The Commodity Futures Trading Commission (CFTC) Wednesday narrowly voted out a much-anticipated joint proposal with the Securities and Exchange Commission (SEC) defining "swap dealers" and "major swap participants."
The proposal cleared the Commission by 3-2, with Commissioners Scott O'Malia and Jill Sommers dissenting. The SEC is expected to act on the proposal Friday and then send it to the Federal Register.
"I do think this proposal strikes the right balance," said CFTC Chairman Gary Gensler. "We didn't just rely on a narrow bona fide hedging definition."
O'Malia disagreed. "The 145-page proposed rule does not provide the regulatory certainty that I believe many market participants are seeking, particularly commercial end-users. In fact, I have concerns that many end-users will be unintentionally swept up in the dealer definition and be subject to significantly higher costs to hedge their commercial risk," he said.
"I strongly encourage the market to comment on the proposal establishing what I perceive as a very limited de minimis standard for swap dealing conduct that will result in few exemptions...The final swap dealer rule can be significantly improved by providing greater specificity to the dealer definition, and considerably narrowing the definition to focus only on those entities that perform traditional dealer roles," O'Malia said.
"In addition to my overall concern that the definition of swap dealer is too broad and will likely capture entities that do not functionally operate as dealers, I am struck by another provision of this proposed regulation that I think is bad policy...I fear the construct and the proposal regulation will needlessly impose onerous requirements on market participants and I cannot support it," Sommers said.
The joint CFTC-SEC proposal defines a "swap dealer" as a person who holds itself out as a dealer in swaps; makes a market in swaps; regularly enters into swaps with counterparties as an ordinary course of business for its own account; or engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps.
The Dodd-Frank Wall Street Reform Act requires swap dealers and "major swap participants" (MSP) to clear their swaps, but it provides a de minimis exemption for companies that use over-the-counter (OTC) derivatives to mitigate their commercial risk.
To qualify for the exemption, the joint proposal said the trading in swaps over a 12-month period must be limited to a aggregate notional amount not exceeding $100 million, of which no more than $25 million can be with "special entities," such as government agencies; the person must not enter into swaps with more than 15 counterparties, other than security-based swap dealers, over the prior 12 months; and a person must not enter into more than 20 swaps over the prior 12 months. The de minimis proposal requires that a person meet all of the conditions.
The Dodd-Frank Act subjects MSPs to the clearing requirements because their market size is so large they pose a systemic risk. Dodd-Frank provides a three-part definition for MSPs. A person that satisfies any one of them is an MSP, according to the CFTC:
The CFTC and SEC proposed two thresholds for "substantial positions." The first measures only a person's current uncollateralized exposure with respect to swap positions. It would have a daily average current uncollateralized exposure of $1 billion in the applicable major category of swaps, except the threshold for the rate swap category would be $3 billion, according to the CFTC.
The second threshold would measure both the current uncollateralized exposure and the potential future exposure associated with a person's swap positions. It would have $2 billion in daily average current uncollateralized exposure, and a rate swap exposure of $6 billion, the CFTC said.
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