The regulation of swaps under Title VII of the Dodd-Frank Act is broken down between non-security-based swaps (NSBS), which are regulated by the CFTC, and security-based swaps (SBS) (see SBS: Security-based Swap), which are regulated by the SEC. Generally speaking, NSBS are swaps in which the underlying payments are not based on a narrow index of equity or debt securities. Non-security-based swaps include, among others, foreign exchange (FX) swaps and interest rate swaps, as well as CDS referencing broad-based indices. NSBS are commonly referred to by regulators and market participants simply as "swaps." The distinction between NSBS and SBS has become less pronounced for the time being, as the CFTC has taken the lead on swaps regulation, with more narrowly applicable SBS regulation from the SEC to follow. For more detail on the breakdown of swaps regulation under Title VII, as well as what constitutes a NSBS and what is an SBS, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Types of Swaps under Title VII.
Swap dealers are entities that engage in a large notional amount of market-making non-security-based swap activity. Regulators have determined that these entities could pose a risk to the soundness of the US financial system based on the magnitude and concentration of their swaps activity. SDs are therefore subject to an extensive framework of regulatory requirements under Title VII rulemaking, including internal and external business conduct rules and other obligations and restrictions (see The Dodd-Frank Act: Requirements for Swap Dealers and MSPs Checklist). Swap dealers are dealers in non-security-based swaps (see NSBS: Non-security-based Swap), though many may ultimately be required to register as security-based swap dealers with the SEC as well (see SBSD: Security-based Swap Dealer). Entities that cross the required de minimis notional thresholds ($8 billion annually) of non-exempt swap dealing activity are required to register as SDs regardless of whether or not they are located in the US (for more information, see Practice Note, Is Your Client a Swap Dealer or Major Swap Participant?: De Minimis Exemptions from Designation as Swap Dealer and Security-based Swap Dealer). There are currently 87 entities globally that have provisionally registered as SDs with the CFTC.
4. SBSD: Security-based Swap Dealer
A security-based swap dealer is a swap dealer in SBS. The notional thresholds for dealing in SBS are based on de minimis levels of notional swap dealing activity in certain types of SBS. The SEC holds regulatory jurisdiction over SBSDs and has yet to implement a full complement of rules for SBSDs as the CFTC has for SDs. For details on the de minimis notional thresholds for designation by the SEC as an SBSD, see Practice Note, Is Your Client a Swap Dealer or Major Swap Participant?: De Minimis Exemptions from Designation as Swap Dealer and Security-based Swap Dealer. The SEC does not yet require registration of SBSDs.
SEFs are electronic swaps trading platforms that let customers enter into swaps with one another directly. SEFs (now often referred to as "Sefs") are a creation of Title VII, as legislators sought to eliminate the role of large banks as gatekeepers to swaps trading. However, SEFs have been the subject of much controversy, as the first SEFs went live last month (see Legal Update, SEFs Go Live, CFTC Issues Limited No-action Relief from Some SEF Rules). Regulators felt the proliferation of SEFs could permanently change the way derivatives are transacted, lowering the cost of entering into derivatives transactions, and increasing transparency in the swaps markets. But many question whether SEFs will achieve these goals, and caution that SEFs are fragmenting the swaps markets, causing potential liquidity problems. Further, the final CFTC SEF rules have injected confusion into the swaps markets, eliciting a number of unanswered regulatory questions. There are currently around 20 provisionally registered SEFs to date, though volume has been modest.
An SCA is a clearinghouse that is registered with the SEC to clear securities transactions, including SBS. The SEC has yet to issue any clearing determinations or similar clearing mandates as the CFTC has issued for certain interest rate swaps and CDS, so no SBS are currently required to be cleared through an SCA. For details on SCAs, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap and SBS Clearinghouses: DCOs and SCAs.
11. SDR: Swap Data Repository
Like clearing, swap data reporting is another important cornerstone of Title VII swaps regulation. Regulators sought to increase transparency into what many called felt were opaque swaps markets, unable to provide regulators and the public with a true picture of outstanding positions and risks. As a result, swap data reporting is the most broadly applicable of all Title VII swaps rules, applying to all swaps with US persons, regardless of whether or not they are exempt from other Title VII requirements. Data must be reported to a CFTC-registered SDR for all swaps entered into with a US person, including certain cross-border swaps (see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules), under the following final rules:
FCMs are not an invention of Title VII. But like other acronyms featured here, are front and center under Title VII regulations. FCMs are banks and financial institutions that are members of major derivatives exchanges, which have historically been gatekeepers for exchange-traded derivatives products such as futures and options. With the expansion of exchange trading under Title VII to include swaps, FCMs have taken on an expanded role. While SEFs could change this market structure (see SEF: Swap Execution Facility), FCMs remain important intermediaries in futures trading as well as in cleared swaps and other derivatives. FCMs are subject to extensive rulemaking under Title VII with respect to their business conduct, capitalization and treatment of posted cleared swaps and customer (futures) collateral, including recent final CFTC rules on customer funds (see Legal Update, Final Rules on Protection of FCM Customer Funds Adopted by CFTC).
Made-available-to-trade (MAT) determinations are the mechanism by which mandatory exchange trading under Title VII of the Dodd-Frank Act becomes applicable to a type of swap. A MAT determination for one or more types of swaps may be submitted by a DCM or SEF to the CFTC for review. If not objected to, those swaps become MAT. This means that they must be entered into on a registered DCM or SEF (though it need not be the DCM or SEF submitted the MAT) and may no longer be entered into bilaterally. To date four MAT determinations have been submitted to the CFTC, though none have yet been approved. For more details on MAT, see Legal Update, New MATs Likely to Expedite Exchange Trading of CDS and Interest Rate Swaps.
16. CSE: Covered Swap Entity
Banks and bank holding companies (BHCs) that fall under the supervision of US federal prudential banking regulators (CSEs) will be subject to uncleared-swap margin collateral collection obligations once the rules proposed in the joint margin proposal, issued by regulators in 2011, are finalized. CSEs include banks and financial institutions that are registered as SDs, MSPs, SBSDs and MSBSPs under Title VII and that are subject to regulation by any of the regulators that issued the joint margin proposal, including the FDIC and the Federal Reserve. Proposed CFTC margin collection rules for uncleared swaps of nonbank SDs and MSPs also refer to these entities as CSEs. For details on these rules, see Practice Note, The Dodd-Frank Act: Margin Posting Collection Rules for Uncleared Swaps.