The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have this week finally provided some long sought after clarity regarding the definition of what classifies as a “swap” and hence should be covered by the new and incoming Dodd Frank derivatives requirements. These definitions should also provide some of the foundations on which new derivatives identification standards can be built, in line with the regulators’ recent joint study work on the feasibility of algorithmic descriptions.
SEC chairman Mary Schapiro explains: “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. 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.”
The SEC therefore voted unanimously and the CFTC voted 4-1 to propose rules further defining the terms “swap,” “security-based swap,” and “security-based swap agreement,” as well as proposing new rules regarding “mixed swaps” and books and records for “security-based swap agreements”. Instruments defined as swaps under Dodd Frank are subject to new data requirements, must trade either on exchange or swap execution facilities, and are required to be centrally cleared. As for regulatory jurisdiction, the rule indicates that the SEC will regulate “security-based swaps,” the CFTC will regulate other “swaps,” and the CFTC and the SEC will jointly regulate “mixed swaps.”
Most of the existing swap products and transactions fall under the definition of “swaps” in the regulators’ recently issued proposals. According to the SEC proposals, foreign exchange forwards, foreign exchange swaps, foreign currency options (other than foreign currency options traded on a national securities exchange), non-deliverable forward contracts involving foreign exchange, currency and cross currency swaps, forward rate agreements, contracts for differences, and certain combinations and permutations of (or options on) swaps and security-based swaps all fall under the “swaps” or “security-based swaps” category.
CFTC chairman Gary Gensler explained: “This rule is consistent with that detailed definition and Congressional intent. For example, interest rate swaps, currency swaps, commodity swaps, including energy, metals and agricultural swaps, and broad-based index swaps, such as index credit default swaps, are all swaps. Consistent with Congress’s definition of swaps, the rule also defines options as swaps.”
As for those products that fall outside of this remit, insurance products, security forwards and consumer (such as agreements, contracts and transactions related to personal services, for example) and commercial (such as employment contracts) transactions fall outside of both categories, according to the SEC. The full list of instruments and definitions are available to view on the SEC website here.
However, there are a number of points of difference between the two regulators with regards to swaps, as noted by CFTC commissioner Scott O’Malia during the roundtable on the subject this week (a frequent talking head on the subject of data standards). “I think the public will be surprised that this rulemaking is over 300 pages in length and by the number of differences that still exist between the two commissions with respect to insurance products, foreign sovereign debt instruments, and swap indexes. I have a particular concern about the anti-evasion proposal, and how the commission will conduct its analysis and implement this provision going forward,” he said.
The differences therefore include: how to tackle anti-evasion procedures; whether insurance on swaps should also be regulated as swaps; how to tackle the swaps linked to certain foreign sovereign debt instruments; and issues related to index credit default swaps (CDSs). Gensler stated this week that he would leave it up to the industry to provide feedback on these issues before action is taken.
To this end, the industry now has 60 days after the proposals have published in the Federal Register in which to provide feedback. Moreover, the CFTC has also indicated that it is reopening the comment period for many of the rules it has already proposed for a period of 30 days. Gensler said: “With the substantial completion of the proposal phase of rule-writing, the public now has the opportunity to review the whole mosaic of rules. This will allow market participants to evaluate the entire regulatory scheme as a whole.”