CFTC/SEC Joint Final Rule on Swap Entity Definitions

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Gavel.png FINAL RULE: Joint CFTC/SEC Final Rule approved at April 18, 2012 open meeting
Dodd-Frank Timeline, Further Defining “Swap Dealer,” “Major Swap Participant” and “Eligible Contract Participant”
Final Rule Issue Effective Date Compliance Date
May 23, 2012 July 23/Dec. 31, 2012 October 12, 2012
Dodd-Frank Timeline, Swap Product Definitions
Final Rule Issue Effective Date Compliance Date
August 13, 2012 October 12, 2012 October 12, 2012

At its April 18, 2012 open meeting the CFTC approved a final joint rulemaking on the further definitions of "swap dealer," "major swap participant," "security-based swap dealer," "security-based major swap participant" and "eligible contract participant." The final rulemaking appeared in the Federal Register on May 23, 2012. The effective date for regulation is July 23, 2012, except CFTC Rule 1.3(m)(8)(iii), which requires registration of commodity pool operators, will be required for commodity pools formed on or after December 31, 2012.<ref>CFTC and SEC Finalize Key Dodd-Frank "Entity Definitions". Sidley Austin LLP. Retrieved on May 23, 2012.</ref>


The Dodd-Frank Act gives the SEC jurisdiction over "security-based" swaps, and jurisdiction to the CFTC on all other swaps, except for a category known as "mixed swaps" which may have both security-based and non-security-based components. For mixed swaps, the two agencies will have joint oversight responsibilities.

The Dodd-Frank Act defines swap dealers or "security-based" swap dealers as persons who:

  1. hold themselves out as a dealer in swaps or security-based swaps;
  2. make a market in swaps or security-based swaps;
  3. regularly enter into swaps or security-based swaps with counterparties as an ordinary course of business for their own account; or
  4. engage in activity causing themselves to be commonly known in the trade as a dealer or market maker in swaps or security-based swaps.

There are three parts to the definition of "major swap participant" or “major security-based swap participant” under the Dodd-Frank Act. A person who satisfies any one of them is a major swap participant or major security-based swap participant:

  1. A person who maintains a “substantial position” in any of the major swap or security-based swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan.
  2. A person whose outstanding swaps or security-based swaps create "substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets."
  3. Any "financial entity" that is "highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency" and that maintains a “substantial position” in any of the major security-based swap categories.

Title VII further provides that the SEC and the CFTC, in consultation with the Board of Governors of the Federal Reserve System, must work jointly to further define the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant” and “eligible contract participant.” <ref>Definitions Contained in Title VII of Dodd-Frank Wall Street Reform and Consumer Protection Act. Federal Register. Retrieved on March 18, 2011.</ref>

Summary of the Rulemaking[edit]

To determine whether an indivudual is a "swap dealer," one must first apply the four-step statutory test above. Next, the individual should follow the interpretive guidance contained in the rulemaking, which take into consideration "all relevant facts and circumstances, and focus on the activities of a person that are usual and normal in the person's course of business and identifiable as a swap dealing business."

For example, the guidance provides that market making is appropriately described as "routinely standing ready to enter into swaps at the request or demand of a counterparty, and it clarifies that it is possible for a person making a one-way market in swaps to be a market maker." On whether a person’s swap activity constitutes “a regular business,” and is therefore potentially indicative of swap dealing, the guidance focuses on activities that are usual and normal in the person’s course of business and identifiable as a swap dealing business.For security-based swaps, the SEC's dealer-trader distinction may also be applied.

Exclusions and Exemptions[edit]

  • Entering into a swap in certain situations for the purpose of hedging a physical position is not swap dealing. The hedging exemption covers swaps traded for the purpose of mitigating or offsetting price risks.
  • The swap dealer determination excludes swaps between majority-owned affiliates, and swap transactions among a cooperative – including agricultural cooperatives and cooperative financial institutions – and its members.
  • Dodd-Frank also allows an exemption for a person who “engages in a de minimis quantity of swap dealing in connection with transactions with or on behalf of its customers.” To qualify for the de minimis exemption, the aggregate gross notional amount in a 12-month period must not exceed:
    • $150 million for security based swaps that are not credit default swaps (CDS);
    • 25 million for swaps with pensions and municipals (so-called "special entities,"); and
    • $3 billion for CDS and all other swaps.

Note: The thresholds will begin at higher levels - $8 billion for swaps and $400 million for security based swaps - and will be phased in. After two and a half years' worth of data has been supplied to swap data repositories, the staff will conduct a study and, depending on the results, may end the phase-in period, or propose new rules to change the de minimis threshold.

Major Swap Participants[edit]

In order to determine which entities will be considered a"major swap participant" (MSP), the agencies must define several terms included within the statutory definition of an MSP:

  • Substantial Position: a two-part test measuring current and future uncollateralized exposure;
  • Hedging or Mitigating Commercial Risk
  • Substantial Counterparty Exposure
  • Eligible Contract Participant (ECP)
  • Financial Entity
  • Highly Leveraged

The final definitions of these terms are detailed on the Swaps Definitions Regulation page.

Finally, the rules highlight three "safe harbors" to relieve market participants of daily calculations:

  1. Total uncollateralized exposure of less than $100 million to all swap counterparties, and maintaining of a notional swap value less than than $2 billion in any major category of swaps, or $4 billion in aggregate;
  2. Total uncollateralized exposure of less than $200 million, and performing a monthly calculation of swap positions indicating a level of no more than one-half of the level of current exposure plus potential future exposure that would cause the person to be a major swap participant; and
  3. Each of those monthly calculations indicate that the person’s swap positions in each major category of swaps are less than one-half of the substantial position threshold.

Related Documents: Fact Sheet, Q&A, and Federal Register Entry[edit]


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