Today, the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”, and together with the SEC, the “Commissions”) jointly published final rules further defining the terms “swap,” “security-based swap,” “mixed swap” and “security-based swap agreement” and providing interpretive guidance with respect to particular products (the “Final Product Definitions”).1 Publication of the Final Product Definitions triggers the implementation of various regulatory requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) with respect to “swaps” regulated by the CFTC. The CFTC has proposed phased-in compliance schedules for many of these rules to provide additional time for market participants to adapt to the new regime so as not to unduly disrupt markets and existing custom. The publication of the Final Product Definitions does not trigger the implementation of regulatory requirements with respect to “security-based swaps” regulated by the SEC as the SEC will sequence implementation of regulations relating to security-based swaps in accordance with a previously issued policy statement.2
Definition of “Swap”
Sections 721(a) and 761(a) of the Dodd-Frank Act outline the definitions of “swap,” “securitybased swap,” “mixed-swap” and “security-based swap agreements” and provide that the Commissions may further define such terms. The final definitions of “swap” and “securitybased swap” follow the statutory definitions inserted into the Commodity Exchange Act (“CEA”) and Securities Exchange Act of 1934 by the Dodd-Frank Act. The Final Product Definitions provide further clarity as to which derivatives products fall under each definition and thus delineate the regulatory and enforcement jurisdictions of the CFTC and the SEC.
They also clarify the regulatory treatment of insurance products, certain commercial and consumer agreements and loan participations.
The Final Product Definitions provide a safe harbor from the definitions of “swaps” and “security-based swaps” for insurance products that fit within certain product and provider criteria.
LSTA and LMA-Style Participations
Similarly, neither LMA-style nor LSTA-style loan participations fall within the definition of “swaps” or “security-based swaps” if the purchaser is acquiring a current or future direct or indirect ownership interest in the related loan or commitment and if certain other conditions are met.3
FX Swaps and FX Forwards
The Final Product Definitions confirm that certain physically settled foreign exchange swaps and foreign exchange forwards will be excluded from the definition of “swap” if the Secretary of the Treasury makes such a determination in accordance with authority granted to him under the Dodd-Frank Act.4 The Secretary currently proposes to exempt these foreign exchange products but has not yet finalized such determination. Reporting requirements and business conduct standards, however, will still apply to foreign exchange swaps and foreign exchange forwards even if they are excluded from the definition of “swap”.
Effectiveness of CFTC Rules Referencing the Term “Swap”
On July 13, 2012, the CFTC issued an order further extending the temporary exemptive relief granted to swap market participants from rules referencing the term “swap” (including reporting and clearing requirements, swap dealer and major swap participant registration and business conduct standards, among others) until December 31, 2012 or until such earlier time at which the Final Product Definitions becomes effective. With the effectiveness of the Final Product Definitions 60 days from today’s publication date, the temporary exemptive relief granted by the CFTC to market participants from various regulatory requirements of the Dodd- Frank Act will expire.
The CFTC has issued compliance schedules for reporting, clearing, registration and business conduct rules, which phase in compliance dates so as to avoid undue disruption to the markets.5 A chart at the end of this client memorandum illustrates the applicable compliance dates for key rules the CFTC has finalized to date.
The recordkeeping and reporting rules promulgated by the CFTC became effective on March 9 and March 13, 2012.6 The CFTC adopted a three-phased compliance schedule to address anticipated technological challenges and build familiarity with the process:
- Interest rate and credit swaps entered into on a designated contract market or swap execution facility, or with a swap dealer or major swap participant, must be reported to a swap data repository within 60 days following publication of the Final Product Definitions.
- Foreign exchange, equity and other commodity swaps entered into on a designated contract market or swap execution facility, or with a swap dealer or major swap participant, must be reported to a swap data repository within 150 days following publication of the Final Product Definitions.
- Swaps not entered into on a designated contract market or swap execution facility, or entered into between parties that are not swap dealers or major swap participants, must be reported to a swap data repository within 240 days following publication of the Final Product Definitions.
- The same compliance dates apply to all swaps in existence prior to the enactment of the Dodd-Frank Act (July 21, 2010) whose terms had not expired as of that date and all swaps entered into after the enactment of the Dodd-Frank Act but before the compliance dates take effect.7
The CFTC has to make an affirmative clearing determination before any specific swap product must be cleared. On August 7, 2012, the CFTC solicited public comment regarding a proposed clearing mandate for certain interest rate and credit default swaps. The CFTC will make a determination as to whether these categories of swaps will be required to be cleared within 60 days following the end of a 30 day public comment period.
Concurrently with the proposed clearing mandate, the CFTC adopted regulations to phase-in compliance with a clearing requirement to provide additional time for compliance and facilitate the transition to the new regulatory regime:8
- Swap dealers, major swap participants and active funds9 will be required to clear swaps within 90 days following a determination by the CFTC that a category of swaps will be required to be cleared.
- Commodity pools, private funds that are not active funds and entities primarily engaged in the business of banking will be required to clear swaps within 180 days following a determination by the CFTC that a category of swaps will be required to be cleared.
- All other swap counterparties will be required to clear swaps within 270 days following a determination by the CFTC that a category of swaps will be required to be cleared.
Swap Dealer and Major Swap Participant Registration
Swap dealers and major swap participants will need to register with the CFTC and become members of a registered futures association.10 The rule defining “swap dealer” and “major swap participant” became effective on March 19, 2012. Upon effectiveness of the Final Product Definitions, swap dealers and major swap participants will be required to have registered with the CFTC.
Business Conduct Rules
External business conduct standards applicable to swap dealers and major swap participants in their dealings with swap counterparties became effective on April 17, 2012.11 Swap dealers and major swap participants are required to comply with this rule on or before October 14, 2012. Compliance with this rule may require swap dealers and major swap participants to collect additional information from counterparties and/or amend existing documentation. To facilitate compliance with the external business conduct rule and other Dodd-Frank regulatory requirements, ISDA today launched the ISDA August 2012 Dodd-Frank Protocol. The Protocol allows adhering market participants to deliver required information to their counterparties and to amend their existing ISDA documentation to comply with certain Dodd- Frank requirements.
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