U.S. regulators voted today to define which companies will face new oversight in the $708 trillion global swaps market, where largely unregulated trades helped fuel the 2008 financial crisis.
A rule approved unanimously by the Securities and Exchange Commission today and awaiting a Commodity Futures Trading Commission vote will initially define a regulated dealer as one that conducts swaps with a notional value of at least $8 billion in a 12-month period. The banks, hedge funds and energy firms defined as swap dealers will be subject to the highest capital and collateral requirements for market participants.
“Adopting these entity definitions is a foundational step in the establishment of the new regime to regulate trading in this very significant market,” SEC Chairman Mary Schapiro said before the vote. “These rules clarify for market participants whether their current activities will subject them to comprehensive oversight in the coming months.”
The $8 billion threshold will fall to $3 billion within five years unless new market data persuade regulators to use a different level. While a lower threshold will capture more dealers, it still exceeds the $100 million level that was initially proposed.
The SEC and CFTC met separately today to weigh parallel versions of the rule. The rule was mandated by the Dodd-Frank Act of 2010 to govern clearing, trading, capital, collateral and internal compliance standards, as well as swap dealers’ relationships with clients including pension funds and cities. Dodd-Frank calls for most swaps to be guaranteed by central clearinghouses and traded on exchanges or other platforms.
‘Major Swap Participants’
A CFTC staff member who briefed reporters yesterday didn’t provide details on how many companies would be subject to the heightened oversight.
The rule also defines a smaller group of “major swap participants” that hold large positions in categories such as currency exchange rates or commodity swaps. One threshold for “substantial position” would be daily uncollateralized exposure of $1 billion in any major swaps category except for rate swaps, where $3 billion will be the mark.
For dealers, swap activity for portfolio hedging and anticipatory hedging wouldn’t be counted in the threshold calculation. Major swap participants will also be allowed to exclude hedging or the mitigation of commercial risk from their position total.
Swaps are a type of derivative, a financial contract tied to interest rates, currencies or events such as a change in weather or a company default.
Companies won’t be subject to the new oversight immediately. The CFTC must define what a swap is before it can impose requirements on dealers. For securities-based dealers, the SEC must also complete registration rules.
Today’s votes cap a nearly two-year debate among the regulators over how broadly to apply the oversight required by Dodd-Frank. That debate was influenced by a lobbying campaign by companies including Regions Financial Corp. and BP Plc that demonstrated how many industries the rule could affect.
Wall Street banks dominate dealing of swaps and other derivatives. JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Morgan Stanley and Goldman Sachs Group Inc. controlled 95 percent of cash and derivatives trading for U.S. bank holding companies as of Dec. 31, according to the Office of the Comptroller of the Currency.
The CFTC also voted 5-0 in favor of a rule today that treats commodity options like all other swaps.