April 18, 2012 / 4:34 PM / 8 years ago

Regulators spare all but biggest swap dealers

WASHINGTON (Reuters) - U.S. regulators limited the number of market players that will be slapped with a pricey “swap dealer” tag, heeding warnings by swap users about getting too tough but dismaying advocates of greater oversight.

The Commodity Futures Trading Commission and the Securities and Exchange Commission finalized joint rules on Wednesday that will determine which firms do so much swaps business that they must register with regulators and back up their trades with more capital and collateral.

The Dodd-Frank financial reform law called on regulators to more closely police 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 CFTC originally said in December 2010 that firms would be counted as swap dealers if they traded more than $100 million in swaps over a 12-month period.

That threshold set off a desperate push by energy companies and big commodity traders, who argued that they are using trades to hedge against market risks, and that their exposure does not endanger the broader financial system.

The final version released on Wednesday bumps the threshold up to $8 billion for most asset classes as an initial phase-in. Eventually, that threshold drops to $3 billion, unless regulators decide a different threshold is appropriate.

It also added a more explicit exemption for swaps that are used 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.

Financial reform advocate groups called the final rules discouraging.

“The $8 billion exemption level is far too high and far higher than was originally proposed last year. I think this demonstrates the enormous lobbying effort of Wall Street and major energy and commodity companies that have been working to undermine Dodd-Frank,” said Tyson Slocum, director of Public Citizen’s Energy Program.

The CFTC estimated that 125 entities would register as swap dealers under the final rule, compared to 300 under the original proposal. Officials would not elaborate if the 125 figure was based on the $8 billion phase-in threshold, or the $3 billion level.

The CFTC approved the reforms in a 4-1 vote, while the SEC voted unanimously to back them.

Republican CFTC Commissioner Scott O’Malia on Wednesday voted against the final swap dealer rule because it includes “several unnecessary and astonishing contortions” to ensure that companies that use swaps to hedge against everyday business risks do not get crushed by unnecessary regulations.


Major Wall Street firms and banks dominate the derivatives market and have been widely expected to fall into the swap dealer category.

JPMorgan Chase & Co, Bank of America, Citigroup, HSBC and Goldman Sachs control 96 percent of cash and derivatives trading for commercial banks and trust companies as of December 31, according to the Office of the Comptroller of the Currency.

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.

It is unclear how many firms will ultimately have to register as a swap dealer because it is up to the firms to decide which of their trades will be excluded as hedges.

Also, the threshold could change in the future because regulators will revisit that number after collecting roughly two years of data.

Andrea Kramer, a partner at law firm McDermott Will & Emery, said only a few very large corporate entities that also have trading operations might still be swept in.

“For the majority of end-users, this will be a huge relief,” Kramer said.

Sam Henry, president and chief executive of International Power-GDF Suez Energy Marketing North America, one of the biggest energy companies in North America dealing in oil, natural gas and power, said the changes are positive.

“I think that means the burdens of compliance will be less on a larger number of energy companies and it may not have as severe an impact on liquidity as we had feared,” Henry said.

“We were close to the $3 billion range. At $8 billion, we should not be classified as a swap dealer.”

Other industry players said it is too early to know how many firms will be impacted because regulators have not yet said how the rule will apply to firms’ international operations.

Also, the CFTC and SEC have not yet formally defined a “swap,” generally considered to involve an exchange of cash flows of one party’s financial instrument for the other’s instrument.

The CFTC said entities will have to register as a swap dealer 60 days after the “swap” definition is completed.

The regulators also finalized a rule defining a “major swap participant”, a designation that also comes with more expensive trades and more oversight. The CFTC estimated that six entities would fall under that category.

The CFTC on Wednesday adopted a separate rule that would subject commodity options to the same rules that govern swaps.


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

The SEC’s oversight covers roughly 5 percent of the over-the-counter derivatives market.

SEC Chairman Mary Schapiro said the final rules aim to only capture the companies that truly deal in derivatives, sparing mutual funds and pension funds from the new regulations.

The SEC’s swap dealer rules on Wednesday were largely similar to the CFTC’s, but there were a few key differences.

The SEC had more swap data to work with, and was able to more closely tailor the thresholds to the different derivatives markets it will regulate.

For single-name credit-default swaps, which make up the vast majority of the security-based swaps market, the $8 billion threshold will apply during the phase-in period and then taper down to $3 billion.

For all other security-based swaps, such as equity swaps, a much smaller threshold will apply, with an initial phase-in level of $400 million that later goes down to $150 million.

SEC Commissioner Luis Aguilar, a Democrat, said at first he was afraid the $3 billion threshold for credit derivatives was too high, but he is now convinced the number will capture nearly all dealing activities.

The SEC said its cost-benefit analysis conservatively estimates that as many as 50 firms that deal with security-based swaps may register as swap dealers.

The agency went out of its way to highlight its economic analysis. Problems with the quality of cost-benefit analyses has drawn legal challenges to both SEC and CFTC rules.

Last year, an appeals court struck down an SEC rule that would have made it easier for shareholders to nominate directors to corporate boards, saying the SEC failed to properly weigh the economic consequences of the rule.

The CFTC is currently fighting a suit by two industry groups who are challenging the agency’s “position limits” rule. That suit also uses the argument of improper economic analysis.

Reporting By Alexandra Alper and Sarah N. Lynch in Washington, with additional reporting by David Sheppard and Scott DiSavino in New York; Writing by Karey Wutkowski; Editing by Tim Dobbyn and Sofina Mirza-Reid

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