The Commodity Futures Trading Commission and the Securities and Exchange Commission have adopted long-awaited final rules that provide further clarity around who will qualify as a swap dealer and major swap participant—labels that would subject such companies to a host of new compliance and reporting standards.
On April 18, the CFTC approved the final rule by a 4-1 vote jointly with the SEC, which approved the rule by a unanimous 5-0 vote. As an initial phase-in, the rule will define a regulated dealer as one that conducts swaps with a notional value of at least $8 billion in swaps over a 12-month period. The CFTC initially had set that threshold at $100 million in the proposed rule.
The CFTC said it will conduct a study of the market two and half years after it begins to collect data on swap data repositories and will then consider whether the limit should be changed. The threshold would automatically be lowered—likely to $3 billion—after five years if the CFTC doesn't act before that time.
Since large entities dominate the swap dealing market, the final swap dealer definition “will encompass the vast majority of swap dealing activity, as Congress had intended,” said CFTC Chairman Gary Gensler
. “For those who question the level of the de minimis, we considered the threshold in the context of an overall $300 trillion notional swaps market.”
Regarding thresholds for “major swap participants,” for a person to have a “substantial position” in a major category of swaps, the final rules require a daily average current uncollateralized exposure of at least $1 billion ($3 billion for the rate swap category), or a daily average current uncollateralized exposure plus potential future exposure of $2 billion ($6 billion for the rate swap category).
For an entity's swap positions to pose “substantial counter-party exposure,” the final rules require positions that present a daily average current uncollateralized exposure of $5 billion or more, or present daily average current uncollateralized exposure plus potential future exposure of $8 billion or more.
The final rule also makes changes to the term “eligible contract participant.” Under the Dodd-Frank Act, a person that is not an eligible contract participant may not enter into a swap other than on, or subject to the rules of, a designated contract market. “Based upon the many comments received, we incorporated further guidance to ensure that small businesses and real estate developers can continue to have access to swaps to hedge commercial risks,” said Gensler.
The final rule also includes numerous exclusions, including those for hedging activity. An interim final rule provides that swaps a person enters into for the purpose of hedging price risks related to physical positions are inconsistent with swap dealing and are excluded from the swap dealer determination, the CFTC said in a fact sheet on the rule.
The interim final rule draws upon principles in the Commission's long-standing interpretation of bona fide hedging. It excludes swap activity for the purpose of portfolio hedging and anticipatory hedging.
The CFTC said it is not adopting a per se exclusion of all swaps that hedge or mitigate risk. “If a swap is not entered into for the specific hedging purposes identified in the rule, then all relevant facts and circumstances about the swap would be considered in determining if the person is a swap dealer,” the CFTC said.
The CFTC also said it will apply the SEC's dealer-trader distinction in identifying swap dealers, which would distinguish between businesses trading swaps on their own behalf to hedge business risk and those who are acting as intermediaries.
Swaps between a company's majority-owned affiliates also will not count toward the swap dealer threshold, which posed a serious concern for energy trading companies, including Shell and BP.
Swap dealer and major swap participant registration will begin when the CFTC and SEC finalize the further definition of “swap.”