CFTC Finalizes Definitions
On April 18, 2012 the CFTC finalized the definition of swap dealer (“SD”), major swap participant (“MSP”) and eligible contract participant (“ECP”) in a joint rulemaking with the SEC.
CFTC Defines “Swap Dealer”
Under the CFTC's final rule, a “swap dealer” is defined as any person who:
- holds itself out as a dealer in swaps;
- makes a market in swaps;
- regularly enters into swaps with counterparties as an ordinary course of business for its own account; or
- engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps.
The final rule includes important exclusions—including the so-called “de minimis” exemption. To qualify for the exemption, the aggregate gross notional amount of the swaps that the person enters into over the prior 12 months in connection with dealing activities must not exceed $3 billion. However, the rule provides for a phase-in of the de minimis threshold. During the phase-in period, the de minimis threshold is $8 billion. Two and one-half years after data starts to be reported to swap data repositories, CFTC staff will prepare a study of the swap markets. Nine months after this study, the CFTC may end the phase-in period, or propose new rules to change the de minimis threshold (either up or down). If the CFTC does not take action to end the phase-in period, it will terminate automatically five years after data starts to be reported to swap data repositories.
CFTC Defines “Major Swap Participant”
Under the CFTC’s final rule, a “major swap participant” is defined to include:
- any person that maintains a “substantial position” in any of the major swap categories;
- any person whose outstanding swaps create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the US banking system or financial markets;” or
- any “financial entity” that is “highly leveraged relative to the amount of capital such entity holds” and that is not subject to capital requirements established by a federal banking agency and that maintains a “substantial position” in any of the major swap categories.
The two “substantial position” tests account for both current uncollateralized exposure and potential future exposure. A position that satisfies either test would be a “substantial position.” Importantly, the definition of substantial position excludes positions “hedging or mitigating commercial risk” (and employee benefit plan positions), and the tests apply to a firm’s swap positions in each of four major swap categories: rate swaps, credit swaps, equity swaps and commodity swaps.
The “substantial counterparty exposure” test uses a calculation that is the same as the method used to calculate substantial position, but substantial counterparty exposure includes all categories of swaps and does not exclude hedging or employee benefit plan positions. The thresholds as adopted for substantial counterparty exposure are a current uncollateralized exposure of $5 billion, or a sum of current uncollateralized exposure and potential future exposure of $8 billion, across the entirety of a person’s swap positions.
CFTC Defines “Eligible Contract Participant”
Dodd-Frank amended the definition of “eligible contract participant”by: (1) providing that, for purposes of retail forex transactions, the term ECP does not include a commodity pool in which any participant is not himself an ECP; (2) raising the monetary threshold that governmental entities may use to qualify as ECPs from $25 million to $50 million in investments owned and invested on a discretionary basis; and (3) replacing the “total asset” standard for individuals to qualify as ECPs with an “amounts invested on a discretionary basis” standard.
The final rule adopted by the CFTC and SEC further defined ECP as follows:
- A commodity pool can qualify as an ECP under several tests even if some of its investors are not ECPs, provided that the pool was not structured to permit non-ECPs to engage in retail forex transactions; and
- An entity, which is not otherwise qualified as an ECP, will be treated as an ECP for purposes of a swap that is used to hedge or mitigate a commercial risk in connection with its line of business, provided that all the owners of such entity are themselves ECPs.