The U.S. Commodity Futures Trading Commission voted today to define when trades are considered swaps under the Dodd-Frank Act, a step that triggers more than a dozen rules under the 2010 financial-regulation overhaul.
The agency’s commissioners voted 4-1 to approve a 600-page measure governing when interest-rate, credit, commodity and other trades involving companies including JPMorgan Chase & Co., Barclays Plc and Cargill Inc. should face rules to limit risk in the $648 trillion global market. The Securities and Exchange Commission unanimously approved the rule in a private vote on July 6, the agency said in a statement yesterday.
“This is significant to the American public because now we will bring transparency to these markets,” CFTC Chairman Gary Gensler said in a Bloomberg Television interview after the meeting. “We will have dealers registering. We will lower the risk to the American public. Congress said further define a term. We further defined it. Two months from now a lot of Dodd-Frank comes into being.”
The two agencies, working under a Dodd-Frank mandate that they craft oversight to prevent a repeat of the 2008 credit crisis, missed the July 2011 deadline to complete rules. The swap definition will trigger almost 20 Dodd-Frank measures for reporting, clearing, trading and record-keeping that may take effect as early as September.
The swap definition contains a series of exemptions for insurance and retail transactions. Life insurance, and property and casualty insurance are exempt. Interest-rate caps on consumer mortgages and home heating oil agreements are also left out.
The CFTC will also allow exemption of forwards tied to non-financial commodities. The agency is seeking comment on exempting energy contracts with so-called volumetric optionality.
“In order to meet varying customer demands, natural gas and electricity suppliers frequently enter into commercial transactions with embedded optionality as to the volume of energy that is physically delivered,” Scott O’Malia, a Republican commissioner, said at the meeting. Mark Wetjen, a Democratic commissioner, supported seeking comment on the exemption.
The Working Group of Commercial Energy Firms, a lobbying organization represented by law firm Hunton & Williams LLP, urged the CFTC to exempt the contracts. Executives at firms such as ConocoPhillips have testified for the group.
“They provide commercial energy firms with the flexibility necessary to reliably acquire and deliver physical commodities necessary to meet the specific requirements of buyers and sellers of the commodities,” the group said in a letter to the CFTC in July 2011.
Bart Chilton, a Democratic commissioner who opposed the measure, said he is concerned that the financial industry will create forwards that embed options that transform the traditional use of the contracts in a way that would skirt Dodd-Frank oversight.
“I’m a little concerned that if you go back to the financial crisis, complexity in financial products is really what got us,” Chilton said at the meeting. “I’m a little concerned that these good forwards these forwards used for legitimate purposes are going to morph, kind of chimerical.”
The swap definition includes non-deliverable foreign exchange forwards and currency swaps, while Dodd-Frank allowed the Treasury Department to exempt foreign exchange swaps and forwards from clearing and trading requirements. Treasury proposed an exemption for those two products last year and has yet to complete the exception. A coalition of 20 firms, including Deutsche Bank AG, Bank of New York Mellon Corp. and UBS AG, asked Treasury Secretary Timothy F. Geithner to grant an exemption.
Within two months of the definition’s publication, swap dealers and so-called major swap participants must register; the CFTC estimates that 125 companies will be required to do so. Data on interest-rate and credit swaps must be reported to the public starting within two months of the swap definition.
Regulations governing conduct standards between banks and swap-buyers, internal standards for chief compliance officers and registration for swap-data repositories are also pegged to the final definition vote. Rules for agricultural swaps and commodity options also rely on the swap definition.
Limits mandated by Dodd-Frank on speculation in oil, natural gas, wheat and other commodities will also begin to take effect two months after publication of the swap definition. The so-called position limits, facing a court challenge by Wall Street trade associations, will start to take effect on contracts in the current, or spot, month.
The CFTC also voted 5-0 to exempt some companies from the law’s requirement to guarantee swaps at central clearinghouses. Commercial and manufacturing companies that use swaps to hedge or mitigate their business risks lobbied for the the so-called end-user exception. The CFTC estimated that about 30,000 entities might take advantage of the exception.
The final rule will also allow banks with $10 billion or less in assets to be considered end-users. The CFTC also voted 5-0 to propose a separate exemption for about 10 farm-credit associations, credit unions and rural electric cooperatives that may fall above the $10 billion threshold.
“Those cooperatives act in the financial markets on behalf of their members and enter into swaps for the benefit of members,” the CFTC said in a summary of the proposal.