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SEC, CFTC Move On US Swap-Related Financial Reforms

by Glen Shapiro,, New York

09 December 2010

The United States Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have proposed joint rules that would further define a series of terms related to the security-based swaps market, and will jointly host a roundtable to discuss issues related to capital and margin requirements for both swaps and security-based swaps.

The rules seek to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which among other things established a comprehensive framework for regulating the over-the counter swaps market. In particular, the Dodd-Frank Act divides regulatory authority over swaps between the SEC and the CFTC.

SEC’s Chair, Mary L. Schapiro, said that the “proposals lay out objective criteria, but they are just a first step, as we seek public comment to help us appropriately address the market impacts and potential risks posed by these entities.”

The SEC has authority over ‘security-based swaps’, which are broadly defined as swaps based on a single security, a loan, or a narrow-based group or index of securities. The CFTC, on the other hand, has primary regulatory authority over all other swaps. The CFTC and SEC share authority over ‘mixed swaps’, which are security-based swaps that also have a commodity component.

Among other things, the Act also authorizes the SEC to provide for the registration and regulation of security-based swap dealers and major security-based swap participants. Dealers and major participants would be subject to several statutory requirements, including those related to capital, margin and business conduct.

The Act 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’.

The joint proposal of the SEC and the CFTC, in part, would add new rules under the Securities Exchange Act of 1934 in connection with the definitions of “security-based swap dealer” and “major security-based swap participant.”

In particular, the Dodd-Frank Act directs the SEC to exempt a person (who otherwise would be deemed a ‘security-based swap dealer) who “engages in a de minimis quantity of security-based swap dealing.” It also directs the SEC to establish factors for determining when someone should be exempt. The proposed rule would therefore require that a person should meet various conditions of maximum dealing activity.

On the other hand, a ‘major security-based swap participant’ will be a person who maintains a substantial position in any of the major security-based swap categories, excluding positions held for hedging or mitigating commercial risk; or whose outstanding security-based swaps create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the US banking system or financial markets.”

It would also include any financial entity that is highly leveraged relative to the amount of capital such entity holds and that maintains a substantial position in any of the major security-based swap categories.

Furthermore, under the Dodd-Frank Act, the SEC has proposed new rules on security-based swap reporting and dissemination, data repositories, conflicts of interest, the reporting of pre-enactment security-based swaps, and strengthening the oversight of investment advisers. Proposed new rules will facilitate the registration of advisers to hedge funds and other private funds with the SEC.

Proposed rules that will also enhance asset backed securities (ABS) disclosure by requiring registered ABS issuers to perform a review of the assets that underlie the ABS, and to disclose the nature, findings and conclusions of that review.

The proposal seeks stakeholder comments, after which the SEC and the CFTC will consider whether to adopt the proposed rules, or modify them.

In addition, both institutions will hold a joint public roundtable to discuss the issues related to capital and margin requirements for swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants, while the CFTC will request comments to assist in the preparation of a study on the feasibility of requiring the derivatives industry to adopt standardized computer-readable algorithmic descriptions that may be used to describe complex and standardized derivatives and calculate net exposures.

A comprehensive report in our Intelligence Report series giving a country-by-country analysis of offshore investment funds, stock exchanges and trusts, with an analysis of the US QI regime, is available in the Lowtax Library at and a description of the report can be seen at
TAGS: investment | law | banking | financial services | hedge funds | United States | regulation | alternative investment | services

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