Final Rules Defining "Swap Dealer" and "Major Swap Participant" under Dodd-Frank Issued by Regulators | Practical Law

Final Rules Defining "Swap Dealer" and "Major Swap Participant" under Dodd-Frank Issued by Regulators | Practical Law

The CFTC and the SEC issued joint final rules defining the terms "swap dealer," "major swap participant," "security-based swap dealer" and "major security-based swap participant" for purposes of the Dodd-Frank Act, the Commodity Exchange Act (CEA) and the US securities laws. The rules also modify the definition of "eligible contract participant" under the CEA to include swap dealers (SDs), major swap participants (MSPs), security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs).

Final Rules Defining "Swap Dealer" and "Major Swap Participant" under Dodd-Frank Issued by Regulators

by PLC Finance
Published on 19 Apr 2012 • USA (National/Federal)
The CFTC and the SEC issued joint final rules defining the terms "swap dealer," "major swap participant," "security-based swap dealer" and "major security-based swap participant" for purposes of the Dodd-Frank Act, the Commodity Exchange Act (CEA) and the US securities laws. The rules also modify the definition of "eligible contract participant" under the CEA to include swap dealers (SDs), major swap participants (MSPs), security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs).
On April 18, 2012, the CFTC and the SEC issued joint final rules defining the terms "swap dealer," "major swap participant," "security-based swap dealer" and "major security-based swap participant." These rules determine which entities will be subject to heightened oversight under Dodd-Frank swaps rules.
Update: PLC Finance has published a Practice Note detailing the provisions of the joint final rules, which were published in the Federal Register on May 23, 2012.
The final rules specify that a swap dealer is an entity that engages in $8 billion of swap dealing annually. Though significantly higher than the originally proposed $100 million threshold, this definition still covers the major broker-dealers and financial institutions engaging in swap dealing in the US.
A swap dealer is a dealer in non-security-based swaps, which are governed by CFTC regulations. A major swap participant is a major swap participant in non-security-based swaps. Security-based swap dealers and major security-based swap participants are entities that engage in security-based swap activity, which is regulated by the SEC. Non-security-based swaps, referred to as "swaps" under the rules, include interest rate and commodity swaps, while security-based swaps include most single name and narrow-index credit-default swaps (CDS).
These terms are defined for purposes of the Dodd-Frank Act, the Commodity Exchange Act (CEA) and the Securities Exchange Act of 1934.
Persons meeting the definitions of swap dealer, major swap participant, security-based swap dealer and major security-based swap participant will be subject to the following under Title VII of the Dodd-Frank Act:

Definitions of "Swap Dealer" and "Security-based Swap Dealer"

The final rules define "swap dealer" and "security-based swap dealer," as applicable, as a person who engages in any of the following:
  • Holds itself out as a dealer in security-based or non-security-based swaps.
  • Makes a market in security-based or non-security-based swaps.
  • Regularly enters into security-based or non-security-based swaps with counterparties as an ordinary course of business for its own account.
  • Engages in activity causing itself to be commonly known in the trade as a dealer or market maker in security-based or non-security-based swaps.

De Minimis Notional Exception from Swap Dealer Definitions

Once a party satisfies one or more of the four prongs listed above, it may still be exempt from classification as a swap dealer or security-based swap dealer. Excluded from the definitions of swap dealer and security-based swap dealer is any person who engages in a "de minimis" quantity of swap dealing. Therefore, an entity is considered a swap dealer (SD) or a security-based swap dealer (SBSD), as applicable, only if its swap dealing or security-based swap dealing exceeds the following thresholds:
  • For non-security-based swaps, the de minimis exemption from classification as an SD is available to persons who have entered into less than $8 billion in notional amount of non-hedging, non-security-based swap transactions over the prior 12 months.
  • For security-based CDS, the de minimis exemption from classification as an SBSD is available to persons who have entered into less than $8 billion in notional amount of non-hedging CDS transactions over the prior 12 months. For all other types of security-based swaps in the aggregate, the de minimis notional threshold is $400 million.
  • Parties that enter into either security-based or non-security-based swaps with special entities in excess of $25 million notional in the aggregate are also classified as SDs or SBSDs, as applicable. Special entities include:
    • municipalities;
    • other political subdivisions; and
    • employee benefit plans.

Definition of "Major Swap Participant" and "Major Security-based Swap Participant"

Under the final rules, a person who satisfies any of the following three criteria is a major swap participant (MSP) or major security-based swap participant (MSBSP), as applicable:
  • It maintains a "substantial position" in any of the non-security-based swap or security-based swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan. The four non-security-based swap categories are rate swaps, credit swaps, equity swaps and other commodity swaps. The two security-based swap categories are security-based CDS and security-based non-CDS.
  • Its outstanding swaps or security-based swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the US banking system or financial markets.
    • For non-security-based swaps, "substantial counterparty exposure" is defined as current uncollateralized notional exposure of $5 billion or more, or $8 billion or more in current uncollateralized notional exposure plus potential future notional exposure.
    • For security-based swaps, "substantial counterparty exposure" is defined as current uncollateralized notional exposure of $2 billion or more, or $ billion or more in current uncollateralized notional exposure plus potential future notional exposure.
  • It is a financial entity that is "highly leveraged relative to the amount of capital such entity holds" (defined by the rules as having a ratio of total liabilities to equity of 12:1), is not subject to capital requirements established by an appropriate federal banking agency and it maintains a "substantial position," as applicable, in any of the major swap categories, or in security-based CDS or non-CDS security-based swaps.

Definition of "Substantial Position"

  • For MSPs, "substantial position" is defined as daily average current uncollateralized exposure of $1 billion in the applicable major category of swaps ($3 billion for rate swaps) or $2 billion in daily average current uncollateralized exposure plus potential future exposure in the applicable major swap category ($6 billion for rate swaps).
  • For security-based swaps, "substantial position" is defined utilizing two tests. A position satisfying either test qualifies as a substantial position under the rules:
    • daily average current uncollateralized notional exposure of $1 billion in either security-based CDS non-CDS security-based swaps.
    • $2 billion in daily average current uncollateralized notional exposure plus potential future notional exposure in either security-based CDS or non-CDS security-based swaps.

Definition of "Eligible Contract Participant"

The final rules also designate swap dealers, major swap participants, security-based swap dealers and major security-based swap participants eligible contract participants (ECPs) under the CEA, whether or not they would otherwise qualify.
For more information on the final rules, see the CFTC's fact sheet and Q&A and the SEC's fact sheet.
For more information on swap regulation under the Dodd-Frank Act, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives.
For more on swap dealers, major swap participants, security based swap dealers and major security-based swap participants, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap Dealers and Security-based Swap Dealers.