US agencies trigger raft of new Dodd-Frank swaps rules
The approval this week by the Commodity Futures Trading
Commission (CFTC) and Securities Exchange Commission (SEC) of swap product definitions
and clearing exemption rules will trigger a landslide of Dodd-Frank rules on reporting,
clearing, trading and record-keeping to come into effect.
The agencies confirmed what had been widely expected – that
the definition of swaps which would need to be centrally cleared and
predominantly traded on-exchange on newly created swap execution facilities
(SEFs) would include commodity options, cross-currency swaps, foreign currency
options, foreign exchange swaps and forwards, and forward rate agreements. The final
definition closely resembles one initially proposed by regulators in April 2011
and Dodd-Frank’s initial mandate.
The CFTC also provided a seven-part test to distinguish
commodity forwards – which are exempt from Dodd-Frank rules – from swaps, but Democratic Commissioner Mark Wetjen criticised
the test, which he believed “could needlessly complicate commercial practices
that I do not believe Congress intended to bring under Dodd-Frank”.
Wetjen also believed more simplicity was needed in determining
which swaps would be regulated by the CFTC or the SEC.
Yet the agencies had retreated on their overly cumbersome
way of deciding the narrow-based security index and broad-based security index –
which defines who looks after what. The watchdogs had originally proposed to
define an index as narrow – therefore subject to CFTC supervision – if it had
nine or fewer component names, if one single constituent accounted for greater
than 30% of the index weighting, or if the five largest components comprised more than 60% of the total weighting of the
index. This would have meant that if an index simply added a tenth component,
it would be broad-based and under SEC jurisdiction.
Instead, and on industry advice, the watchdogs created a new
test based on 2006 joint SEC and CFTC rules.
Other commissioners have raised concerns over the flood of
Dodd-Frank rules which would now come into play.
“We are asking hundreds, if not thousands, of market participants
to comply with several arduous rules at the flick of a switch,” said Republican
Commissioner Scott O'Malia. “I predict many companies will find the
registration and compliance schedule to be very aggressive and quite
Wetjen said now that product definitions were in place, swap
dealers and major swap participants will be required to register. Additionally,
the Commission’s compliance dates for certain transaction-level requirements – such
as external business conduct standards and real-time reporting – will take
effect for transactions with US persons. The Commission’s spot-month position
limits for swaps referencing certain energy and agricultural commodities will also
Long-awaited clearing exemptions were also finalised. The
CFTC said it would exempt some companies from having to clear through central
counterparties. Corporates and manufacturers which use swaps to hedge or
mitigate risk – estimated to be around 30,000 companies nationally – have
been granted an ‘end-user exception’. As too, banks with US$10 billion or less in
assets under management have been exempted, along with a number of farm-credit
associations, credit unions and rural electric cooperatives which could outgrow
the US$10 billion threshold.
“Those cooperatives act in the financial markets on behalf
of their members and enter into swaps for the benefit of members,” said the
While the definition
of swaps was the CFTC’s main agenda this week, O’Malia also took the opportunity
to call on the agency to provide greater protection for customer monies in
light of the MF Global and other scandals where client funds have been
improperly used by brokers.
“It is now time that the agencies propose a one-pot margining
methodology to provide capital efficiency as envisioned by Congress,” he said,
invoking Section 713 of the Dodd-Frank Act, which gave both the CFTC and SEC
the authority to grant exemptions to allow futures commission merchants and
broker/dealers to maintain customer funds in single, omnibus accounts. “By
allowing FCMs and broker/dealers to maintain customer funds in these omnibus
accounts, the Commissions would facilitate systemic risk reduction, improve
capital efficiencies, encourage clearing and provide flexibility to market