U.S. Regulators Define Swaps, What Falls Under Dodd-Frank

By and | April 27, 2011

U.S. futures and securities regulators unveiled a crucial part of their expanded supervision of the swaps market on Wednesday, by defining what products will be covered by last year’s financial oversight legislation.

The proposals provided the market some long-awaited clarity. Regulators have been criticized for not acting on the definitions rule sooner — making it difficult for everyone from banks and insurance companies to commodity traders to prepare for the new regulations and the impact on their bottom line.

Some have argued it is problematic for regulators to move forward on other regulations for the roughly $600 trillion swaps market without first clearly laying out which products will be covered.

Most existing swap products and transactions would be defined as swaps under the proposal considered by the U.S. Commodity Futures Trading Commission and Securities and Exchange Commission. Products designated as swaps are subject to clearing requirements and must trade on exchanges or swap execution facilities.

Transactions deemed swaps include foreign exchange swaps and forwards, foreign currency options, commodity options, cross-currency swaps, and forward rate agreements, among others.

An exemption would apply to certain insurance products, consumer and commercial transactions, such as a contract to purchase home heating oil and loan participations.

The plan does not regard commodity forward contracts as swaps, providing a relief to physical commodity traders who feared those transactions might face greater regulation and higher costs. Security-based forwards, such as mortgage-backed securities that are eligible to be sold in the “to-be-announced” market, also would be excluded. The SEC voted unanimously to put the definitions out for public comment. The CFTC approved its measure 4-1 with Republican Jill Sommers dissenting on the basis that the agency was exceeding its mandate.

Both regulators got approval from Congress last July in the Dodd-Frank legislation to oversee the opaque over-the-counter derivatives market. “It took us a few extra months, but I think it was time well spent,” said CFTC Chairman Gary Gensler. “It will provide the public greater certainty as to jurisdictional lines without creating gaps in the regulatory oversight.”

Regulators have identified four areas where the CFTC and SEC differ in their plans. They include anti-evasion procedures; insurance on swaps and whether they should be regulated as insurance or swaps; swaps linked to futures on the foreign debt of 21 countries that the SEC has exempted for purposes of futures trading; and issues on index credit default swaps.

Gensler downplayed the gap between the two regulators, saying they were “in near total agreement.”

The regulators moved ahead with their proposals even though Treasury Secretary Timothy Geithner has not issued his decision on whether to exempt foreign exchange swaps and forwards.

If Geithner decides to exempt the contracts, it may force regulators to revamp their plans. Calls to Treasury were not immediately returned.

The swap definitions were just onearea regulators tackled on Wednesday. Other topics on the agenda included capital protection rules at the CFTC, and reducing reliance on credit-ratings at the SEC. The CFTC and SEC have issued first drafts of dozens of regulations to implement the derivatives reforms in the Dodd-Frank law, but until now have not released definitions for swaps products to be covered by the rules.

With most of the proposals out for public comment, the agencies next week will hold a roundtable to discuss the schedule for implementing final swaps rules.

(Reporting by Christopher Doering and Sarah N. Lynch; Additional reporting by Rachelle Younglai; Editing by Tim Dobbyn)

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