Derivatives — Several Developments of Note

EU TO BAN NAKED SOVEREIGN CDS: 

After much debate, the European Union voted on October 18 to ban naked credit default swaps (CDS) referencing European sovereign entities. Naked credit default swaps are CDS purchased by entities that do not own the underlying obligation referenced in the CDS and are thus not purchasing CDS to hedge an underlying obligation held in portfolio. The ban will not apply to market makers and primary dealers. Additionally, individual European countries will be able to suspend the ban subject to certain conditions and restrictions. As part of the ban, traders in CDS will be obligated to enact new reporting regimes to enforce the ban. As part of this initiative, the EU also granted power to national regulators to ban short selling of sovereign debt, and to the European Securities and Market Authority to ban short selling of equities in extreme circumstances. While the CDS proposal requires the further approval of the European Council and European Parliament, the ban is expected to become effective on or about November 1, 2012.

CFTC ADOPTS FINAL RULE ON POSITION LIMITS FOR FUTURES AND SWAPS:

On October 18, 2011, the Commodity Futures Trading Commission (CFTC) voted to adopt the final rules on establishing speculative limits on certain physical commodity contracts and “economically equivalent” futures, options and swaps. The CFTC will generally set the spot-month position limits at “25% of estimated deliverable supply,” applied separately for physical-delivery and cash-settled contracts except that position limits for cash-settled NYMEX Henry Hub Natural Gas contracts will be set at “five-times the limit that applies to the physical-delivery NYMEX Henry Hub Natural Gas contract.” As for the non-spot-month position limits, which include “limits applied to positions in all contract months combined or in a single contract month,” the position limits will be set at “10 percent of the contract’s first 25,000 of open interest and 2.5 percent thereafter.” Such non-spot-month position limits will be “reset biennially based on two years open interest data.” The text of the factsheet on the final rule is available on CFTC’s website by clicking here; and the related Q&A are available by clicking here.

SEC ISSUES PROPOSED RULE TO REQUIRE REGISTRATION OF SECURITY-BASED SWAP DEALERS AND SECURITY-BASED MAJOR SWAP PARTICIPANTS: 

On October 12, 2011, the SEC voted to issue a proposed rule requiring the registration of security-based swap dealers and security-based major swap participants with the SEC. Under the Dodd-Frank Act (Dodd-Frank), the SEC has jurisdiction over security-based swaps which consist of equity swaps and most credit default swaps. The CFTC has jurisdiction over all other swaps. The CFTC proposed its own registration rules for swap dealers and major swap participants last November. The SEC proposed rule will detail the registration requirements for security-based swap dealers and security-based major swap participants which will be similar to the registration process for broker/dealers. Since the definition of security-based swap dealer and security-based major swap participant has not yet been finalized, the rule will contain conditional registration requirements for entities who wish to register on the condition that they will be deemed to be security-based swap dealers and security-based swap participants. The comment period will be 60 days after publication in the Federal Register. A copy of the SEC press release is available by clicking here.