At its open meeting on September 8, 2011, the Commodity Futures Trading Commission (the “CFTC”):
- announced that it would not complete its rulemaking process for rules necessary to implement the Title VII swaps-related provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) until 2012; and
- outlined a proposed sequence of rules to be considered during the remainder of 2011 and the first quarter of 2012.
In addition, the CFTC also:
- proposed timelines for implementation of proposed clearing, trade execution, trading documentation, and margining requirements (once finalized) (September 8, 2011 meeting); and
- issued a letter providing temporary relief from its rules regarding large trader reporting of physical commodity swaps activity through November 21, 2011 (for cleared swaps) or January 20, 2012 (for uncleared swaps) (dated September 16, 2011).
Meanwhile, as the rulemaking process continues, the CFTC and the Securities and Exchange Commission (“SEC”) have also drawn increased attention from the House and the Senate, including three recent bills and a formal letter expressing concerns regarding the rulemaking.
The September 8 announcement represents the second time the CFTC has delayed its Dodd-Frank swaps rulemaking. Although the CFTC was originally expected to have completed the rulemaking prior to July 16, 2011, it was unable to meet that deadline and issued an exemptive order earlier this summer to provide temporary relief to derivatives market participants until the earlier of the finalization of its final rules, or December 31, 2011. An update to that exemptive order will be considered at the CFTC’s upcoming October 18, 2011 meeting.
The SEC was also unable to complete its Dodd-Frank rulemaking for security-based swaps prior to July 16, 2011 and similarly issued interim rules and an order providing for certain temporary exemptions. The SEC has not yet made an official projection of how long it will need to complete its overall rulemaking process, but at its October 12, 2011 open meeting it did propose new rules regarding (i) registration of security-based swap dealers and major security-based swap participants and (ii) implementation of “Volcker Rule” restrictions on proprietary trading and ownership or sponsorship of hedge funds or private equity funds by insured depository institutions.
Updated Rulemaking Timeline
Following the postponement of two open meetings scheduled in September and October, the CFTC’s next scheduled open meetings will take place on October 18, November 1, and November 17, 2011.
At its October 18, 2011 meeting, the CFTC will consider:
- a final rule on position limits on speculative trading (which media reports had indicated might be linked to the cancellation of the two earlier meetings, due to possible internal disagreements1);
- a final rule on derivatives clearing organization general provisions and core principles; and
- a proposed amendment to its previously issued final rule on the effective date for swap regulation (although the CFTC has not given details of the exact duration of any additional postponement).
In his remarks on September 8, 2011, CFTC Chairman Gary Gensler had laid out the anticipated sequence of rules to be considered during the remainder of 2011 and the first quarter of 2012:
Remainder of 2011:
- position limits;
- derivatives clearinghouses;
- entity and product definitions;
- commodity options;
- registration requirements;
- swap data recordkeeping and reporting;
- end-user exceptions;
- external business conduct rules and internal business conduct rules relating to duties, recordkeeping, and
- chief compliance officers;
- segregation of cleared swaps; and
- core principles for trading platforms (including designated contract markets and foreign boards of trades).
First Quarter of 2012:
- core principles for swap execution facilities;
- capital and margin requirements for uncleared swaps;
- client clearing documentation and risk management;
- straight-through trade processing;
- segregation of uncleared swaps;
- internal business conduct rules relating to documentation;
- investment of customer funds;
- governance and conflicts of interest;
- disruptive trade practices; and
- conforming rules.
In remarks following a Futures Industry Association conference on October 11, 2011, Chairman Gensler expressed his hope that the rulemaking could be completed within “the next six to nine months,” although in his September 8 remarks he had noted that “we are focused on considering these rules thoughtfully – not against a clock” and appeared to leave room for possible further delays, stating “no doubt, as this is a human endeavor, there will likely be changes to this outline down the road.”
Proposed Implementation Timelines for Clearing and Execution Rule and Documentation and Margin Rule
At its September 8, 2011 meeting, the CFTC also approved two proposed rules setting forth timelines for implementation of the proposed requirements for (i) clearing and trade execution (the “Clearing and Execution Rule”), and (ii) trading documentation and margining (the “Documentation and Margin Rule”). Each rule is open for public comment through November 4, 2011, and is subject to amendment before finalization by the CFTC.
The CFTC recognizes that certain types of market participants may require more time than others to comply with these requirements, and therefore has proposed different implementation timelines for various categories of entities.
Clearing and Execution Rule
Pursuant to Section 723(a) of the Dodd-Frank Act, Section 2(h) of the Commodity Exchange Act has been amended to require (i) the CFTC to make a determination as to whether a swap must be cleared, and to make it unlawful for any person to engage in a swap that is required to be cleared unless that person submits the swap for clearing to a derivatives clearing organization, and (ii) all clearable swaps to be executed on a designated contract market or swap execution facility (except where no designated contract market or swap execution facility will accept such swap for trading). Under the Clearing and Execution Rule, depending on the type of parties involved:
- such new clearing requirements would be phased in over 90, 180, or 270 days (subject to satisfaction of certain conditions such as finalization of relevant rules and determination that the relevant swap must be cleared); and
- such new trade execution requirements would be phased in by the earlier of (i) the same 90-, 180-, or 270-day period or (ii) 30 days after the relevant swap is made available for trading on a designated contract market or swap execution facility.
Documentation and Margin Rule
Pursuant to Section 731 of the Dodd-Frank Act, Section 4s of the Commodity Exchange Act has been amended to require (i) the CFTC to adopt trading documentation requirements to govern swaps and trading relationships between swap dealers or major swap participants and their counterparties, and (ii) the CFTC to adopt margin requirements for uncleared swaps entered into by registered swap dealers and major swap participants that are not regulated by the prudential banking regulators.
Under the Documentation and Margin Rule, such new trading documentation and margin requirements would be phased in over 90, 180, or 270 days after such requirements (and related rules and definitions) are finalized, depending on the type of parties involved.
Temporary Relief from Large Trader Reporting Requirements
The CFTC issued a letter dated September 16, 2011 providing temporary relief from its new large trader reporting requirements for physical commodity swaps activity (the “Large Trader Reporting Requirements”). The Large Trader Reporting Requirements had been issued on July 22, 2011 and were scheduled to come into effect on September 20, 2011.
In light of ongoing discussion and efforts to address compliance and implementation issues, the CFTC will delay the Large Trader Reporting Requirements through November 21, 2011 (for cleared swaps) or January 20, 2012 (for uncleared swaps), provided that clearing organizations and clearing members provide open interest data for positions as of each month end during the relief period, beginning September 30, 2011 (such data must be provided no later than February 20, 2012).
Under the Large Trader Reporting Requirements, a new Part 20 is to be added to the CFTC’s regulations providing for daily reporting of activity in physical commodity swaps by clearing organizations, clearing members, and swap dealers. The Large Trader Reporting Requirements will apply to swaps and swaptions that are linked directly or indirectly to any of 46 enumerated physical commodity futures contracts (or the underlying commodities), and will generally require daily reporting if a clearing member or swap dealer holds a position in such swaps or swaptions in any one futures month for which the number of economically equivalent futures contracts would meet or exceed a specified threshold. The CFTC has estimated that approximately five clearing organizations, 100 clearing members, and 100 swap dealers will ultimately be required to provide such reports.
Political Scrutiny and Developments
Against this backdrop, the CFTC and the SEC have also been the focus of increased attention from lawmakers in the House and the Senate recently, including:
- a letter dated October 4, 2011 from Representative Barney Frank and Senator Tim Johnson (also addressed to prudential banking regulators) encouraging coordination between the CFTC and the SEC and with foreign regulators, and expressing concerns regarding the extraterritorial scope of new rules, the regulatory burden on foreign subsidiaries of U.S. institutions, the risk of regulatory arbitrage, and the impact upon end users and “special entities” such as pensions and state and municipal governments2;
- a draft bill introduced by Senator Richard Shelby (to be known as the “Financial Regulatory Responsibility Act of 2011”) and a draft bill introduced by Representatives Collin Peterson and Lamar Smith and Senators Rob Portman and Mark Pryor (to be known as the “Regulatory Accountability Act of 2011”), both on September 22, 2011, each of which, if enacted, would require, among other things, more rigorous cost-benefit analysis and transparency in the Dodd-Frank and other federal rulemaking processes; and
a draft bill introduced on October 4, 2011 by Senators Mike Crapo, Mike Johanns, Richard Shelby, David Vitter, Patrick Toomey, Jerry Moran, and Mark Kirk (to be known as the “Dodd-Frank Improvement Act of 2011”), which, if enacted, would extend the Dodd-Frank Title VII rulemaking deadline to July 16, 2012; require the CFTC, the SEC, and the prudential banking regulators to
- publish a schedule outlining the order in which rules will be proposed and implemented;
- provide the CFTC and the SEC with exemptive authority;
- provide end users with a clear exemption from margin requirements;
- modify the definitions of “major swap participant” and “swap dealer”;
- expand exemptions for intracompany and intra-affiliate transactions;
- require greater consideration of international regulatory developments; and
- create a centralized office of derivatives within the SEC.
In remarks at the London School of Economics on October 13, 20113, Chairman Gensler echoed the need for international coordination in derivatives reform efforts. He expressed his concern that, contrary to current proposals in the U.S., the current version of the European Market Infrastructure Regulation being considered by European regulators did not contemplate clearing of exchange-traded derivatives, only those traded over-the-counter or on electronic trading platforms, and reiterated the need to “ensure a level playing field and promote consistent and comparable requirements internationally within our derivatives regulations.”
Chairman Gensler also responded to some of the concerns expressed by lawmakers in comments following his address at the Futures Industry Association on October 11, 2011, noting that “Some have raised cost considerations about our rulemakings…. But the greatest cost is having a public that is not protected from the risks of the swaps market and that does not get the benefits of transparent markets.” Meanwhile, media reports and public comments from Chairman Gensler and CFTC Commissioner Scott O’Malia have indicated some uncertainty as to whether the CFTC will choose to follow the approach of the SEC and prudential banking regulators on the “Volcker Rule” or put forward proposed rules reflecting a different approach4.
In light of continuing political uncertainty and the possibility of regulators adopting different approaches, it will be critical over the coming months for market participants to monitor developments as the regulators advance towards finalization of their rules.