Trade rejections spark clearing document rethink

Industry group considers changes to the standard cleared derivatives execution agreement, following concerns that dealers have the unilateral right to terminate rejected cleared trades

An industry working group is discussing changes to the standard cleared derivatives execution agreement that will allow the mandatory resubmission of rejected trades. The move is in response to concerns that dealers currently have the right to terminate a trade that is rejected for clearing, potentially saddling the buy-side counterparty with breakage costs.

The issue has become particularly pressing following the introduction of a Commodity Futures Trading Commission (CFTC) rule on March 11 that requires futures commission merchants (FCMs) to accept or reject trades for clearing within 60 seconds of receiving them. A trade can be rejected if a firm has breached the clearing limits set by its FCM, or due to an operational or technical problem. As it stands, however, the executing dealer can unilaterally choose to terminate the rejected transaction – a situation that worries buy-side firms.

"You don't want to have a contractual agreement that gives dealers the right to break the trade. It wasn't such a big deal before the 60-second rule came about, because if your trade was rejected then it was probably for a real reason. With the 60-second rule, sometimes your trade is rejected because of a technical glitch or another reason where it should just get resubmitted," says Supurna VedBrat, co-head of electronic trading and market structure at BlackRock.

Dealers say they anticipate an increase in the number of fails as more entities are required to clear. Swap dealers, major swap participants and so-called active funds have been obliged to clear certain interest rate and credit derivatives since March 11, while category two clients – commodity pools, private funds and banks – followed suit on June 10. For the most part, dealers say rejections have been the result of operational teething problems and have been quickly resubmitted – but buy-side firms are reluctant to leave it to chance.

Amendments to the Futures Industry Association and International Swaps and Derivatives Association cleared derivatives execution agreement were proposed by a group of buy-side firms on February 8. Dealers responded with their comments on May 10, and a new draft document was circulated on June 12. An industry working group will now hammer out the details.

The new proposal introduces a resubmission trigger, which allows either party to notify the other that it intends to resubmit the trade – the notification must be made within a certain time frame, proposed at 30 minutes. That differs from the current document – called version 1.1 – which gives the dealer the sole right to terminate any transaction that hasn't been accepted by an FCM 90 minutes after the details of the trade have been confirmed. In practice, many rejected trades have been resubmitted during that 90-minute window, but the new proposal gives buy-side firms the right to insist on that option.

The fact resubmission is already occurring in practice means the change is relatively uncontroversial, says one lawyer who is representing buy-side firms.

"There isn't much objection from the dealers now - this isn't contentious. Everyone agrees a mandatory resubmission is the right approach, especially because that is what we have seen develop in practice as people have begun to clear," he says.

Nonetheless, some participants are concerned about certain elements of the proposal – for instance, the 30-minute resubmission window.

"What if you go to grab lunch after the trade is executed, or you went to get a coffee? Now 15 minutes of your 30 are suddenly gone. If it is one trade, then fine – you can monitor that. But a lot of these processes will be manual to begin with and monitoring thousands of trades is challenging. You may not even know when exactly that resubmission period started, so it becomes hard to contractually commit to that. What if there is chaos in the market? Are you really going to be concentrating on a 30-minute resubmission period? I think it's perhaps trickier than it seems at first," says a lawyer representing the sell side.

Some participants also express irritation at the time it has taken to get to this point. Some buy-side firms were hoping to have the amendments in place for the category two clearing deadline, and accuse dealers of dragging their heels.

"Because the sell side has been so slow, we had to go ahead with version 1.1 and make the changes to get the resubmission period and put those agreements in place, with the expectation that when we come up with a better agreement we will terminate these and go to the new one," says another buy-side lawyer. "But it is a huge waste of time and legal resources, and it would have been better to get together in a concentrated period and agree a version that was more acceptable."