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US regulators set to narrow swap dealer definition
April 18, 2012 / 1:35 PM / 6 years ago

US regulators set to narrow swap dealer definition

* SEC, CFTC to finalize definition of “swap dealer”

* Tag comes with more oversight, more expensive trades

* Final rule would capture fewer market players

* CFTC says the trigger point could change after study

* Gives firms latitude to exempt swaps for hedging

By Alexandra Alper and Sarah N. Lynch

WASHINGTON, April 18 (Reuters) - U.S. regulators have narrowed the universe of big commodity market players that will get slapped with an expensive “swap dealer” tag, but left room to later adjust rules that are due to be finalized on Wednesday.

The Commodity Futures Trading Commission and Securities and Exchange Commission are scheduled to vote on rules that will determine which firms must register with regulators and trim their risks by backing up their trades with more capital and collateral.

The rules required by the Dodd-Frank financial oversight law in reaction to the financial crisis have changed dramatically from when they were proposed in December 2010.

The CFTC originally said firms would be counted as swap dealers if they traded more than $100 million in swaps over a 12-month period. A swap trade involves an exchange of cash flows of one party’s financial instrument for the other’s instrument.

After heavy lobbying from energy companies and big commodity traders, the final version bumps the threshold up to $8 billion for most asset classes as an initial phase-in. Eventually, that threshold could drop to $3 billion.

The CFTC also added a more explicit exemption for swaps that are done to hedge market risks, such as reducing exposure to interest-rate fluctuations or oil price moves. Those trades will not count toward the threshold that triggers the swap dealer designation.

It is unclear how many firms would be affected by the rules, partially because the CFTC will leave it up to the firms themselves to determine which swap trades are hedges.

Also, the CFTC gave itself wide latitude to change the threshold. The agency would collect two-and-a-half years of swaps data, then study that data, and then the CFTC would have nine months to determine whether to bring down the trigger from $8 billion in annual swap trades to $3 billion.

Alternatively, the CFTC could propose new rules to completely change the threshold.

Dodd-Frank gave the CFTC and SEC broad new authority over the swaps market after widespread ignorance about swaps exposure, especially at insurer American International Group , severely damaged the financial system during the 2007-2009 crisis.

The law split oversight of the $700 trillion market between the SEC, which will regulate securities-based swaps, and the CFTC, which will regulate the vast majority of the market, including interest-rate and commodity-linked swaps.

Commissioners at the two agencies are due to vote later on Wednesday on their respective joint rules on defining “swap dealer” as well as “major swap participant”.

Being defined as a major swap participant would also drive up the cost of trades and come with more oversight.


Major Wall Street firms that regularly trade in derivatives, like Goldman Sachs or Morgan Stanley, have been widely expected to fall into the swap dealer category.

But large energy companies and traders such as Royal Dutch Shell, BP and Vitol contend that while they may trade billions of dollars a year in swaps, their trades are done to shield themselves from market risk such as changes in commodity prices or fluctuations in currency.

As a result, they say they should not be subjected to the new regulations.

Disagreements between the SEC and the CFTC on the final rules have led to numerous delays and kept companies waiting with great anticipation 16 months after the rules were first proposed.

The uncertainty has already taken a toll on liquidity, according to large brokers.

The industry has also preliminarily questioned whether the regulators have done enough to estimate the costs that will be associated with being a dealer.

The quality of cost-benefit analyses has been grounds for legal challenges to both SEC and CFTC rules.

On Tuesday, two trade groups sued the CFTC over a rule that would force some mutual funds to register with the agency. The CFTC is also facing a legal challenge to its position limits rule, and the SEC in July had a Dodd-Frank rule overturned for flawed economic analysis.

SEC and CFTC officials told reporters late on Tuesday that they lack hard estimates for how many companies will be deemed swap dealers.

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