Final Rules Exempting Cleared Security-based Swaps from Securities Laws Issued by SEC | Practical Law

Final Rules Exempting Cleared Security-based Swaps from Securities Laws Issued by SEC | Practical Law

The SEC issued final rules exempting security-based swap transactions cleared through qualifying security-based swap clearinghouses (clearing agencies) from US securities laws.

Final Rules Exempting Cleared Security-based Swaps from Securities Laws Issued by SEC

by PLC Finance and PLC Corporate & Securities
Published on 05 Apr 2012 • USA (National/Federal)
The SEC issued final rules exempting security-based swap transactions cleared through qualifying security-based swap clearinghouses (clearing agencies) from US securities laws.
On March 30, 2012, the SEC adopted final rules exempting nearly all security-based swap (SBS) transactions cleared by SBS clearinghouses known as clearing agencies from:
  • All of the requirements of the Securities Act of 1933 (Securities Act) other than the antifraud provisions of Section 17(a), but including the registration requirements of Section 5.
  • The registration requirements of Sections 12(a) and 12(g) of the Securities Exchange Act of 1934 (Exchange Act).
  • The requirements of the Trust Indenture Act of 1939 (TIA).
The final rules adopted the proposed rules without any modification and cover all cleared SBS, including most cleared credit default swaps (CDS), that are:
  • Cleared by clearing agencies that are either registered with the SEC or exempt from registering.
  • Entered into by eligible contract participants (ECP), as defined under the CEA. Security-based swaps entered into by or with a non ECP are rare and still must be registered with the SEC under the securities laws. Currently, under the CEA, to qualify as an ECP, a business must generally have $5 million in assets and an individual $10 million. (This definition is, however, subject to change under Dodd-Frank,)
The final rules become effective on April 16, 2012.
These final rules supplant the temporary cleared CDS exemptions adopted on January 14, 2009. (Because the temporary cleared CDS exemptions were expected to expire before the final exemptions were adopted, the SEC had extended the temporary cleared CDS exemptions to April 16, 2012 to continue facilitating the clearing of CDS by clearing agencies clearing CDS.)
The final rules effectively exempt almost all cleared SBS from application of the US securities laws. The exemptions are designed to address unintended consequences created by the following Dodd-Frank rules which would make SBS clearing impracticable:
  • Provisions that require certain SBS to be cleared through clearing agencies.
  • Provisions that amend the definition of "security" in the Securities Act and Exchange Act to include SBS (Sections 761(a)(2) and 768(a)(1) of the Dodd-Frank Act that amend Section 3(a)(10) of the Exchange Act and Section 2(a)(1) of the Securities Act, respectively).
Swap clearinghouses (also known as central counterparties or CCPs) that clear SBS are known as clearing agencies under Dodd-Frank. Most major US clearinghouses will ultimately be classified as clearing agencies under Dodd-Frank. When a swap is cleared through a clearinghouse such as a clearing agency, after the swap is entered into, each party to the swap novates the swap agreement to the clearinghouse. This means that the original single swap agreement is replaced by two new swap agreements between:
  • The buyer of the swap and the clearinghouse.
  • The seller of the swap and the clearinghouse.
If these SBS were subject to the securities laws, the entry by the clearing agency into the two new SBS agreements would constitute an issuance of securities by the clearing agency. Depending on the circumstances, this could require registration under the Securities Act and the Exchange Act or require an indenture under the TIA, in addition to other requirements. These requirements would make clearing of SBS impracticable, frustrating a main goal of Dodd-Frank. The final rules eliminate this unintended consequence.
The rules note that uncleared SBS are not covered by these final exemptions. Therefore, uncleared SBS transactions will be subject to the registration and other requirements of the Securities Act, the Exchange Act and the TIA, unless an existing exemption applies. The SEC issued interim final rules on July 1, 2011 providing exemptions for certain uncleared SBS under the Securities Act, the Exchange Act and the TIA (see Dodd-Frank Delay: SEC Issues Further Temporary Securities Law Exemptions for Security-based Swaps). These interim final rules for uncleared swaps remain in effect until the compliance date for final rules defining "security-based swaps" and "eligible contract participant."
For more information on the application of the securities laws to security-based swaps under Dodd-Frank, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Application of Securities Laws to Security-based Swaps.
For more information on the regulation of swaps and derivatives under the Dodd-Frank Act, see Practice Note, Road Map to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: Swaps and Derivatives.
For detailed information on the mechanics of derivatives clearing, see Practice Note, Mechanics of Derivatives Clearing.