Swap Dealer Definition: Who's In, Who's Out, and What's Next? ��������������� ����������������������� ������������ �������������������������������� Slide 1
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Swap Dealer Definition • Dodd-Frank defines a “swap dealer” as any person that: – holds itself out as a dealer in swaps; – makes a market in swaps; – regularly enters into swaps with counterparties in the ordinary course of its business for its own account; or – engages in any activity causing the person to be commonly known in the trade as a dealer or market- maker in swaps. Slide 3
Swap Dealer Definition • An insured depository institution is not a swap dealer to the extent it offers to enter into a swap with a customer in connection with originating a loan with that customer. • Limited designation: A person may be designated as a swap dealer for a single type or single class or category of swap or activities and considered not to be a swap dealer for other types, classes, or categories of swaps or activities. • Exception: A person that enters into swaps for such person’s own account, either individually or in a fiduciary capacity, but not as a part of a regular business, is not a swap dealer. Slide 4
Swap Dealer Final Rule • The Final Rule provides additional clarity into the definition of swap dealer: • Market-Making: – described as routinely standing ready to enter into swaps at the request or demand of a counterparty; – a person making a one-way market in swaps may be a market maker, and exchange-executed swaps are relevant in the determination; and – does not require a public or contractual commitment; an undisclosed intent to profit from quoting on two sides of the market gives rise to dealer status. Slide 5
Swap Dealer Final Rule • Regular Business: – Does not matter whether swap dealing is a person’s primary business or an ancillary business, so long as the person’s swap dealing business is “identifiable.” – Examples of a “regular business” include: • entering into swaps to satisfy the business or risk management needs of the counterparty, • maintaining a separate profit and loss statement for swap activity, or • allocating staff and resources to dealer-type activities Slide 6
Swap Dealer Final Rule • The SEC's dealer-trader distinction is relevant to swap dealer status. • A swap dealer enters into swaps as a principal; a person entering into swaps as agent would be required to register in another capacity (e.g., as an FCM), depending on the nature of the person’s activity. Slide 7
Exclusions from Swap Dealer Activity • Inter-Affiliate Transactions. Transactions between common majority-owned affiliates do not give rise to swap dealer status. – Although the Final Rule does not require the consolidation of financial statements for affiliates to qualify for the exclusion, the Adopting Release notes that “a majority ownership standard is generally consistent with consolidation under GAAP.” • Loan Origination. To be excluded, swaps in connection with loan origination must be effected within 90 to 180 days before or after loan origination and must relate to one or more financial terms of the loan or be a credit condition to the loan. Slide 8
Exclusions from Swap Dealer Activity • Floor Traders. The CFTC (but not the SEC) provided an exception from swap dealer status for a registered floor trader that limits its swap dealing to cleared exchange/SEF-traded transactions, complies with risk management and recordkeeping requirements, and is not affiliated with a registered swap dealer, among other conditions. Slide 9
Physical Hedging Interim Final Rule • The CFTC adopted as a safe harbor, an interim final rule that excludes swaps entered into for the purpose of hedging physical positions. • Although the CFTC did not explicitly incorporate the bona fide hedging definition from its position limit rule, the physical hedging exclusion builds on that definition and depends not on the effect or consequences of the swap, but on whether the purpose for which a person enters into a swap is to hedge a physical position. • The CFTC seeks comments on all aspects of the interim rule, including whether the exclusion should be limited to swaps hedging risks related to physical positions or extended to encompass swaps hedging financial risks or other types of risks. Slide 10
De Minimis Threshold • Dodd-Frank requires the Commissions to exempt from dealer designation any entity “that engages in a de minimis quantity” of dealing “in connection with transactions with or on behalf of customers.” • The final rule exempts a person from being a swap dealer if they do not exceed the de minimis threshold, which is a notional aggregate amount of $8 billion or less of swap dealing activities over a 12- month period. – The calculation of the de minimis threshold does not recognize netting or collateral offsets and will be based on “effective notional” amounts when the stated notional amount is leveraged or enhanced by the structure of the swap. Slide 11
De Minimis Threshold • The de minimis threshold includes all swap dealing activity by commonly controlled affiliates, but excludes all transactions that would not give rise to swap dealer status (including inter-affiliate transactions, certain physical commodity “hedging” transactions and other “trading” transactions). Slide 12
De Minimis Threshold • The threshold is expected to be lowered to $3 billion following the 5 year phase-in period. – The CFTC may end the phase-in period earlier by CFTC order or issue proposed rules to modify the de minimis threshold. – Regardless, the Final Rules mandate that the phase-in period will end no later than five years after the date that a swap data repository first receives swap data. • That threshold is limited to $25 million of swaps with a counterparty that is a "special entity," a category that generally includes a federal agency, employee benefit plan or state, city, county or municipality. Slide 13
Limited Designation • A person who meets one of the dealer definitions will be deemed to be a dealer with regard to all of its swaps unless the CFTC exercises its authority to limit the person’s designation as a dealer to specified categories of swaps, or specified activities. • The Commissions did not provide generalized criteria for application of the swap dealer definitions’ limited designation provisions, but rather provided for individual registrants to apply for limited designation on a case by case basis. • The Commissions will not designate a person as a limited purpose dealer unless it can demonstrate that it can fully comply with the requirements applicable to dealers. Slide 14
Extraterritorial Application • The CFTC excluded foreign sovereigns and central banks from swap dealer status based on non-Dodd- Frank application of principles of sovereign immunity. • The CFTC and the SEC deferred addressing the extraterritorial application of the swap dealer definitions. • The SEC indicated it would address this issue in a subsequent release. Slide 15
Major Swap Participant Definition • Dodd-Frank defines a major swap participant (“MSP”) as a person, other than a swap dealer, that meets any of the following three tests: – maintains a substantial position in swaps for any of the major swap categories as determined by the CFTC (excluding positions held for hedging or mitigating commercial risk and positions maintained by any employee benefit plan); – has substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets; or – is a financial entity that is not subject to capital requirements imposed by any federal banking agency, is highly leveraged relative to the amount of capital it holds, and maintains a substantial position in outstanding swaps in any major swap category. Slide 16
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