The CFTC voted 4-to-1 on April 18, 2012 to approve its final rule outlining the definitions of “swap dealers” and “major swap participants.” The SEC also approved its final rule on the definition of “security-based swap” and “major securitybased swap participant.” While these final rules have not been published as of this writing, it appears that a “swap dealer” will be an entity that (i) holds itself out as a dealer in swaps, (ii) makes a market in swaps, (iii) regularly enters into swaps with counterparties as an ordinary course of business for its own account, or (iv) engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps. There will be a de minimis exception from dealer status during an initial phase-in period for entities that engage in swap dealing where the aggregate effective notional amount, measured on a gross basis, of the swaps that the person enters into over the previous 12 months in connection with dealing activities does not exceed $8 billion. (The exception threshold for swaps with counterparties that are “special entities” is a much lower $25 million notional). Two-and-a-half years after data starts to be reported to swap data repositories, the CFTC staff will prepare a study of the swap markets. Nine months after the study, the CFTC may put in place a lower $3 billion threshold or propose new rules to change the threshold. Additionally, certain activity where swaps are used to hedge or mitigate risk will be excluded for purposes of calculating gross notional swap exposure (although the definition of “hedging” will apparently be different from the definition found in the position limits rules). The SEC’s de minimis thresholds for security-based swap dealers are $3 billion notional in the case of CDS, $150 million for all other security-based swaps, and $25 million notional in the case of security-based swaps with “special entities,” which are states, municipalities, state and federal agencies, pension plans, and endowments.
The final rules also include definitions of “major swap participant” and “major security-based swap participant.” A person will be a major swap participant if it maintains a “substantial position” in swaps, excluding swaps held to hedge or mitigate commercial risk; if it has outstanding swaps that create “substantial counterparty exposure” that could have serious adverse effects on the financial stability of the U.S. bank system or financial markets; or if it is a “financial entity” that is highly leveraged (i.e., a ratio of total liabilities to equity of 12 to 1) relative to its capital and holds a substantial position in swaps. “Substantial position” is defined by the CFTC based on numerical criteria. A substantial position is defined to be daily average current uncollateralized swap exposure of $1 billion for any swap category (or $3 billion for rate swaps). Substantial position is also defined to be potential future swap exposure of $2 billion for any swap category ($6 billion for rate swaps) determined by multiplying the notional principal amount of a person’s swap positions by risk factors set forth in the final CFTC rule. Such amounts are further adjusted by discounts for swaps subject to master netting arrangements and swaps cleared or subject to daily mark-tomarket margining. Finally, substantial counterparty exposure is defined as current uncollateralized exposure of $5 billion or the sum of current uncollateralized exposure and potential future exposure of $8 billion across all swap positions. The SEC has adopted its own numerical thresholds for determining substantial position with respect to security-based swaps.