Major financial industry associations including SIFMA, ISDA, and FIA largely supported a CFTC proposal setting the amount and types of swap dealing activity that trigger the requirement to register as a swap dealer. However, public interest groups blasted the proposal. According to Better Markets, the rule would create so many loopholes that the swap dealer registration regime would look like “Swiss cheese.”
De minimis threshold. The Dodd-Frank Act directed the CFTC and SEC to jointly define the term “swap dealer” and to exempt persons that engage in a “de minimis” quantity of swap dealing from designation as a swap dealer. The Commissions set the threshold for swap dealing activity at $3 billion, with an initial phase-in amount set at $8 billion, which was set to drop to $3 billion at the end of the phase-in. The CFTC has extended the phase-in period twice, and it is currently scheduled to terminate on December 31, 2019.
On June 4, 2018, the CFTC proposed rule amendments to set the threshold at $8 billion in swap dealing activity entered into by a person over the preceding 12 months. The calculation would exclude certain swap dealing activity, including (1) swaps entered into with a customer by an insured depository institution in connection with originating a loan to that customer; (2) swaps used to hedge financial or physical positions; and (3) swaps resulting from multilateral portfolio compression exercises. The CFTC also asked for comment on whether to add a minimum dealing counterparty count threshold and a minimum dealing transaction count threshold, and whether to exclude exchange-traded and/or cleared swaps and non-deliverable forward transactions from the calculation.
CFTC Chairman J. Christopher Giancarlo supported the proposal, while Commissioner Rostin Behnam dissented, stating that it went too far beyond just setting the threshold. Commissioner Brian Quintenz supported keeping the threshold at $8 billion—or increasing it to $20 billion—but favored using a risk-based approach rather than a monetary amount.
Pros and cons of $8 billion threshold. Major financial industry associations including FIA, the International Swaps and Derivatives Association (ISDA), and the Securities Industry and Financial Markets Association (SIFMA) supported keeping the threshold at $8 billion. According to SIFMA and ISDA, if the threshold were reduced, fewer swap market participants would enter into swaps with end-users for fear of going above the threshold and triggering the registration requirement. FIA believes the data support a higher threshold, but support the $8 billion threshold in the interest of legal certainty.
Public interest groups, however, expressed concerns. Better Markets believes the CFTC should let the $3 billion threshold become effective when the current phase-in extension expires. Americans for Financial Reform (AFR) believes that data do add weight to the CFTC’s claim that an $8 billion notional de minimis level is appropriate for some financial swaps markets. But in the non-financial commodity (NFC) swaps, data indicate that significant dealing activity in the NFC market is escaping registration due to the $3 billion threshold. In AFR’s view, the CFTC should be willing to vary de minimis treatment based on market characteristics and in particular should cut the $8 billion threshold in NFC markets.
Exclusion of swaps that hedge financial positions. FIA, ISDA, and SIFMA generally support the proposed exclusion for swaps hedging financial positions, but would remove certain proposed restrictions. The groups would put the exclusion on a par with the existing exclusion of swaps that hedge physical positions. Specifically, they would eliminate the restriction that a person can only exclude hedges of financial positions if that person “is not the price maker and does not receive or earn a bid/ask spread, fee, commission, or other compensation for entering into the swap.” In addition, SIFMA would eliminate the requirement that the primary purpose of entering into the swap must be to reduce or otherwise mitigate one or more “specific” risks.
However, Better Markets strongly criticized the hedging exclusion, saying it goes far beyond an incidental dealing exclusion and would be used even by entities whose common hedging practices are inextricably tied to swap dealing. The group predicts that the hedging exclusion will be liberally interpreted by “an army of highly compensated industry lawyers” to allow institutions to build large derivatives positions and to characterize those transactions as “hedges” after the fact. According to Better Markets, J.P. Morgan Chase & Co. did just this in connection with multi-billion dollar losses on its synthetic credit portfolio.
Exclusion of cleared and exchange-traded swaps. According to FIA, the goals of swap transparency and risk reduction are fulfilled for cleared and exchange-traded swaps by the clearinghouse and exchange. Therefore, cleared and exchange-traded swaps should not be included in the calculation of swap-dealing activity.
In contrast, AFR called this “the most concerning” part of the proposal. AFR noted that in major markets such as interest rate swaps, clearing penetration has now reached at least 75 percent of all swaps activity globally, and is close to 40 percent of all activity even in less standardized markets like credit derivatives cleared swaps. A broad exemption for cleared swaps would thus exempt some major swap dealers from dealer designation because they transact mostly in cleared swaps.
Other issues. Commenters also weighed in on other aspects of the proposal, including:
- Exclusion of non-deliverable forwards. The industry groups support the exclusion of non-deliverable forwards from the calculation of the de minimis threshold.
- Exclusion of Multilateral Portfolio Compression Exercises (MPCE) swaps. SIFMA and ISDA support the proposed exclusion of swaps resulting from MPCEs.
- Exclusion of Insured Depository Institutions (IDI) swaps. SIFMA and ISDA support the proposal to except certain loan-related swaps entered into by IDIs, but would remove the 90-day restriction and eliminate the syndicated loan requirement.
- Delegation of authority. The industry groups as well as AFR oppose the proposed delegation of authority to determine the calculation methodology to the Director of the CFTC's Division of Swap Dealer and Intermediary Oversight.