Why US swap definitions need clarifying quickly

Author: | Published: 23 Jul 2012
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The US Securities & Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) earlier this month defined how the term swap would be treated under Dodd-Frank rules. The jointly-finalised definitions start the swap compliance countdown, but some entities still don’t know whether they are required to comply.

Foreign-based companies with US subsidiaries and vice versa might have to do some guesswork to avoid violating a registration deadline scheduled for 60 days after publication of the rules in the federal register. It all depends on when the regulators finalise guidance on the cross-border application of swap rules.

The CFTC proposed guidance allows for substitute compliance programs with foreign regulators that have comparable requirements. The SEC has not yet proposed such guidance, and it is unclear whether either regulator will issue final guidance before the swap dealer (SD) and major swap participant (MSP) registration requirements become effective.

"It’s affecting people’s ability to make decisions about how to organise their business," Robert Pickel, chief executive officer of the International Swaps and Derivatives Association (ISDA) said.

"I think everybody fully understands if they are going to engage in business in the US with a US person, they are going to need to register some entity with the CFTC (or SEC) as a swap dealer," added Pickel.

A problem arises in the definition of US person, though. Lawyers told IFLR the CFTC’s proposed interpretation of US person, found on page 16 of the proposed guidance, is vague regarding what counts as a principal place of business in the US.

Foreign-based swap traders that could qualify as a US person have expressed some concern over a possibility that non-US related operations could become exposed to US oversight.

"Even if their parent corporate is in Germany or France [for example], I think they’re concerned about the effort embedded in the guidance on the registration of US-based swap dealers as a springboard to regulate aspects of the business back in France or Germany," Pickel said.

Some foreign swap traders might not think doing business in the US is worth the cost of registration and exposure to US regulatory oversight, Pickel added. "We think that’s a bad result."

The definition of swap follows a number of new requirements for entities qualifying as SDs and MSPs. SDs and MSPs will have to register with either the SEC or CFTC depending on their activities. They will also have to record and report information on interest rate and credit swaps on a real-time basis in accordance with rules on internal and external business conduct standards.

"It was heartening to hear the chairman recognised there would be challenges in the implementation [of Dodd-Frank swap rules]. We hope the CFTC adheres to its pledge to work with market patricipants to ensure a smooth transition," Diana Preston, vice president and senior counsel at the American Bankers' Association said.

Another highly publicised requirement caps investment in commodities in an attempt to curb high prices thought by the CFTC to result from over-speculation. The ISDA and the Securities Industry and Financial Markets Association filed suit in an effort to vacate the position limits rule late last year. The case against the CFTC is still pending before the US District Court for the District of Columbia.

"It’s important at this time to take action, one way or another, on the case," Pickel said.


The final rule lists transactions that do not qualify as a swap or security-based swap: insurance contracts, certain consumer and commercial transactions, loan participations and forward contracts in nonfinancial commodities will not be regulated by the new swap rules.

One derivatives lawyer who preferred to remain anonymous supported the Commission’s decision to exclude forward contracts in nonfinancial commodities from the definition of swap.

"That I think is a very helpful recognition from the standpoint of the market place," he said. "If you negotiate a contract that allows accelerating the delivery date, or delaying the delivery date, adjusting the volumes, the fact you have those options shouldn’t change the commercial nature of the agreement."

In addition to defining swap, the CFTC released a final rule exempting end-users with less than $10 billion in assets from complying with a requirement that swap trades be approved by independent clearing houses.

The US Treasury Secretary has not yet determined whether foreign exchange forwards and foreign exchange swaps will be regulated as swaps. Even if they are not defined as swaps by the Treasury, as expected, they would still be subject to swap reporting requirements according to the CFTC’s Q&A.

"People would be very surprised to learn simple foreign exchange forwards and swaps are still swaps for all purposes, which I think would be a problem for the market," the derivatives lawyer said. "It will be a little awkward if they don’t do it before this rule goes into effect."