Enter to open, tab to navigate, enter to select
CFTC Sends Mixed Signals on Lowering Swap Dealer Threshold
Practical Law Legal Update w-003-1202 (Approx. 6 pages)
CFTC Sends Mixed Signals on Lowering Swap Dealer Threshold
by Practical Law Finance
| Published on 18 Aug 2016 • USA (National/Federal) |
The CFTC released its final staff report and recommendations on the de minimis swap dealer exception under Title VII of the Dodd-Frank Act and CFTC rules. Barring CFTC action, the de minimis swap dealer exception is set to automatically lower from $8 billion to $3 billion at the end of 2017.
On August 15, 2016, the CFTC released its final staff report on the de minimis swap dealer (SD) exception under Title VII of the Dodd-Frank Act and CFTC rules. Barring CFTC action, the de minimis swap dealer exception is set to automatically lower from $8 billion annual notional to $3 billion at the end of 2017.
However, the CFTC concludes in the final report that lowering the requirement to register as a swap dealer from the current $8 billion notional threshold of swap dealing activity to $3 billion, as contemplated, would subject less than 1% of additional notional activity and swap transactions, and less than 4% of additional unique counterparties, to SD regulation.
The CFTC concludes that a substantial change would only come from lowering the threshold to $1 billion, which would potentially captures an additional 265 SDs, 15,294 transactions, and 1,608 unique counterparties. Similarly, if the threshold were to be raised, CFTC data suggested that a substantial change would come from an increase to $100 billion, not to $15 billion.
Currently, market participants that exceed $8 billion in gross notional swap dealing activity over a 12-month period must register as a swap dealer with the CFTC (see US Derivatives Regulation: Swap Dealer and MSP Threshold Calculations). Registered SDs must comply with a variety of regulations designed to reduce systemic risk, increase customer protections, and promote market integrity within the financial system (see Practice Note, The Dodd-Frank Act: Requirements for Swap Dealers and MSPs Checklist).
Absent any action to amend the de minimis exception, the threshold for registration as a swap dealer will drop to $3 billion notional in December 2017.
The final report recommends that the CFTC consider one of three options for the de minimis swap dealer threshold:
- Permanently set the de minimis threshold at the current $8 billion.
- Phase in a reduction in the de minimis threshold to $3 billion.
- Delay the reduction in the de minimis threshold to allow for the collection and improvement of data in order to better determine an appropriate de minimis threshold.
The CFTC does not provide any indication as to which of these courses of action it plans to take. The CFTC seems likely to allow for more data to be collected before making a final decision.
The final report follows a preliminary report issued on November 18, 2015, which sought public comment on the de minimis threshold (see Legal Update, CFTC Seeks Public Comment on Lowering Swap Dealer Threshold).The final report supplements the preliminary report, providing further data analysis and recommendations on whether to amend the de minimis exception.
Preliminary Report Findings
The analysis in the preliminary report covered data from the following asset classes over a period of 12 months (April 1, 2014 through March 31, 2015): interest rate swaps (IRS), credit default swaps (CDS), non-financial commodity swaps, foreign exchange derivatives (FX Derivatives), and equity swaps.
Applying certain assumptions due to key information missing in order to approximate total notional dealing activity, the CFTC found that the potential dealing activity appeared to be concentrated among a limited number of entities across all asset classes studied.
The CFTC also determined that only a substantial increase or decrease in the de minimis threshold would have a significant impact on the amount of IRS or CDS activity covered by swap dealer regulation. For example, the CTFC modeled the following impacts from either lowering or raising the de minimis threshold:
Threshold | Registered Swaps Dealers | IRS/CDS Activity Impacted |
$3 billion | 83 additional entities | <2% additional IRS/CDS coverage |
$15 billion | 22 fewer entities | <1% decreased IRS/CDS coverage |
The preliminary report also found that under the current $8 billion de minimis threshold, a majority of all swap transactions included a registered SD as a counterparty. For the IRS and CDS asset classes, more than 95% of swaps included an SD while 93%, 90%, and 78% of equity swaps, FX Derivatives, and non-financial commodity swaps, respectively, included a registered SD as a counterparty.
Final Report Findings and Recommendations
In preparing the final report, the CFTC analyzed an additional one-year period of data to provide a comparison to the preliminary report. This period covered April 1, 2015 through March 31, 2016. The CFTC analyzed swap activity in IRS, CDS, and non-financial commodity swap asset classes during this period. The same data limitations and assumptions made in the preliminary report were again applied.
In its analysis of adjustments made to the de minimis threshold, the CFTC found the results consistent with those in the preliminary report: Only a substantial increase or decrease in the de minimis threshold would have an appreciable impact on the amount of IRS and CDS activity, as measures by notional amount, transactions, or unique counterparties.
The chart below, from the final report, shows that if the threshold were lowered to $3 billion, less than 1% of additional notional activity and swap transactions, and less than 4% of additional unique counterparties, would be potentially covered by SD regulation. A meaningful change would only come from lowering the threshold to $1 billion, where an additional 265 SDs, 15,294 transactions, and 1,608 unique counterparties would be captured by the lower threshold.
The same is true in a scenario where the threshold was raised to $15 billion as compared to a raise to $100 billion. If the threshold were raised to $15 billion, the final report estimates that approximately 34 fewer entities trading in IRS and CDS might need to register as an SD, resulting in a decrease in covered of less than 1% of notional activity, swap transactions, and unique counterparties.
Gross Notional Amount of IRS/CDS (in USD Billions) Greater Than | Potential Swap Dealing Entities/Change | Total Notional Amount (in USD Billions)/Change from $8 Billion Threshold | Total Transactions/Change from $8 Billion Threshold | Unique Counterparties/ Change from $8 Billion Threshold |
1 | 410/+265 | 146,532/666 | 1,203,628/15,294 | 23,862/1,608 |
3 | 229/+84 | 146,231/365 | 1,195,872/7,538 | 23,075/821 |
8 | 145/N/A | 145,866/N/A | 1,188,334/N/A | 22,254/N/A |
15 | 111/-34 | 145,526/-340 | 1,181,986/-6,348 | 22,110/-144 |
100 | 62/-83 | 143,770/-2,096 | 1,153,568/-34,766 | 19,673/-2,581 |
The final report also discusses the following:
- Swaps executed on a SEF or DCM and/or cleared. The preliminary report considered and invited public comment on whether swaps that are executed on a registered swap execution facility (SEF) or designated contract market (DCM), and/or cleared by a registered derivatives clearing organization, should be excluded from de minimis threshold calculations. Currently, these swaps are not excluded from de minimis threshold calculations. The CFTC notes in the final report that it was unable to comprehensively evaluate the following factors: the effectiveness of clearing mandates; margin requirements on uncleared swaps; and, capital requirements in connection with the oversight of SDs. These factors could potentially have a significant impact on the implementation of the exclusion, and therefore the final report recommends further study.
- IDI exclusion. The final report discusses comments received on the preliminary report on whether the CFTC should reconsider the parameters for the exclusion of swaps entered into by insured depository institutions (IDI exclusion). The CFTC generally received comments in favor of expanding the IDI exclusion. Commentators explained that an expansion would provide banks with greater flexibility and better align the IDI exclusion with current lending practices.
- Alternative threshold formulations. The preliminary report considered and invited public comment on both the establishment of a multi-factor de minimis threshold test and the use of a different de minimis notional threshold by asset class. In both cases, the CFTC concluded that a multi-factor de minimis threshold and different de minimis threshold based on asset class would be counterproductive based on the comments received and the data reviewed. Commentators were generally against the establishment of a multi-factor threshold approach. Additionally, based on the data reviewed, the CFTC found that most swap activity for the asset classes studied would be subject to SD regulation at the current de minimis threshold.