Since last fall, the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) have issued additional final rules and/or guidance to implement the Dodd-Frank Act’s provisions regulating derivatives. These pronouncements address the following topics:
- Clearing, Trading and Execution
To give effect to the Act’s requirement that standardized swaps be cleared through an authorized derivatives clearing organization1 and traded through a registered derivatives contract market (“DCM”) or swap execution facility (“SEF”), the CFTC on May 16, adopted final rules that:
- Clarify which swaps are “made available to trade” because they have sufficient liquidity to be offered for sale through such a facility;
- Specify minimum functional requirements for a SEF;
- Require that swaps subject to mandatory execution must be effected through either an “Order Book” under which all participants can enter multiple bids/offers, view and receive bids/offers and transact on those bids/offers or a “Request for Quote System” (“RFQ”) that requires market participants to obtain quotes from at least two unaffiliated bidders (increasing to three within about 15 months); and
- Establish certain categories and minimum block sizes for “block trades” that can be executed bilaterally outside a DCM or SEF and are not subject to the Order Book or RFQ requirements, and for which swap data reporting can be delayed.
- Margin Rules Regarding Collateral for Swaps
Among the Act’s reasons for requiring mandatory clearing and exchange trading of swaps and reducing the number of private, bilateral swaps was to make the market safer by subjecting swap counterparties to margin rules imposed by the clearinghouses to protect against the risk of a default by one party to a swap.
- In response to requests from financial institutions, the SEC is reported to be relaxing certain margin requirements for credit default swaps tied to a single issuer where offsetting swaps tied to indexes are held in the same portfolio account.
- The CFTC, SEC and U.S. bank regulators are due to meet in the next month with European swap regulators to discuss competing proposals, including whether both initial and variation margin are necessary, how margin should be calculated and what types of collateral will be acceptable to satisfy margin requirements for uncleared swaps.
- Cross-Border Application of Swap Rules
Under the Act, the swap provisions of the Commodity Exchange Act apply to cross-border swap activities when they have a “direct and significant connection with…or effect on commerce in the U.S.” As a result, major foreign financial institutions that are parties to swaps with “U.S. persons” organized or domiciled in the U.S. are potentially subject to many of the stringent new rules under the Act.
- On July 12, 2013, the CFTC’s temporary Exemptive Order excusing foreign banks and other “non-U.S. persons” from compliance with the swap rules expires. Unless the Order is extended, if such parties qualify as “swap dealers” or “major swap participants,” they must register as such with the CFTC, becoming subject to requirements for additional capital, numerous swap documentation and compliance procedures, swap data recording and recordkeeping, confirmation, reconciliation, risk monitoring and other swap processing and trading rules.
- On or before July 12, the CFTC is expected to provide additional guidance on the definition of “U.S. person.”
- Upcoming meetings between U.S. swap regulators and their foreign counterparts could determine the extent to which non-U.S. persons engaged in swaps with U.S. persons could rely on “substituted compliance” with controls imposed by their home country or regional swap regulatory authority rather than the rules of the CFTC and the SEC under the Act.
- Deferred Deadlines for Swap Reporting Compliance
In response to requests from many swap market participants that are not SDs/MSPs to extend deadlines for the reporting of information on current and “historical” swaps, the CFTC’s April 9 No-Action letter pushed out the compliance dates from April 10 as follows:
- For interest rate and credit swaps: the new compliance date is July 1, 2013 (with backlogged data from April 10 to July 1 delayed until August 1, 2013).
- For equity, foreign exchange and other commodity swaps: the new compliance date is August 19, 2013 (with backlogged data from April 10 to August 19 delayed until September 19, 2013).
- For historical swaps (those in effect on July 21, 2010): the new compliance date is October 31, 2013.