Financial regulators voted to propose rules excluding insurance policies, home heating oil contracts and forwards tied to commodities from swaps regulations required under the Dodd-Frank Act.
The U.S. Commodity Futures Trading Commission and Securities and Exchange Commission, at separate Washington meetings today, proposed a rule defining which types of trades will face rules aimed at limiting risk and boosting transparency in the $583 trillion global swaps market. The proposal also determines when transactions fall under the jurisdiction of the SEC or CFTC. SEC commissioners voted 5-0 and the CFTC voted 4-1 to open the proposal to public comment.
Dodd-Frank, enacted last year by President Barack Obama, gave the agencies parallel authority over the swaps market after largely unregulated trades helped fuel the 2008 credit crisis. The CFTC will oversee swaps tied to interest rates and commodities, while the SEC primarily will oversee swaps tied to loans or other securities. Derivatives, including swaps, are contracts tied to underlying assets, currencies or events, such as a change in weather or a company default.
“The definitions we propose today balance several policy and legal issues in a way I believe is practical, takes into account the specific nature of derivatives contracts, and is consistent with existing securities regulations,” SEC Chairman Mary Schapiro said in a statement before the vote.
Under the proposal, credit-default swaps tied to indexes of nine or more securities would be regulated by the CFTC, while such swaps linked to narrower indexes would be overseen by the SEC. Foreign currency options and currency swaps would be regulated as swaps under Dodd-Frank, while the Treasury Department is considering whether to exclude foreign exchange swaps and forwards for most of the law’s clearing and trading requirements.
Transactions regulated by the Federal Energy Regulatory Commission aren’t included in the swap definition rule and would be subject to a separate waiver process.
The proposal also sets up a system for overseeing mixed swaps that don’t fall exclusively under the oversight of the CFTC or SEC. Swaps that aren’t settled by a clearinghouse and in which one party is registered with the two agencies may be subject to both securities and commodities laws. For other mixed swaps, including those that are cleared, a trader can seek a joint order from the agencies permitting regulation by either the SEC or CFTC instead of facing two sets of regulations.
Separately, the CFTC voted 4-1 to propose rules for how much capital non-bank dealers and major participants in swaps must set aside to offset the risk in trades. Dealers and major swap participants that are also regulated by the CFTC as brokers for futures would need at least $20 million in Tier 1 capital.
Dealers and major swap participants that are subsidiaries of bank holding companies would face the same capital requirements set by the Federal Reserve and other banking regulators.
During the debate over Dodd-Frank last year, then-Senator Blanche Lincoln, an Arkansas Democrat, sought to limit taxpayer money supporting risky derivatives trades within banks that get federal support, such as deposit insurance. Separately capitalized units created to handle riskier swaps would be regulated by the CFTC under a so-called push-out provision in Dodd-Frank aimed at limiting such trading within firms that receive federal support.
The proposal would set up a third series of regulations for all other non-bank dealers and major swap participants. Those firms would need to set aside at least $20 million in tangible net equity instead of Tier 1 capital.
“There may be some regulatory arbitrage,” CFTC Chairman Gary Gensler said at today’s meeting. “It will be a lower capital standard for these nonbank commercial dealers.”