The Dodd-Frank Act established the broad outlines of a new regulatory scheme for the over-the-counter derivatives market. As we explained in a prior alert, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) were tasked under Dodd-Frank with creating a comprehensive regulatory framework. The combined effort of the two agencies has so far produced over 70 proposed and final rules concerning derivatives.
Both the SEC and CFTC have delayed the adoption of various regulations on derivatives because of the burdens of other Dodd-Frank rulemaking, litigation and public opposition to the rule proposals. In fact, one of the cornerstones of the new rules – the definitions of the terms "swap," "security-based swap," "swap dealer," "security-based swap dealer," "major swap participant" and "major security-based swap participant" – has still not been adopted, even while the two agencies proceeded in adopting other derivatives rules.
What Rules Have Been Adopted So Far?
The CFTC had published 17 final rules on derivatives as of January 20, 2012. The most important rulemaking concerning derivatives includes the rules on swap data repositories, the core duties and principles for derivatives clearing organizations and rules for large trader reporting of physical commodity swaps. The controversial rules on position limits for futures and swaps have been finalized and can be accessed on the CFTC website, and litigation challenging the rules was recently dismissed. The CFTC also recently approved final rules on the registration of swap dealers and major swap participants, the protection of cleared swaps customer contracts and collateral and business conduct standards for swap dealers and major swap participants.
The CFTC's final rule on the Protection of Cleared Swaps Customer Contracts and Collateral and Conforming Amendments to the Commodity Broker Bankruptcy Provisions ("segregation rule") has garnered the most attention of the three. The segregation rule requires that derivatives clearing organizations and futures commission merchants (FCMs) segregate customer collateral that supports cleared swaps from their own property. In pre-bankruptcy situations, the new rules permit the FCM to keep cleared swaps customer collateral together in a single omnibus customer account. However, the derivatives clearing organizations may not use the collateral of FCM customers to cover an FCM default. These new rules are intended to build on customer protections included in the rule on core clearinghouse principles that was adopted in October 2011.
The CFTC final rules on the registration of swap dealers and major swap participants (MSPs), as well as the related rules on business conduct standards for swap dealers and MSPs, prohibit fraud, define the duties of swap dealers and MSPs to their counterparties and adopt various requirements relating to recordkeeping and compliance policies and procedures. The final rules also require swap dealers and MSPs to become and remain members of a registered futures association, such as the National Futures Association (NFA).
The SEC proposed many rules on derivatives last year, but has only adopted in final form two rules concerning derivatives. The SEC "readopted" beneficial ownership rules as they apply to security-based swaps, and the SEC adopted rules for interim reporting of security-based swap transactions. The interim rule requires parties to security-based swaps to keep records of all such transactions and to report such information to the SEC or to a registered security-based swap data repository if requested. The SEC has proposed thirteen rules concerning derivatives that are still pending, the most controversial being the concept release on the use of derivatives by registered investment companies and proposed rules (which are similar and proposed in consultation with the CFTC) on swap data repositories. The SEC, like the CFTC, has extended the comment period for many of the proposals and acknowledged that the eventual adoption of derivatives rules would not take place as originally scheduled.
What Are the Agencies Doing Now?
The CFTC has recently proposed rules to establish a process for how designated contract market and swap execution facilities can make a swap available for trade. These proposed rules are still open for comment until February 13, 2012. The CFTC may also vote soon on final regulations that would set business conduct standards between swap dealers and certain public clients, including pension funds, endowments and state and local governments. On January 11, 2012, the CFTC finally proposed rules on proprietary trading limits for banking entities, the last of the five regulatory agencies to propose limits under the so-called Volcker Rule.
In the first part of 2012, the CFTC intends to finalize eleven new rules, including rules providing for an end-user exemption and regulating commodity options. Later in 2012, the CFTC is scheduled to propose or adopt eleven more rules, including rules on block trades, extraterritoriality, and swap execution facilities.
The SEC scheduled the adoption of six proposed rules on derivatives for the end of 2011, but did not meet this schedule. Most importantly, both agencies are expected to adopt imminently final rules on the definitions of key terms used in Dodd-Frank with respect to derivative products and intermediaries. The SEC had also been scheduled to adopt before the end of 2011 derivatives rules governing real-time public reporting, swap data repositories, mandatory clearing, and end-user exceptions for the mandatory clearing of security-based swaps. However, the SEC failed to adopt or vote on these rule proposals. It is unclear how much further the scheduled adoption of derivatives rules will be delayed this year. Derivatives rules concerning anti-manipulation, security-based swap execution facilities, as well as the registration of swap dealers and conflicts of interest rules, will likely also be delayed from the original scheduled adoption in 2012.