The Commodity Futures Trading Commission adopted final rules implementing business conduct standards rules for swap dealers (SDs) and major swap participants (MSPs) (collectively, SDs/MSPs), regulating their dealings with counterparties and additional requirements when they deal with “Special Entities,” which the final rules define to include: (1) a Federal agency; (2) a State, State agency, city, county, municipality, or other political subdivision of a State, or any instrumentality, department, or a corporation of or established by a State or political subdivision of a State; (3) any employee benefit plan subject to Title I of the Employee Retirement Income Security Act of 1974 (ERISA); (4) any governmental plan, as defined in Section 3 of ERISA; (5) any endowment, including an endowment that is an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986; or (6) any employee benefit plan defined in Section 3 of ERISA, not otherwise defined as a Special Entity, that elects to be a Special Entity by notifying an SD/MSP of its election prior to entering into a swap with the particular SD/MSP.
SDs /MSPs owe the following duties to all counterparties:
- Verifying that a counterparty is an eligible contract participant and whether a counterparty is a Special Entity;
- Disclosing material information in a manner sufficient to allow the counterparty to assess material risks, material characteristics, material incentives, and conflicts of interest;
- Providing the daily mid-market mark for uncleared swaps to the counterparty;
- Notifying a counterparty of its right to clear a swap that is not required to be cleared and to select the DCO; and
- Communicating with counterparties in a fair and balanced manner, based on principles of fair dealing and good faith.
SDs owe the following additional duties to all counterparties:
- Notifying its counterparty of its right to request and consult on a scenario analysis for the swap;
- Understanding risks and rewards of a recommended swap and to have a reasonable basis to believe that a recommended swap is suitable for the counterparty.
SDs acting as advisors to a Special Entities are required to comply with the above duties and to act in the best interests of the Special Entity. An SD acts as an advisor to a Special Entity when the SD recommends a swap or swap trading strategy tailored to the needs or characteristics of the Special Entity.
In addition, SDs/MSPs acting as counterparties to Special Entities are required to (1) disclose the capacity in which they are acting when entering into a swap and (2) have a reasonable basis to believe that the Special Entity (other than an ERISA plan) has a “representative” that:
- Is sufficiently knowledgeable to evaluate the transaction and risks;
- Is not subject to a statutory disqualification;
- Is independent of the SD/MSP;
- Acts in the best interest of the Special Entity;
- Makes appropriate and timely disclosures to the Special Entity;
- Evaluates, consistent with any guidelines provided by the Special Entity, fair pricing and appropriateness of the swap; and
- In the case of a governmental Special Entity, is subject to restrictions on certain political contributions to public officials of the governmental Special Entity.
When entering into a swap with a Special Entity, the SD/MSP must disclose to the Special Entity the capacity in which it is acting. Regarding ERISA plans, SDs/MSPs must have a reasonable basis to believe an ERISA plan’s “representative” is an ERISA fiduciary.
Reliance on Counterparty Representations
SDs/MSPs may (as appropriate) (1) reasonably rely on representations of counterparties to meet due diligence obligations, (2) make disclosures by any reliable means agreed to by the counterparty, (3) make disclosures of material information to counterparties in a standard format, and (4) include representations and disclosures in counterparty relationship documentations, and deem them renewed with each subsequent swap.
Restrictions Because of Political Contributions
Under the final rules, SDs are subject to a two-year prohibition on entering swaps with a governmental Special Entity, if such SD makes certain political contributions to officials of the governmental Special Entity.
CTA Definition Exclusion
The final rules also add a new exclusion from the definition of a commodity trading advisor for SDs whose recommendations or advice are solely incidental to their business as SDs.
Exemptions from Certain Duties
If the swap is executed on a SEF or DCM and the SD/MSP does not know the identity of the counterparty prior to execution, the SD/MSP does not have to verify the eligibility of the counterparty or make disclosures of material information, other than the daily mark. Further, the requirements to disclose material information regarding a swap do not apply when the counterparty is another SD/MSP or a security-based swap dealer or major security-based swap participant.
A copy of the fact sheet regarding the final rules is available here.