When they decide which derivatives are considered swaps underthe Dodd-Frank Act, U.S. regulators will unleash a cascade of ruleson the $648 trillion global market designed to prevent a repeat ofthe 2008 credit crisis.

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The Commodity Futures Trading Commission is poised to completeseveral hundred pages of regulations tomorrow that determine whentrades by JPMorgan Chase & Co., Goldman Sachs Group Inc.,Cargill Inc. and other companies must fall under rules to reducerisk and increase transparency. The Securities and ExchangeCommission unanimously approved the rule July 6 without holding apublic meeting.

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“It's really very critical to complete the further definition ofthe word swap and the end-user exception,” CFTC Chairman GaryGensler said in a telephone interview on July 5. “Those arefoundational rules.”

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Dodd-Frank required the two agencies to write scores ofregulations to govern swaps reporting, record-keeping, trading,collateral and other issues. The agencies missed the July 2011deadline for implementing the changes and have repeatedly announcedfurther delays.

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“All of these regulatory requirements depend on a derivativebeing defined as a swap in the first place,” said Lynn Stout,professor of law at Cornell University. “The definition of swap isthe critical underpinning of the success of the regulatoryregime.”

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The U.S. agencies are striving to meet an end-of-year deadlineset by Group of 20 member nations to improve market oversight inresponse to a credit crisis that led to the collapse of LehmanBrothers Holdings Inc. and U.S. bailouts of companies includingAmerican International Group Inc. Getco LLC, Citadel LLC and agroup of proprietary traders, hedge funds and other asset managershave urged the CFTC and SEC to complete rules requiring clearing oftrades before next year.

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The CFTC also will exempt banks with $10 billion or less inassets from requirements to guarantee swaps at centralclearinghouses, according to two people briefed on the matter whorequested anonymity because the rule hasn't been made public.

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The swap definition will trigger almost 20 Dodd-Frank changes tothe market over the coming months. Within two months of thedefinition's publication, swap dealers and so-called major swapparticipants must register; the CFTC estimates that 125 companieswill be required to do so. Data on interest rate and credit swapsmust be reported to the public starting within two months of theswap definition.

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Conduct Standards

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Regulations governing conduct standards between banks andswap-buyers, internal standards for chief compliance officers andregistration for swap-data repositories are also pegged to thefinal definition vote. Rules for agricultural swaps and commodityoptions also rely on the swap definition.

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Limits mandated by Dodd-Frank on speculation in oil, naturalgas, wheat and other commodities will also begin to take effect twomonths after publication of the swap definition. The so-calledposition limits, facing a court challenge by Wall Street tradeassociations, will start to take effect on contracts in thecurrent, or spot, month.

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“This is a key rule because once this definitions domino drops,others will fall into place pretty quickly,” Bart Chilton, aDemocratic CFTC commissioner, said July 6.

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The limits spurred more than 13,000 comments to the agency fromsupporters such as Delta Air Lines Inc. and opponents such asBarclays Plc. The International Swaps and Derivatives AssociationInc. and Securities Industry and Financial Markets Associationfiled a lawsuit in December seeking to overturn the limits, arguingthat the agency didn't demonstrate that they were required by thelaw. The groups also argued that the CFTC failed to conduct anadequate analysis of the costs and benefits before approving theregulation.

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A ruling is pending from U.S. District Judge Robert Wilkins.

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The case is International Swaps and Derivatives Association v.U.S. Commodity Futures Trading Commission, 11-02146, U.S. DistrictCourt, District of Columbia (Washington).

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Bloomberg News

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