Title VII creates a framework for the regulation of swap markets. Title VII grants the Commodity Futures Trading Commission (the “CFTC”) regulatory authority over swaps, except for security-based swaps, which are regulated by the Securities and Exchange Commission (the “SEC”). The CFTC and the SEC must also coordinate future swap-related rulemaking to ensure regulatory consistency across both organizations. Subject to limited exceptions, Title VII also requires certain swaps to be cleared by a clearinghouse and executed or an electronic execution facility and imposes registration requires on dealers and major participants, which are entities that engage in very large swap transactions that can significantly impact the health of the U.S. financial system
Title VII provides a framework for the regulation of swap markets, which were in largely responsible for the 2008 financial crisis. Business conduct standards increase transparency and promote market integrity with regard to swap and SBS transactions, consequently lowering the levels of risk inherent to such transactions. Clearing requirements ensure that any risk of loss caused by a defaulting counterparty is absorbed by large, independent institutions. Regulators will be able to make well-informed decisions because they will have increased access to data on swap and SBS markets provided by swap and SBS data repositories. Increased reporting requirements and the availability of pricing information will also lead to greater price efficiencies in swap markets.
Definitions and Regulatory Authority
Title VII grants the CFTC regulatory authority over swaps, except for security-based swaps, which are regulated by the SEC. See 15 U.S.C. § 8302(a). In order to clarify which types of agreements and contracts fall subject to the jurisdiction of the SEC or the CFTC, Title VII directs the SEC and the CFTC to jointly specify the scope of certain terms within the Dodd-Frank Act, such as “swap,” “security-based swap,” “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” “eligible contract participant” and “security-based swap agreement.” See 15 U.S.C.§ 8302(d)(1). Title VII also permits the Secretary of the Treasury (the “Secretary”) to affirmatively determine that foreign exchange products, such as foreign exchange swaps and futures, are excluded from the definition of swaps and thus excluded from the CFTC’s regulatory authority. See 7 U.S.C. § 1a(a)(21)(E). Furthermore, Title VII directs the SEC and the CFTC to coordinate future rulemaking under the Dodd-Frank Act in order to ensure increased regulatory consistency across both organizations. See 15 U.S.C.§ 8302(a).
Title VII directs the CFTC and the SEC to impose new registration requirements on “swap dealers,” “security-based swap dealers,” “major swap participants” and “majorsecurity-based swap participants” because such entities engage in very large swap and security-based swap (“SBS”) transactions that can significantly impact the health of the U.S. financial system. See 7 U.S.C. § 6s(a); see also 15 U.S.C. § 78o-10(a). Title VII amends the Commodity Exchange Act (the “Commodity Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”) to define swap dealers and SBS dealers (collectively, “dealers”) as those who make markets in swaps or SBS’s, or those who regularly trade “swaps” or “SBS’s” in the ordinary course of business for their own account. See 7 U.S.C. § 1a(47); see also Dodd Frank Wall Street Reform and Consumer Protection Act § 761(a)(6). [H1] Title VII provides a registration exemption for dealers that engage in a de minimisamount of swap dealing activity, and directs the CFTC and SEC to promulgate standards clarifying which activities fall within the de minimis threshold. See 7 U.S.C. § 1a(49)(D). Title VII also amends the Commodity Act and the Exchange Act to classify “major swap participants” and “major security-based swap participants” as entities that are not dealers but that engage in swap or SBS trading activities that can substantially impact the health of the U.S. financial system. See 7 U.S.C.§ 1a(33); see also Dodd-Frank Act§ 761(a)(6). [H2] As discussed above, the SEC and the CFTC must jointly define “swap dealer,” “security-based swap dealer,” “major swap participant” and “major security-based swap participant” (collectively, “dealers and major participants”) in order to specify which entities fall subject to the new registration requirements. See 15 U.S.C.§ 8302(d)(1).
Furthermore, Title VII amends the Commodity Act to create electronic swap and SBS execution facilities (collectively, the “electronic execution facilities”), which serve as trading venues for swaps or SBS’s, and which must be registered with the CFTC and the SEC, respectively. See 15 U.S.C.§ 78c; see also 7 U.S.C. § 7b-3.
If the CFTC or the SEC determines that a swap or an SBS is of a type that should be cleared, swaps and SBS’s must be cleared by clearinghouses. See 7 U.S.C. § 2(h); see also 7 U.S.C. 78c-3(a)(1). A clearinghouse is an institution that acts a middleman between two parties engaging in a swap transaction by promising to compensate the non-defaulting party for the transaction in the event that the other party defaults. Any swap or SBS requiring clearing must also be executed on an electronic execution facility, or a designated contract market in the case of a swap or a national securities exchange for in the case of an SBS, unless no such facility makes such a swap or SBS available to trade. See 7 U.S.C. § 2(h)(8)(B); see also 7 U.S.C. § 78c-3(h). Despite much confusion, the SEC and the CFTC have not clarified what it means for a swap or SBS to be “available for trade.” See Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates, Title Vii of the Dodd-Frank Act One Year Later: Piecing Together the Dodd-Frank ‘Mosaic’ for Derivatives Regulation (2011). Also exempted from the execution and clearing requirements is a swap or SBS that involves a non-financial party using the swap or SBS to hedge against commercial risk. See § 7 U.S.C. § 2(h)(7); see also 15 U.S.C. § 78c-3(g).
Margin and Capital Requirements and Business Conduct Standards:
In addition to registration requirements, Title VII also imposes business conduct, capital and margin requirements on dealers and major participants. Title VII subjects dealers and market participants to new internal and external business conduct requirements, such as establishing procedures for detecting internal conflicts of interests and requiring increased disclosures of material information about a swap or SBS to counterparties. See 7 U.S.C. § 6s. For dealers and market participants that are not regulated by “Prudential Regulators,” Title VII requires the CFTC and the SEC to establish margin and capital requirements for swaps and SBS that are not required to be cleared through a clearinghouse. See 7 U.S.C. § 6s(e)(2)(B). The CFTC, SEC and Prudential Regulators must consult with one another at least annually to create comparable requirements. See 7 U.S.C. § 6s(e)(2).
Title VII amends the Commodity Act to require dealers and major participants that are subject to the Dodd-Frank Act’s new registration requirements to also comply with ongoing reporting requirements. See 7 U.S.C. § 2(a). Dealers and major participants must now submit swap and SBS transaction data to regulated and registered swap and SBS data repositories, which process and store the transaction data for the CFTC and SEC to use in analyzing and regulating swap markets. See 7 U.S.C. § 2(a)(13)(G); see also 7 U.S.C. § 24a.
On July 10, 2012, the SEC and the CFTC jointly released final rules, which define “swap,” “security-based swap” and “security-based swap agreement,” and clarify which financial products fall outside of the regulatory authority of the CFTC and the SEC, such as insurance products and consumer and commercial transactions. Furthermore, the Secretary has issued a proposed determination to exempt foreign exchange swaps and forwards from the definition of “swaps,” rendering such foreign exchange products outside of the regulatory authority of the CFTC.