The Hidden ‘Gotcha’ in the SEF Rules
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An overlooked detail in the swap dealer definition rule approved by the CFTC will be a real headache for some market participants.
With all the analysis of the SEF rules that were approved by the CFTC last week, one little “gotcha” appears to have been overlooked. It doesn’t apply to everyone, but it will be a real headache for some market participants.
The problem began about a year ago, when the CFTC and SEC approved the rule specifying who must register as a swap dealer (SD). That rule identified four trading patterns as a starting point, any of which gets the ball rolling. One pattern is: “Regularly enters into swaps with counterparties as an ordinary course of business for its own account,” which covers a lot of firms.
Next, the rule sets a de minimis threshold for annual trading volume. What most people focused on was the $8 billion of notional volume, going down to $3 billion over time; but the end of that sentence added another threshold: “$25 million with regard to swaps in which the counterparty is a ‘special entity’[SE] (as that term is defined in Section 4s(h)(2)(C) of the Act.”
Of course, this was no problem for firms that have already registered as SDs, but it was a big problem for general market participants. Soon after the dealer definition rule was approved, I pointed this anomaly out to the CFTC staff. They recognized the problem and assured me that it would be dealt with in the forthcoming SEF rules. So last week I went through the final rule, and found no mention of SEs at all, and certainly not of the troubling de minimis language. So I contacted the CFTC and pointed out the problem. Here’s what they said to me:
“There may be a few options that you can pursue if you believe that the Commission should take action to address the issue. One option may be to petition DSIO for no-action relief under Commission regulation 140.99. For example, you could request that DSIO provide relief against the $25 million de minimis threshold with special entities for transactions done on SEFs and DCMs. Any no-action request should go to Gary Barnett, who is the Director of DSIO. Another option may be to petition the Commission to amend the swap dealer rule under Commission regulation 13.2. These are only a few options, there may be others.”
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It would appear that petitioning the CFTC to amend the swap dealer definition rule is the best alternative. I have done that (see letter to Director Gary Barnett, below), but others who would be affected should as well.
The address is:
Mr. Gary Barnett, Director
Division of Swap Dealer and Intermediary Oversight
Commodity Futures Trading Commission
Three Lafayette Center
1155 21stSt. NW
Washington, DC 20581
Although the CFTC has exempted trades conducted on a SEF or DCM from many of its rules, it neglected to do so in this case. What that meant was that any market participant that satisfied the pattern criterion and happened to do a trade larger than $25 million with a special entity on a SEF would be stuck having to register as a SD. When you consider that asset managers might execute large trades for their ERISA clients on SEFs, and their counterparties wouldn’t know about it until the trades were allocated, you begin to see the dangers. In fact, an ERISA account could wind up being both a SD and a SE at the same time!
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