|April 16, 2014|
Previously published on April 11, 2014
On May 1, 2014, no-action relief from compliance with U.S. Commodity Futures Trading Commission (“CFTC”) Regulation 1.35 will come to an end. With the expiration of this no-action period, certain market participants will be subject to substantial recordkeeping requirements, including records for oral communications. With the impending end of the relief period, some swap execution facilities (“SEFs”) have begun reminding members of their recordkeeping obligations under Regulation 1.35 and SEF members may receive additional information from their SEFs on the rule. The specter of compliance has also led to questions about the scope of the regulation and the extent of the required recordkeeping, as some market participants have argued that there should be expanded exemptions for certain types of funds or managers.
In December 2012, the CFTC issued the final form of Regulation 1.35 under the mandate of the Commodity Exchange Act. The regulation set forth recordkeeping obligations for commodity interest and related cash or forward transactions. It requires futures commission merchants (“FCMs”), larger introducing brokers (“IBs”), retail foreign exchange dealers (“RFEDs”) and commodity trading advisors (“CTAs”) that are members of a designated contract market (“DCM”) or SEF to maintain records of all relevant information concerning all transactions related to the business of dealing in commodity interest and related cash or forward transactions.1 This recordkeeping includes all oral and written communications regarding quotes, solicitations, bids, offers, instructions, trading and prices that lead to the execution of a transaction in a commodity interest and related cash or forward transactions. These records must be identifiable and searchable by transaction.
The breadth of these recordkeeping requirements, and particularly the obligation to record oral communications, could create notable complications for affected market actors. The language of the regulation includes communication by telephone, voicemail, facsimile, instant messaging, chat rooms, electronic mail, mobile device or other digital or electronic media.2 While expansive, the regulation does exempt certain persons from recordkeeping for oral communications, including commodity pool operators (“CPOs”) and DCM or SEF members that are not registered or required to register with the CFTC.3 Notably, this leaves CTAs that are members of SEFs without an exemption.
On December 20, 2013, the Division of Swap Dealer and Intermediary Oversight and Division of Market Oversight of the CFTC issued a letter stating that they will not recommend enforcement action be taken against CTAs that are members of a SEF for failure to keep records of oral communications. The relief delayed the enforcement date of Regulation 1.35 from December 21, 2013 to May 1, 2014. This temporary respite was limited to CTAs because certain asset managers, such as CPOs and unregistered members of DCMs or SEFs, are already exempted from recordkeeping of oral communications.
As the end of the relief period approaches on May 1, 2014, market participants have questioned the rationale and methods behind the extensive recordkeeping requirements. Acknowledging the substantial effect the regulations will have on the market, the CFTC hosted a roundtable discussion with market participants on Regulation 1.35, as well as other topics, on April 3, 2014. During the roundtable, the CFTC inquired about market practice related to oral recordkeeping and the costs of compliance with Regulation 1.35. The members of the roundtable expressed significant concerns about the scope of Regulation 1.35 and the burdensome nature of recordkeeping for oral communications. The panelists, among others across the industry, have observed that the interpretation of “members” and application of the rules to CTAs are particularly problematic.
Some SEFs may also offer options to simplify their members’ recordkeeping obligations and ease them into this new regulatory regime. These solutions may provide a viable method for members to comply with the CFTC’s rules while keeping compliance costs relatively low. At least one SEF offers a click-to-dial system where phone conversations are captured and pinned to individual transactions, which can then be recorded to the member’s account.
Who must comply? Each FCM, IB, RFED and member of a DCM or SEF must keep full, complete and systematic written records, while FCMs, IBs with aggregate revenues exceeding $5 million over the preceding three years, RFEDs and certain members of a DCM or SEF must record all oral communications.
When is compliance required? The affected parties must begin compliance with Regulation 1.35 on May 1, 2014, following the expiration of the no-action relief.
1 17 CFR 1.35(a)(1).
2 17 CFR 1.35(a)(1).
3 17 CFR 1.35(a)(1)(v), (viii).