WASHINGTON Most existing swap products will be traded on exchanges under proposals by U.S. futures and securities regulators that define what transactions should be covered by last year's financial oversight law.
The proposals provide the market some long-awaited clarity. Regulators have been criticized for not acting on the definitions rule sooner -- making it hard for everyone from banks and insurance companies to commodity traders to prepare for the new regulations and the impact on their bottom line.
Some critics have argued it is problematic for regulators to move forward on other regulations for the roughly $600 trillion swaps market without first clearly laying out which products will be covered.
The Commodity Futures Trading Commission said on Wednesday it was reopening the comment period for most rules it has already proposed for as much as 30 days.
The bulk of existing swap products and transactions would be defined as swaps under the proposals issued by the CFTC and the Securities and Exchange Commission. Products designated as swaps are subject to clearing requirements and must trade on exchanges or swap execution facilities.
Swaps would include foreign exchange swaps and forwards, foreign currency options, commodity options, cross-currency swaps, and forward rate agreements, under the proposals.
An exemption would apply to certain insurance products, consumer and commercial transactions, such as a contract to purchase home heating oil and loan participations.
Commodity forward contracts are not regarded as swaps, a relief to physical commodity traders who feared those transactions might face greater regulation and higher costs.
"From an ag markets perspective, I think the forward exclusion provision is a real success," said Commodity Markets Council President Christine Cochran on the Reuters Global Ags Forum. "We were able to get it on the CFTC's radar and the framework outlined gives us something to work with."
Security-based forwards, such as mortgage-backed securities that are eligible to be sold in the "to-be-announced" market, also would be excluded.
The SEC voted unanimously to put the definitions out for public comment. The CFTC approved its measure 4-1, with Republican Jill Sommers dissenting on the basis that the agency was exceeding its mandate.
Regulators are expected to start finalizing the swaps rules later this summer and into the fall.
The CFTC and SEC were tasked by Congress last July in the Dodd-Frank legislation to oversee the opaque over-the-counter derivatives market, a response to the 2007-2009 financial crisis.
"It took us a few extra months, but I think it was time well spent," said CFTC Chairman Gary Gensler of the definitions.
Regulators have identified four areas where the CFTC and SEC differ in their plans. They include anti-evasion procedures; insurance on swaps and whether they should be regulated as insurance or swaps; swaps linked to futures on the debt of 21 countries that the SEC has exempted for purposes of futures trading; and issues on index credit default swaps.
Gensler downplayed the gap between the two regulators. "I don't think there are differences. I think we're completely aligned," Gensler told reporters. "We're really saying jointly we want to hear from the public for instance on those couple of areas."
The regulators moved ahead with their proposals even though Treasury Secretary Timothy Geithner has not issued his decision on whether to exempt foreign exchange swaps and forwards.
If Geithner decides to exempt the contracts, it may force regulators to revamp their plans.
Treasury had no comment on Wednesday. The department has said Geithner would make a decision before the CFTC issues final rules. Officials have said Treasury is very close to making a decision.
The futures regulator also outlined on Wednesday its proposal for capital requirements for swap dealers and major swap participants.
Those already registered as futures brokers would have to meet existing requirements and hold at least $20 million of adjusted net capital. A nonbank subsidiary of a U.S. bank holding company, meanwhile, would have to follow banking regulators' requirements and hold at least $20 million of Tier 1 capital.
Companies that are not in either category would have to maintain net equity equal to $20 million plus additional funds to account for market and credit risk.
Earlier this month, the CFTC issued its margin requirement in swap transactions. It largely spared energy companies, airlines and other end-users from paying billions of dollars in margin on uncleared swap trades.
CUSTOMER COLLATERAL DURING DEFAULT
The CFTC also proposed a new scheme to help protect customer collateral in the event of a default. The proposal represents a hybrid approach between how collateral is protected today in futures markets and a model that is advocated by money managers such as BlackRock.
Under the plan, customer margin would be pooled together in an omnibus account, just as it is done in the futures market. But each individual account would still be legally protected and could not be tapped to cover losses in the event of another firm's default.
A CFTC official said the proposal will also ask questions about other possible ways to protect customer funds. But a push by money managers to maintain complete individual account segregation will not be explored because it is too expensive.
With most of the proposals out for public comment, the agencies next week will hold a two-day roundtable to discuss the schedule for implementing final swaps rules.
The SEC on Wednesday also took its latest step toward removing all references to credit-ratings from its regulations, in an effort to reduce market reliance on them after they performed poorly in the financial crisis.
The SEC proposed stripping ratings from a series of rules, most notably those governing net capital for brokers.