Speech by SEC Commissioner:
Defining the Perimeter of Swap Regulation to Ensure Effective Oversight
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
SEC Open Meeting
April 27, 2011
Today’s proposed rules and interpretations are designed to accomplish two broad goals.
First, to clarify that certain products are not swaps, and therefore not subject to the comprehensive regulatory regime for swaps envisioned in the Dodd Frank Wall Street Reform and Consumer Protection Act. This includes products never intended to be swaps, such as traditional insurance policies, household financial contracts, and ordinary commercial contracts.
Second, for products that are swaps, the proposal seeks to establish workable lines indicating whether a particular product should be regulated by the CFTC, by the SEC, or both. If the two agencies had been combined, many of these difficult questions would be moot. As things stand today, however, the agencies must try to draw jurisdictional lines that are clear, and not susceptible to regulatory arbitrage. Moreover, these lines must ensure that the agencies retain the authority needed to advance the regulatory objectives of their different statutes.
One of the several areas where this line drawing is particularly difficult is in the context of credit default swaps on an index that contains numerous companies. In general, Congress determined that swaps on narrow indexes of securities would be regulated by the SEC, and swaps on an index containing a large number of securities, like the S&P 500 index, would be regulated by the CFTC. Credit default swaps on indexes are different, however, in some important ways. For example, a credit default swap, even if it is on a large index of companies, can require a payment to be made if only a single company on the index defaults. As a result, an insider who knew a default was imminent and bought credit protection on even a broad index could profit from that inside information.1 So the release asks:
- Does the proposed treatment of index CDS whereby a payment is contemplated based on the default of a particular entity in the index rather than solely on the value of the index adequately address the federal regulatory interests under the federal securities laws and the Commodity Exchange Act?
I look forward to the public comment on the issues identified in the release.
I do want to express my appreciation to you all, the SEC staff team, who worked to prepare this recommendation, and I also commend the Commissioners of the Commodity Futures Trading Commission and its staff for their efforts in preparing the joint proposals.
1 This example illustrates how, in the context of an index CDS, a single entity on a broad security index can be material to the economic performance of the swap. Because the SEC retains antifraud authority over security-based swap agreements, insider trading on a broad-based index CDS is unlawful.