Over-the-counter (OTC) derivatives legislation passed the U.S. House of Representatives this month. Specifically, the Derivatives Markets Transparency and Accountability Act of 2009 was included as Title III in the Wall Street Reform and Consumer Protection Act of 2009 and establishes a framework for regulating OTC derivatives.
Title III represents a compromise between the competing bills for OTC derivatives regulation approved back in October 2009 by the House Financial Services Committee and the House Committee on Agriculture , respectively. (See Foley's Legal News: Energy for October 2009 at http://www.foley.com/publications/pub_detail.aspx?pubid=6553.) Title III is intended to provide comprehensive regulation of OTC derivatives markets, swap dealers, and major swap participants through amendments to the Commodity Exchange Act (CEA) and federal securities laws.
For purposes of defining Title III’s reach, “swaps” do not include “any sale of a nonfinancial commodity for deferred shipment or delivery, so long as such transaction is physically-settled.” This appears to be a narrower formulation of the CEA’s existing “forward contract exclusion” from the scope of futures contracts subject to regulation under the CEA.
Title III includes provisions for mandatory clearing and centralized trading of standardized swaps. However, commercial end users that enter into OTC swaps to hedge, reduce, or otherwise mitigate their commercial risks would generally be excluded from those requirements, unless the end-user also is a major swap participant. The end-user would be a major swap participant if it has a substantial net position in swaps that are not held for hedging/risk management or if its total outstanding swap positions create substantial net counterparty exposure. The CFTC and SEC would determine what constitutes a “substantial” net position or net counterparty exposure, to be set at levels considered prudent to protect the financial system from systemic risk.
Notably, Title III gives the CFTC, SEC, and banking regulators the authority to impose margin requirements for swaps that are not cleared. However, the regulators are not required to exercise that authority when one of the parties to the swap is a not a swap dealer or major swap participant, which would generally cover commercial end-users. If the regulators were to exercise that discretionary authority, the margin requirements would have to allow for the use of non-cash collateral. That latter element is apparently an effort to mitigate concerns that mandatory, government-imposed margin requirements could greatly increase end-users’ costs to engage in legitimate hedging using OTC swaps.
Title III does not appear to resolve potential jurisdictional overlap and conflict between the CFTC, on the one hand, and FERC or the Public Utility Commission of Texas, on the other hand, over markets for transmission rights instruments that are cash-settled (versus those settled by physical delivery).