The rules will ultimately determine what OTC derivatives will have to be traded on electronic platforms and cleared. The CFTC also voted to propose capital requirements for non-bank swap dealers.
In the latest round of hearings to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC and CFTC commissioners separately voted on one set of proposals, which will classify the vast majority of swaps as such, changing the way the contracts are traded and cleared.
Market participants have 60 days to comment on the proposals.
“The proposed definitions balance several policy and legal issues in a way I believe is practical, takes into account the specific nature of derivatives contracts, and is consistent with existing securities regulations,” said SEC chairman Mary Schapiro.
“The proposal seeks to provide guidance in rules and interpretations by using clear and objective criteria that should clarify whether a particular instrument is a swap regulated by the CFTC, a security-based swap regulated by the SEC, or a mixed swap regulated by both agencies.”
What’s in, what’s out
The two agencies have defined swaps to include those on interest rates, commodities, currencies and equities, as well as credit default swaps, non-exchange-traded FX options, commodity options, non-deliverable FX forwards, cross-currency swaps, forward rate agreements, contracts for difference, and options to enter into swaps and forward swaps. These products will all have to be traded on an exchange or swap trading facility and cleared by a central counterparty, unless an exemption applies.
However, work is still needed to determine what to do about currency swaps and forwards. Under the agencies’ plans, they would be mandated to be traded and cleared unless US treasury secretary Tim Geithner exempts them – which he is under market pressure to do.
Should these products be exempted, they will still have to be reported to a data repository and dealers will be held to business conduct rules.
The regulators have also proposed a rule that would give them the authority to prosecute any firm that structures a regulated swap contract as a currency swap or forward to avoid the rules.
A few exempt contracts will not be subject to these requirements, to the relief of the market. Several insurance products, as well as consumer and commercial transactions, will be exempt from being classified as swaps.
Critically for the commodity markets, commodity forwards are not regarded as swaps. This exemption is a victory for market participants, who had argued that the costs of physical goods would rise if these contracts were treated strictly.
While the SEC commissioners approved the definition unanimously, there was one dissenting voice at the CFTC. Commissioner Jil
Sommers voted against the proposal, saying the CFTC was “exceeding its mandate”.
Capital requirement set
The CFTC also approved a proposal outlining how much minimum capital would be needed by firms deemed non-bank swap dealers and major swap participants, classifications which have already been defined, should they wish to be active. Under the CFTC’s plan, dealers and major swap participants would need at least $20m of Tier 1 capital.
This time, Commissioner Scott O’Malia voted against the deal. He said he believed imposing a capital requirement exceeded the Dodd-Frank Act and that the figure was too high for non-bank swap dealers.
“A non-bank, non-futures commission merchant swap dealer is an entity that generates the overwhelming majority of its income from commercial activity and engages in a de minimis amount of ‘swap dealing’,” O’Malia said.
"I predict this capital rule, combined with the broad swap dealer definition, will drive commercial firms that pose little, if any, systemic risk to the financial system out of the market-making business and concentrate the entire swap dealing business in Wall Street banks.
“Higher costs and less competition for commercial end users is not a proposition I favour.”
Like the swap definition proposal, the capital requirement plan will now be opened to the public for a comment period before the CFTC votes on whether to pass it into law.
Colin Packham, Sydney cpackham@fow.com
This story is from Futures and Options Intelligence, to get daily news updates direct to your inbox, sign up to FOi