Firms Gauge Extent of Dodd-Frank Regulatory Risk

Terry Flanagan

Uncertainty over the scope of Dodd-Frank legislation is swirling as regulators flesh out the final details of rules covering swaps execution, clearing and reporting.

The Commodity Futures and Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) have approved final rules and interpretations for key definitions of certain derivative products.

The rules and interpretations further define the terms “swap” and “security-based swap” and whether a particular instrument is a “swap” regulated by the CFTC or a “security-based swap” regulated by the SEC.

The rules also address “mixed swaps”, which are regulated by both agencies, and “security-based swap agreements”, which are regulated by the CFTC but over which the SEC has anti-fraud and other authority.

The rules and interpretations written implement provisions of the 2010 Dodd-Frank Act that established a comprehensive framework for regulating over-the-counter derivatives.

“Now that the definitions are final, then my clients, who are derivatives end users, will need to figure out which transactions are ‘swaps’,” said Andie Kramer, partner and head of the financial products, trading and derivatives group at law firm McDermott Will & Emery.

“They will also need to figure out what’s required from a reporting and recordkeeping standpoint.”

The final product definition rules and interpretation will set in motion an “implementation chain reaction”, CFTC commissioner Scott O’Malia said in a statement.

Nearly a dozen rules will go into effect 60 days after the final rule and implementation is published in the Federal Register, including relating to the registration of swap dealers and major swap participants; internal and external business conduct standards; swap dealer and major swap participant reporting and recordkeeping obligations; and position limits for swaps.

“I predict many companies will find the registration and compliance schedule to be very aggressive and quite challenging,” O’Malia said.

The CFTC in April issued final rules providing critical definitions such as “swap dealer”, “major swap participant” and “eligible contract participant”.

The final rules significantly relaxed the threshold for firms to engage in hedging without being classified as swap dealers.

Under the final rule, the CFTC raised the threshold to $8 billion over a 12-month period throughout a two-and-a-half year phase-in period, during which time the CFTC will conduct a study of swap data that’s reported to swap data repositories.

“Most worrisome to end users is whether they will be considered a dealer, because the dealer definition is so broad,” said Kramer at McDermott Will & Emery. “They will need to track all transactions to see which ones will be considered swaps and which will qualify for the de minimum exception.”

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