Background: In 2000, Congress passed the Commodity Futures Modernization Act (CFMA) to provide legal certainty for swap agreements. The CFMA explicitly prohibited the SEC and CFTC from regulating the over-the-counter (OTC) swaps markets, but provided the SEC with antifraud authority over “security-based swap agreements,” such as credit default swaps. However, the SEC was specifically prohibited from, among other things, imposing reporting, recordkeeping, or disclosure requirements or other prophylactic measures designed to prevent fraud with respect to such agreements. This limited the SEC’s ability to detect and deter fraud in the swaps markets.
Title VII of Dodd-Frank Wall Street Reform and Consumer Protection Act addresses the gap in U.S. financial regulation of OTC swaps by providing a comprehensive framework for the regulation of the OTC swaps markets.
The Dodd-Frank Act divides regulatory authority over swap agreements between the CFTC and SEC (though the prudential regulators, such as the Federal Reserve Board, also have an important role in setting capital and margin for swap entities that are banks). The SEC has regulatory authority over “security-based swaps,” which are defined as swaps based on a single security or loan or a narrow-based group or index of securities (including any interest therein or the value thereof), or events relating to a single issuer or issuers of securities in a narrow-based security index. Security-based swaps are included within the definition of “security” under the Securities Exchange Act of 1934 and the Securities Act of 1933.
The CFTC has primary regulatory authority over all other swaps, such as energy and agricultural swaps. The CFTC and SEC share authority over “mixed swaps,” which are security-based swaps that also have a commodity component.
In addition, the SEC has anti-fraud enforcement authority over swaps that are related to securities but that do not come within the definition of “security-based swap.” These are called “security-based swap agreements.” The Dodd-Frank Act provides the SEC with access to information relating to security-based swap agreement in the possession of the CFTC and certain CFTC-regulated entities, such as derivatives clearing organizations, designated contract markets, and swap data repositories.
Implementation: There are a number of rulemakings required under Title VII. The CFTC and SEC are required to act jointly to define key terms relating to jurisdiction (such as swap, security-based swap, and security-based swap agreement) and market intermediaries (such as swap and security-based swap dealers and major swap and security-based swap participants), as well as adopt joint regulations regarding mixed swaps and prescribe trade repository recordkeeping requirements, and books and records requirements for swap entities related to security-based swap agreements. The SEC is required to consult with the CFTC and the Federal Reserve Board on non-joint rulemakings and with the other prudential regulators on capital and margin rules. The CFTC, SEC and U.S. prudential regulators also are consulting with non-U.S. regulatory authorities on the establishment of consistent international standards for products and entities in this area.
As of April 2014, the SEC has proposed:
- Rules prohibiting fraud and manipulation in connection with security-based swaps
- Rules regarding trade reporting, data elements, and real-time public dissemination of trade information for security-based swaps that would lay out who must report security-based swaps, what information must be reported, and where and when it must be reported
- Rules regarding the obligations of security-based swap data repositories that would require them to register with the SEC and specify the extensive confidentiality and other requirements with which they must comply
- Rules regarding certain standards that clearing agencies would be required to maintain with respect to, among other things, their risk management and operations
- Rules regarding the exception to the mandatory clearing requirement for hedging by end users that would specify the steps that end users must follow, as required under the Act, to notify the SEC of how they generally meet their financial obligations when engaging in security-based swap transactions exempt from the mandatory clearing requirement
- Rules regarding the registration process for security-based swap dealers and major security-based swap participants
- Rules regarding business conduct that would establish certain minimum standards of conduct for security-based swap dealers and major security-based swap participants, including in connection with their dealings with "special entities", which include municipalities, pension plans, endowments and similar entities
- Rules regarding the confirmation of security-based swap transactions that would govern the way in which certain of these transactions are acknowledged and verified by the parties who enter into them
- Rules defining and regulating security-based swap execution facilities, which specify their registration requirements, and establish the duties and implement the core principles for security-based swap execution facilities specified in the Act
- Rules intended to address conflicts of interest at security-based swap clearing agencies, security-based swap execution facilities, and exchanges that trade security-based swaps
- Rules establishing capital, margin, and segregation requirements for security-based swap dealers and major security-based swap participants
- Rules and interpretive guidance regarding cross-border security-based swap activities
- Rules to establish recordkeeping, reporting, and notification requirements for security-based swap dealers and major security-based swap participants.
In addition, as of May 2013, the SEC has adopted:
The SEC also has adopted an interim final rule regarding the reporting of outstanding security-based swaps entered into prior to the date of enactment of the Dodd-Frank Act.
The SEC has taken a number of steps to provide legal certainty and avoid unnecessary market disruption that might otherwise have arisen as a result of final rules not having been enacted by the July 16, 2011, effective date of Title VII. Specifically, the SEC has:
The SEC has issued a policy statement describing the order in which it expects new rules regulating the derivatives market would take effect. The policy statement does not estimate when the rules would be put in place, but describes the sequence in which they would take effect. The phased-in approach is intended to avoid the disruption that could occur if all the new rules took effect simultaneously.
In addition, the policy statement discusses the timing of the expiration of the temporary relief the SEC previously granted to securities-based swaps market participants under the interim actions described above.