Co-authored by Blake J. Brockway.
On April 18, the Commodity Futures Trading Commission and Securities and Exchange Commission adopted final rules defining swap dealer, major swap participant, and eligible contract participant under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The final rules define “swap dealer” as any person who: (i) holds itself out as a dealer in swaps; (ii) makes a market in swaps; (iii) regularly enters into swaps with counterparties as an ordinary course of business for its own account; or (iv) engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps. The rule excludes persons that enter into swaps for their own account but not as a part of a regular business, insured depository institutions to the extent that they offer to enter into swaps with a customer in connection with originating a loan with that customer, certain hedging swaps, and swaps between majority-owned affiliates.
The rules also provide a de minimis exemption for persons who have over the past 12 months entered into swaps and security-based swaps that are credit default swaps with a notional value of less than $3 billion and swaps with “special entities,” as defined in the Commodity Exchange Act (CEA), with a notional value of less than $25 million. During a phase in period that will last a maximum of five years, the de minimis threshold applicable to swaps and security-based swaps that are credit default swaps will effectively be $8 billion, with the same $25 million limitation for swaps with special entities. For other types of security-based swaps, the final de minimis threshold and the de minimis threshold that applies during the phase in period will be $150 million and $400 million, respectively.
“Major swap participant” has been defined to mean a person who satisfies any one of the following criteria: (i) a person that maintains a “substantial position” in any of the major swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain types of employee benefits plans for hedging or mitigating the risk of the plan; (ii) a person whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking or financial system, or (iii) any financial entity that maintains a “substantial position” in any major swap category and is highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency.
Under the rules, a position qualifies as a “substantial position” if it meets either of two tests. The tests are applied based on a person’s swap positions in each of four major categories: rate swaps, credit swaps, equity swaps, and other commodity swaps. Under the first test, a person has a substantial position if it has a daily average current uncollateralized exposure of at least $1 billion in credit, equity or commodity swaps or $3 billion for rate swaps. Under the second test, a person has a substantial position if its daily average current uncollateralized exposure plus potential future exposure in credit, equity or commodity swaps exceeds $2 billion or $6 billion in rate swaps. The final rules provide specific procedures for calculating average daily uncollateralized exposure.
The definition of “eligible contract participant” (ECP) was expanded to include swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants. The rules also implement a look through requirement for commodity pools that effect transactions in so-called “retail forex transactions.” Under these provisions, a commodity pool that is a counterparty to retail forex transactions generally will not qualify as an ECP if any participant in the pool is not itself an ECP. However, this rule will not apply if: (i) the pool is not formed for the purpose of evading sections 2(c)(2)(B) and 2(c)(2)(C) of the CEA or related rules, regulations or orders; (ii) the pool has total assets exceeding $10,000,000; and (iii) the pool is formed and operated by a registered CPO or by a CPO who is exempt from registration pursuant to CFTC Regulation 4.13(a)(3).