Corp Fin has posted a new Exchange Act CDI regarding swaps and forward contracts. Swaps and security-based swaps are subject to a comprehensive regulatory framework established under Dodd-Frank. Under release 33-9338, forward contracts are excluded from the definitions of the terms “swap” and “security-based swap.” More specifically, these definitions exclude “any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled.” But what if the underlying securities cannot be legally transferred when the parties enter into the contract? Are they still ”intended to be physically settled”? New Question 101.01 addresses this question.

The above-referenced release states that the exclusion for forwards involves “an agreement to purchase one or more securities, or groups or indexes of securities, at a future date at a certain price….The sale of the security in this case occurs at the time the forward contract is entered into with the performance of the contract deferred or delayed. If such agreement, contract, or transaction is intended to be physically settled, the Commissions believe it would be within the security forward exclusion and therefore outside the swap and security-based swap definitions.” The new CDI addresses the question of whether the exclusion would apply to a future or forward contract that permits cash or physical settlement “if, at the time the parties enter into the contract, the underlying securities cannot be legally transferred, or the transfer of the underlying securities is restricted by contract.”

According to the staff, the exclusion would not apply. In the above-referenced release, the SEC stated that the analysis as to whether sales of securities for deferred shipment or delivery are intended to be physically settled is a facts-and-circumstances determination. However, the CDI states, the “determination of whether an instrument is a swap or security-based swap should be made prior to execution, but no later than when the parties offer to enter into the instrument.” If, at the time of sale, the underlying securities could not be legally transferred, or the transfer of the underlying securities would be restricted by contract, the staffs “would not consider the contract to be ‘intended to be physically settled’” for purposes of these definitions. To conclude that a sale of securities for deferred shipment or delivery is intended to be physically settled, “at the time the parties enter into the contract (i) the offer and sale of the underlying securities must be registered in compliance with Section 5 of the Securities Act or an exemption from registration must be available with respect to the underlying securities, and (ii) any applicable contractual provisions restricting the transfer of the underlying securities must be satisfied or otherwise waived.”