Swap Entities Regulation

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FINAL RULES: CFTC Final Rule: Provisions Common to Registered Entities Approved at CFTC Open Meeting, July 19, 2011 CFTC Final Rule: Conflicts of Interest for Swap Dealers, Major Swap Participants, Futures Commission Merchants, and Introducing Brokers Approved at CFTC Open Meeting, February 23, 2012. CFTC Final Rule: Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management Approved at CFTC Open Meeting, March 20, 2012.

Swaps regulation is part of the Dodd-Frank Act and has fallen under the jurisdiction of various regulatory agencies such as the CFTC and the SEC. Other agencies are also addressing swap execution facilities such as the Financial Services Authority (FSA) and European Commission. Among the proposed rules and rule changes, many are written to specifically address a certain type of swap entity, such as a swap execution facility (SEF), designated contract market (DCM), derivatives clearing organization (DCO) or swap data repository (SDR).

Other proposals have been written to address all of these regulated swap entities as a group. These proposed rules and rule changes can be found below, with links to:

• the open meeting at which the rule was discussed and approved,
• the rulemaking as it appeared in the Federal Register, and
• comment letters from stakeholders, including industry leaders, trade associations, and advocacy groups.

Contents 1 CFTC Final Rules 2 CFTC Proposed Rules 3 Swap Entities Proposal from November 10, 2010 CFTC Meeting 4 Swap Entities Proposal from December 9, 2010 CFTC Meeting 5 Swap Entities Proposal from February 24, 2011 CFTC Meeting 6 Swap Entities Proposal from July 19, 2011 CFTC Meeting 6.1 SEC Proposed Rules 7 Swap Entities Proposal from October 13, 2010 SEC Meeting 8 Swap Entities Proposal from March 2, 2011 SEC Meeting 9 References

CFTC Final Rules

Provisions Common to Registered Entities

At its July 19, 2011 open meeting, the CFTC approved its final rule regarding provisions common to registered entities, including the following changes to "Part 40" as required by Dodd-Frank:

• new entities created by Dodd-Frank, namely swap execution facilities and swap data repositories;
• a streamlining of the comment periods, review periods, and implementation dates for rule changes;
• a requirement that "systemically important" derivatives clearing organizations (SIDCOs)provide the CFTC with a 60-day advance notice of rule changes; and
• a prohibition on the listing, trading, or clearing of certain "excluded commodities" or contracts based upon unlawful activities.^[1]

Conflicts of Interest for Swap Dealers, Major Swap Participants, Futures Commission Merchants, and Introducing Brokers

At its February 23, 2012 open meeting, the CFTC approved its first set of final internal business conduct standards for swap dealers and major swap participants (SD/MSPs), futures commission merchants (FCMs) and introducing brokers (IBs). Among the provisions is a final rule establishing conflicts of interest policies.

Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management

At its March 20, 2012 open meeting, the CFTC approved a final rulemaking that outlines certain "industry best practices" such as documentation, the handling of orders submitted for clearing, time frames for submission for clearing, allocation of bunched orders, and clearing member risk management.

CFTC Proposed Rules

Swap Entities Proposal from November 10, 2010 CFTC Meeting

Requirements for DCMs, DCOs, and SEFs Regarding the Mitigation of Conflicts of Interest

In this proposed rule, three areas of decision making in which the governing body of a DCO may encounter conflicts of interest are identified:

• whether a swap contract is capable of being cleared;
• the minimum criteria that an entity must meet in order to become a swap clearing member; or
• whether a particular entity satisfies such criteria.

For DCMs and SEFs, areas of potential conflict of interest were identified as issues regarding "balancing the advancement of commercial interests and the fulfillment of self-regulatory responsibilities, including with respect to determinations on access." To mitigate potential conflicts of interest, the commission proposed:

• structural governance requirements specifying the composition of Boards of Directors, risk management and regulatory oversight committees; and
• ownership and voting rights specifying an that an individual member may not own more than 20% of ownership or voting equity.

Swap Entities Proposal from December 9, 2010 CFTC Meeting

Governance Requirements for DCOs, DCMs, and SEFs; Additional Requirements Regarding the Mitigation of Conflicts of Interest

Under the proposed rule, the Commission would proposes the following regulations:

• Each DCO must report to the Commission when its board rejects a recommendation from or supersedes an action of the Risk Management Committee.
• Each DCM or SEF must report to the Commission when its board rejects a recommendation from or supersedes an action of the Regulatory Oversight Committee or the Membership or Participation Committee.
• Each DCO, DCM, or SEF must implement programs and monitor existing and potential conflicts of interest.
• Each DCO, DCM, or SEF must prescribe limits on the use or disclosure of non-public information by owners, members of the board, members of any committee, officers or other employees and make certain information on governance arrangements available to the public.

Swap Entities Proposal from February 24, 2011 CFTC Meeting

Requirements for Processing, Clearing, and Transfer of Customer Positions

In this proposed rule, the functions and objectives of Derivatives Clearing Organizations (DCOs), including Core Principle F (Treatment of Funds) are further clarified. In addition, the proposed rule specifies:

• If a swap is subject to mandatory clearing,the swap dealer or major swap participant must submit the swap for clearing no later than the close of the business day.
• If the swap is not subject to mandatory clearing, it must, if cleared, be submitted no later than the business day following the swap transaction.
• Swap Execution Facilities (SEFs) and Designated Contract Markets (DCMs), must submit swaps immediately upon execution.

Swap Entities Proposal from July 19, 2011 CFTC Meeting

Customer Clearing Documentation and Timing of Acceptance for Clearing

Under this proposal, certain swap entities - futures commission merchants, swap dealers and major swap participants - would be prohibited from entering into an arrangement with their customers that would disclose the identity of a customer’s original executing counterparty. The entities would be prohibited from:

• limiting the number of counterparties with whom a customer may enter into a trade;
• restricting the size of the position a customer may take with any individual counterparty, apart from an overall credit limit for all positions held by the customer;
• impairing a customer’s access to execution of a trade on terms that have a reasonable relationship to the best terms available; and
• preventing compliance with specified time frames for acceptance of trades into clearing.

SEC Proposed Rules

Swap Entities Proposal from October 13, 2010 SEC Meeting

Ownership Limitations and Governance Requirements for SBS Entities Regarding the Mitigation of Conflicts of Interest

The ownership limitations proposal would set one of the following alternatives for SBS clearing agencies:

• "Restrict an individual clearing agency participant from beneficially owning or voting more than 20 percent of any voting interest in the security-based swap clearing agency;
• Restrict clearing agency participants from beneficially owning or voting more than 40 percent of any voting interest in the security-based swap clearing agency in the aggregate with any other clearing agency participants;
• The board of directors and any committee that has authority to act on behalf of the board be composed of 35 percent of independent directors;
• The nominating committee be composed of a majority of independent directors;"

or

• "Restrict an individual clearing agency participant from beneficially owning or voting more than 5 percent of any voting interest in the security-based swap clearing agency;
• The board of directors and any committee that has authority to act on behalf of the board be composed of a majority of independent directors;
• The nominating committee be composed solely of independent directors.

Swap Entities Proposal from March 2, 2011 SEC Meeting

Clearing Agency Standards for Operation and Governance

Under the proposed rule, clearing agencies would be required to:

• "maintain certain standards with respect to risk management and operations;
• have adequate safeguards and procedures to protect the confidentiality of trading information;
• have procedures that identify and address conflicts of interest;
• require minimum governance standards for their boards of directors;
• designate a chief compliance officer; and
• disseminate pricing and valuation information if they perform central counterparty services for security-based swaps."

References

1. ↑ Open Meeting on Three Final Rule Proposals and Two Proposed Rules under the Dodd-Frank Act. CFTC. Retrieved on July 19, 2011.