Exam Alert: SEC and CFTC define “swap,” “security-based swap,” and “mixed swap”

Effective October 12, 2012, the SEC and CFTC will put into effect rules that specify whether a given product counts as a “swap,” “security-based swap,” “mixed swap,” or none of the above. The new rules also require market participants to keep the same books and records for “security-based swap agreements” as would be required for swaps. Continue reading

Effective October 12, 2012, the SEC and CFTC will put into effect rules that specify whether a given product counts as a “swap,” “security-based swap,” “mixed swap,” or none of the above.  The new rules also require market participants to keep the same books and records for “security-based swap agreements” as would be required for swaps.

 

The CFTC regulates swaps, the SEC regulates security-based swaps, and both agencies regulate mixed swaps.  The CFTC regulates security-based swap agreements, but the SEC has antifraud authority over those products.

 

Products that are not swaps or security-based swaps include:

-insurance that falls under 1) the grandfather provision, 2) the product safe harbor, or 3) the enumerated product safe harbor

-security forwards

-consumer transactions

-commercial transactions

 

Products that are considered swaps include:

-Title VII instruments on interest rates and other monetary rates

-Title VII instruments on rates or yields of U.S. Treasuries and certain other exempt securities

-Title VII instruments on futures (other than futures on foreign government debt securities)

-broad-based index credit default swaps that require cash settlement or auction settlement

 

Products that are considered security-based swaps include:

-Title VII instruments on yields of a non-exempt debt security, loan, or narrow-based security index

-Total Return Swaps on a single security, loan, or narrow-based security index

-Title VII instruments on security futures

 

Products that are considered mixed swaps include:

-Total Return Swaps that include interest-rate optionality or a non-securities component

-broad-based index credit default swaps that require mandatory physical settlement

 

Products that may be swaps or security-based swaps:

-Title VII instruments based on futures contracts on certain foreign government debt securities

-index credit default swaps

-foreign exchange forwards

-foreign exchange swaps

-foreign currency options (other than foreign currency options traded on a national securities exchange)

-non-deliverable forward contracts involving foreign exchange

-currency and cross-currency swaps

-forward rate agreements

-contracts for differences

-certain combinations and permutations of (or options on) swaps and security-based swaps

 

Market participants may request a determination from the SEC and the CFTC of whether a product is a swap, a security-based swap, or a mixed swap.

 

Sources:

SEC Approves Rules and Interpretations on Key Terms for Regulating Derivatives (SEC Release 2012-130)

Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping (Federal Register publication)

 

This alert applies to the Series 62, Series 79, Series 99, Series 7, Series 66, and Series 65.

Exam Alert: SEC adopts definitions for security-based swap rules

Under the Dodd-Frank Act, the SEC and CFTC (Commodity Futures Trading Commission) regulate the OTC swaps market. On April 18, 2012, the SEC adopted rules that provide definitions for terms used in the law, specifying who will be subject to regulation. Continue reading

Under the Dodd-Frank Act, the SEC and CFTC (Commodity Futures Trading Commission) regulate the OTC swaps market.  On April 18, 2012, the SEC adopted rules that provide definitions for terms used in the law, specifying who will be subject to regulation.

The rules provide two categories of persons subject to SEC registration: “security-based swap dealers” and “major security-based swap participants.”  In essence, a security-based dealer is a person that regularly trades security-based swaps for their own account.  A de minimis exemption exists for dealers who traded up to $3 billion worth of credit default swaps over the past year and up to $150 million worth of other security-based swaps.  Note that there is a different de minimis threshold of $25 million for security-based swaps involving “special entities,” including certain government agencies.

A major security-based swap participant is a person who maintains a “substantial position” in any of the major security-based swap categories, or whose outstanding security-based swaps create “substantial counterparty exposure.”  Note that hedging positions are not counted towards the “substantial position” threshold if the person is not a “highly leveraged financial entity,” meaning a financial entity with a ratio of liabilities to equity in excess of 12-to-1.  Two tests are provided for determining “substantial position,” and two thresholds are provided for “substantial counterparty exposure.”  The specifics of these tests and thresholds may be found in the SEC release, along with background information, a plan to phase-in the de minimis rule, a safe harbor to avoid being considered a major participant, and other details.

The rule will become effective 60 days after publication in the Federal Register, though the deadline for registration will be given in SEC’s final rules for registration of dealers and major participants.

Source: SEC Release 2012-67

This exam alert applies to the Series 62, Series 79, Series 99, Series 65, and Series 66.