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CFTC Proposes Definitions for Derivatives-Market Participants

The U.S. Commodity Futures Trading Commission proposed definitions to help determine which firms face additional requirements for clearing, trading and posting of margin in the $583 trillion over-the-counter swaps market.

The CFTC, which is defining swap dealers and major swap participants as part of new rules to govern derivatives trading, voted 3-2 to propose the rules today at a meeting in Washington. Commissioners Jill Sommers and Scott O’Malia voted against the proposal, which Chairman Gary Gensler said aims to follow the intent of the Dodd-Frank law. The measures will be subject to public comment before they are completed.

Dodd-Frank, the financial-regulation overhaul enacted in July, aims to shift most swaps to clearinghouses, exchanges and other trading platforms. The CFTC and the Securities and Exchange Commission have been directed to draft rules to reduce risk after largely unregulated swaps trading complicated efforts to resolve the 2008 credit crisis. The SEC is scheduled to consider definitions for the swaps market on Dec. 3.

The CFTC proposal would define swap dealers as firms that meet demand for transactions, enter swaps to facilitate other parties’ interests, tend not to ask that other parties propose terms and tend to arrange customized swap terms, according to an agency summary. The proposal would exempt firms that had less than $100 million in swap activities in the preceding year.

Sommers said the dealer definition is “too broad.” O’Malia said the 145-page proposal, “does not provide the regulatory certainty many market participants are seeking.”

‘Substantial Position’

The CFTC proposal expands on Dodd-Frank’s three-part test for whether a company is defined as a major swap participant, which would lead to higher capital and margin requirements.

Under the first, a company would fall under the definition if it has a “substantial position” in swaps tied to interest rates or currency exchange rates, credit swaps, equity swaps and commodity swaps. The CFTC would define a substantial position according to two additional measures.

In the first part of the CFTC test, a company would be a major swap participant if it has a daily average of current uncollateralized exposure of at least $1 billion for credit, equity or commodity swaps. The threshold would be $3 billion for rate swaps.

Under the second CFTC test, a firm would be a major swap participant if it has a daily average of current uncollateralized exposure and future exposure of at least $2 billion for credit, equity or commodity swaps or $6 billion for rate swaps.

Hedging Risks

The Dodd-Frank law sought to exempt from the major swap participant definition companies that use the instruments to hedge or mitigate commercial risks. Under the CFTC proposal, such hedging would be defined as transactions to reduce risks related to a potential change in value or the impact of foreign exchange rates on a firm’s assets, liabilities or services.

A company would be defined as a major swap participant if it has “substantial counterparty exposure” on any type of a swap, under the CFTC plan. Firms would be defined as major swap participants if they have uncollateralized exposure of more than $5 billion or current and future exposure exceeding $8 billion.

The third Dodd-Frank test for the definition is related to financial entities that aren’t regulated by federal banking agencies, are “highly leveraged” and have a substantial position in swaps.

Firms meeting any of the three standards would be defined as major swap participants, according to the CFTC, which said it would seek to exempt so-called end users.

CFTC commissioners also proposed to allow clearinghouses to provide portfolio margining of futures and securities in a futures account. A clearinghouse seeking to provide those services would need to receive CFTC approval.

Daily Records

The CFTC also proposed requirements for swaps dealers and major swaps users to keep daily records of their transactions, including e-mail communications, instant messages and recordings of telephone calls. The proposal would require the records to be open to inspection by the CFTC.

Gensler said that the agency would hold two additional meetings in December and two meetings in January.

Derivatives, including swaps, are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

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