The Commodity Futures Trading Commission, by a 4 to 1 vote, has approved final rules that further define the terms “swap,” “security-based swap,” and “security-based swap agreement” and who they apply to.
Tuesday's vote, which follows a 600-page document prepared and approved by the SEC, will start the clock on compliance deadlines for numerous regulations mandated by the Dodd-Frank Act.
To provide better oversight to the nearly $650 trillion derivatives marketplace, Title VII of the Act gives the CFTC regulatory authority over swaps, the SEC has authority over security-based swaps, and both commissions are jointly responsible for regulations regarding mixed swaps.
Nearly a dozen rules will go into effect 60 days after the final rule and interpretation is published in the Federal Register, including those relating to the registration of swap dealers and major swap participants (“MSPs”), internal and external business conduct standards, swap dealer and MSP reporting and recordkeeping obligations, and position limits for swaps.
“Although the product definitions are important in their own right, they are even more significant because so many other aspects of the Dodd-Frank regime depend on them,” said CFTC Commissioner Mark Wetjen in remarks prior to the vote.
“The final product definitions rule and interpretation will set in motion an implementation chain reaction,” added CFTC Commissioner Scott O'Malia.
In keeping with the broad strokes of the Dodd-Frank Act, and in concert with SEC-approved definitions, the following are defined as swaps: foreign exchange forwards, currency swaps, cross-currency swaps, foreign currency options, commodity options, total-return swaps, interest rate swaps, and forward rate agreements.
Certain insurance products are not considered swaps. Neither are many consumer transactions, including those primarily for personal, family or household purposes.
Among those transactions are: agreements to purchase products purposes at a fixed, capped or collared price (such as arrangements to lock in the price of heating fuel ); transactions that provide for an interest rate cap or lock on a consumer loan or mortgage; loans or mortgages with variable rates of interest or embedded rate options, including those with rates that change upon triggering events (such as a higher rate of interest following a default); service agreements, product warranties, extended service plans, or buyer protection plans (such as those purchased with appliances and electronics); options to lease apartments or furnishings; and purchases made through layaway plans.
Also not considered swaps are: employment contracts and retirement benefit arrangements; sales, servicing, or distribution arrangements; and the purchase, sale, lease, or transfer of real or intellectual property, intellectual property.
Exemptions apply to commercial entities that use derivatives to hedge against risks, such as see-sawing commodity prices or spiking interest rates. Banks with assets of $10 billion and cooperatives (such as credit unions) are also exempt.
Commissioner Bart Chilton was the lone vote against the proposal, dissenting because he feared exemptions provided loophole opportunities that could be exploited to bypass pending regulations.
Wetjen, however, said the product definitions “strike a proper balance.”
“On the one hand, they provide that insurance, forward contracts, and certain consumer and commercial transactions – which have never been considered to be swaps, and which I am convinced Congress did not intend to be regulated as swaps – are not swept up by Dodd-Frank,” he said. “On the other hand, I am confident they are comprehensive enough to prevent relevant derivatives products from escaping the new regulatory structure through inadvertent loopholes.”
Now that the definitions are in place to kick-start additional rules and regulations, O'Malia predicted that many companies will find “the registration and compliance schedule to be very aggressive and quite challenging”
“Although I am very supportive of [Title VII of the Dodd-Frank Act] implementation generally, I am somewhat fearful that the majority of market participants will be unprepared to comply with the cascade of requirements that are about to befall them,” he said “We are asking hundreds, if not thousands, of market participants to comply with several arduous rules at the flick of a switch."
"It is important that we take the necessary time to consider the potential consequences of the compliance dates for our rules going forward," he added. "We have proven time and time again that when the Commission engages in high frequency regulation, we are forced to delay compliance dates or to provide no-action relief for affected persons. The Commission should get it right at the outset—not at the back end.”