkable. If a trade is rejected for 

clearing, "falling back" to an ISDA Agreement is not viable for several reasons. First, a bilateral 

trade has higher capital costs than a cleared trade. Second, a bilateral trade introduces 

counterparty credit risk that was not present for the original cleared trade. Increasing capital 

costs and exposing the parties to direct credit risk were not bargained for by the parties when 

they originally initiated, what they thought was to be, a cleared trade. These are material 

changes to the terms of the trade that warrant a new price or "market" to which the parties must 

now agree. By changing the trade terms, price included, it is in fact a new trade and the original 

rejected trade should be broken. 

Moreover, suggesting that a cleared trade may exist in an uncleared, bilateral state contravenes 

the express language of the Dodd Frank Act. Sections 723 and 763 of the Dodd Frank Act are 

clear. These sections provide that it is unlawful for any person to engage in a swap or securitybased swap unless that person submits such swap or security based swap for clearing to a 

CCP, if the swap is required to be cleared. 

Interestingly enough, requiring the use of an ISDA Agreement to save a trade that has not been 

accepted for clearing does not escape the obvious fact that the bad counterparty still cannot pay 

for the trade. In practice, trades are rejected not because the offending counterparty cannot pay 

for the trade same day. It is because the counterparty's clearing broker reasonably expects that 

the offending counterparty will not be able to pay for the trade next day or any day thereafter. 

To somehow force a counterparty into a bilateral trade with a non credit worthy counterparty 

seems an unfair cure that benefits the offending counterparty at the direct expense of the 

compliant counterparty. Importantly, having an ISDA Agreement in place with an insolvent 

counterparty does not improve a counterparty's chance of getting paid on the trade. 

Lastly, "falling back" to an ISDA Agreement would restrict trading and adversely affect liquidity, 

as it limits buyers and sellers to trading only with counterparties with whom they have ISDA 
D. Stawick 

E. Murphy 

April 19, 2011 

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Agreements in place. Therefore, this restricts trading by (1) eliminating the viability of the "all to 

all" platforms - since you must have an underlying ISDA Agreement to trade with a counterparty 

to ensure the "fall back" procedure holds; and (2) eliminating the anonymity that the buy-side 

desires in the post Dodd Frank market place. 

For these reasons, the SDMA believes that having an ISDA "fall back" provision does little to 

lessen settlement risk and may actually increase it. 

Still other market groups have suggested other documentation for the market to adopt that 

memorializes an asymmetric workflow that not only increases trade latency but limits customer 

choice and access to liquidity. These parties have suggested that a trade may only be 

submitted to clearing by a self-clearing dealer. That is, the dealer submits the trade to clearing 

on it's and the customer's behalf. In other words, SEFs are forbidden from neutrally submitting 

"buyside" and "sellside" trade legs simultaneously, quickly and directly to the clearing house.. 

Such a requirement that SEFs must submit trades via certain dealers is problematic for several 

reasons. First, it forces an asymmetric workflow that adds more latency to the post-trade 

process, thus reducing trade integrity. Second, it forbids non self-clearing dealers from 

submitting trades unless they are a "customer" to the dealing desk of a clearing member, thus 

effectively denying them access to the marketplace. Third, it is a clear restraint on free trade 

because it prohibits customers from trading with each other in a cleared "all to all" marketplace 

clearly envisaged by the Dodd Frank Act. Fourth, it violates customer anonymity as customers 

are now always known to their dealer counterparties. Fifth, it limits customer choice to all but a 

few dealers and FCM entities and thus dangerously restricts market liquidity. 

As an additional feature to this workflow, these industry parties have suggested an option that 

clearing firms provide customer margin information directly to a dealer so that it may check the 

customer on a pre-trade basis. While such a solution sounds similar to the SDMA pre-trade 

margin check proposal (discussed above), it is fundamentally different. The SDMA 

recommends that the clearing firm share such information with an independent and neutral 
D. Stawick 

E. Murphy 

April 19, 2011 

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party, acting as agent for both buyer and seller - the SEF, not with an interested party to the 

transaction --the dealer, acting as principal. 

Sharing such information with a principal to the transaction no doubt creates a conflict of interest 

and is unworkable. It is also contrary to information partition provisions of Sections 731 and 764 

of the Dodd Frank Act that preclude FCMs from sharing customer information with their dealer 

desk counterparts. Moreover operationally, implementing such a decentralized system might 

prove to be difficult as some have already noted. Separate connectivity would be needed to link 

each one of several clearing firms to each one of several dealers in a new communications 

network. As the number of dealers, customers and clearing brokers grew, the system's 

complexity would increase exponentially. Such a system might prove so costly for the end user 

that, in practical terms, they would be forced to operationally connect to all but a handful of 

dealers, thus limiting their choice and their access to liquidity. 

Regulators should be wary of such documentation and workflows that on their face claim to 

enhance trade certainty and market integrity, but are transparent attempts to restrict trade, 

customer choice and liquidity. Such proposals only serve to undermine the core principles of 

the Dodd Frank Act. 

IV. Conclusion 

The SDMA believes post-trade trade integrity and pre-trade trade integrity are both necessary 

components to promote market integrity and lessen settlement risk in the cleared swaps market 

created by Dodd Frank Act. For central clearing to be successful, the Commissions must 

intervene to require that the market adopt precedents set in other markets and use widely 

available technology and workflow necessary to create (a) post-trade trade integrity through 

immediate real-time clearing, and (b) the pre-trade trade integrity through real-time pre-trade 

margin checks. 

The SDMA recommends that the Commissions be vigilant that any proposed workflow not be 

restrictive or represent an anticompetitive restraint on customer choice of counterparty or 
D. Stawick 

E. Murphy 

April 19, 2011 

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execution method. or should it be a restraint on a buyer's or seller's choice of clearing firm. 

The workflow must provide for a symmetrical post-trade trade submission to clearing by which 

SEFs simultaneously leliv r both customer trade legs real-time to the CCP. CCPs should in 

turn accept or reject trades for clearing in real-time. Any proposed wor! flow must increase. not 

decrease. the speed at which a trade is confirmed for clearing by the CCP. Moreover. any 

proposed workflow should not be an attempt to circumvent the core principles of the Dodd Frank 

Act. As a market, all participants under the guidance of the Commissions should be able to 

work in concert to bring about a solution that is consistent with the Dodd Frank Act and ensures 

the aTC clearing of swaps is a success. 

Submitted Respectfully, 

James Cawley 

The Swaps & Derivatives Market Association 

(646) 588-2003