If requirements for minimum block sizes for credit-default swaps are improperly gauged, firms could get a 30-minute window into large trades by taking advantage of overlapping laws requiring transparency and automatic sweeps from swap execution facilities. Eric Gross, credit strategist at Barclays Capital, told DI that the minimum size of the blocks is crucial for liquidity in the CDS market. If it is too high, he said, liquidity could dry up by limiting the number of firms that can participate in trading.
But if it is too small, firms could take advantage of regulations on SEFs to get advanced notice on bigger trades that have yet to be executed. During the first year that the regulations are put in place, SEFs will be obligated to disseminate information to the public on a 30 minute to 48 hour delay. But a separate rule also obligates SEFs to clear smaller trades in order before larger ones.
“Let’s say limit trades requests are put in to trade IBM 10-year CDS in small size, and they’re not currently near the market level, but you put them there and let them sit there,” Gross said. “There’s a proposed rule that requires you to sweep trades that are ahead of you. So if a block trade came by and the limit on your small trades was better than the block trade, the small trades you put in would have to transact first. And since the small trades have to be disseminated immediately, there could be a mismatch between when different participants find out about block trades.”
“This is one of many reasons why it’s very delicate where you draw the line in terms of block sizes,” Gross added. “Transparency is not supposed to breed inequality of information.”
The Securities and Exchange Commission and Commodity Futures Trading Commission, which respectively regulate single-name and indexed CDS, have yet to establish the size of the blocks. In January of last year, a report written jointly by the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association said that any new rules should be phased in over time, and any size requirements should be tailored to what is appropriate for normal notional volume of each asset class.