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7.3 Impact on Banks and Dealers

<< Title VII Overview

7.3 Impact on Banks and Dealers

The following links provide expanded analysis within this section:


            7.3.       Impact on Banks and Dealers.

                        7.3.1.    What Types of Banks and Dealers are Covered?  Under Title VII, banks, dealers and other financial institutions active in the derivatives markets may be considered "swap dealers" and subject to registration and record-keeping requirements.  As noted above, a swap dealer is defined as any person who: (i) holds itself out as a dealer in swaps; (ii) makes a market in swaps; (iii) regularly enters into swaps with counterparties as an ordinary course of business for its own account; or (iv) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in swaps.

            Title VII includes a substantially similar definition for a "security-based swap dealer," which deals primarily in security-based swap transactions. 

            Unknown at this point is what may constitute a person "hold[ing] itself out as a dealer in swaps" or purchasing or selling swaps in the "ordinary course of business."  Title VII does not task the Commissions with defining these terms.

7.3.2.    Can Banks and Dealers Engage in Swap Activities Without Being Deemed a "Swap Dealer"?  Yes, the entities below will not be deemed swap dealers in the following circumstances: (i) an insured depository institution to the extent it offers to enter into a swap with a customer in connection with originating a loan with that customer; (ii) an entity that buys or sells swaps for such person's own account, either individually or in a fiduciary capacity, and not as "part of a regular business;" and (iii) an entity that engages in a "de minimis quantity" of swap dealing in connection with transactions with or on behalf of its customers.  The CFTC and SEC are charged with promulgating regulations to establish factors in making the determination of a "de minimis quantity."

                        7.3.3.    What are the Consequences of Being a Swap Dealer?  Each swap dealer is required to register with the CFTC or SEC depending on whether such swap dealer's derivatives business involves swaps or security-based swaps.  The Commissions are charged with developing the form and manner of such registration.  Swap dealers will also be required to submit on-going reports containing such information relevant to the swap dealer's business as the Commissions may require. [§731]

            Commission rules must provide for the registration of swap dealers not later than 1 year after the date of enactment of the Act.  Note, however, that Section 754 of the Act states that the provisions of the Act shall take effect on the later of 360 days after enactment of the Act or, to the extent a provision in the Act requires rulemaking, not less than 60 days after publication of the final rule implementing such provision.

The CFTC and SEC will each determine for swap dealers and security-based swap dealers the form and manner of the registration applicable to be filed with the applicable Commission.  The CFTC and SEC will further determine what information will be required to be submitted to the applicable Commission on an on-going basis.

                        7.3.4.    What are the new Regulatory Capital and Margin Requirements for Swap Dealers?  In the event a swap dealer is registered with one or both Commissions, each such swap dealer for which there is a prudential regulator, such as the Fed or the FDIC, must meet new minimum capital standards and initial and variation margin requirements for uncleared swaps as required by such prudential regulator.  For any swap dealer for which there is no prudential regulator, such capital standards and margin requirements will be set by the applicable Commission.[§731]

            In terms of the amount of any such additional regulatory capital required, the Act mandates that such amounts must help ensure the safety and soundness of the swap dealer and be appropriate for the risk associated with the uncleared swaps held by the swap dealer.

The applicable prudential regulators, in consultation with the SEC and CFTC, shall jointly adopt rules for swap dealers, with respect to their activities as swap dealers, for which there is a prudential regulator imposing capital requirements and both initial and variation margin requirements on all Swaps that are not cleared by a derivatives clearing organization ("DCO").  

The SEC and CFTC shall adopt rules for swap dealers, with respect to their activities as swap dealers, for which there is no prudential regulator imposing capital requirements and both initial and variation margin requirements on all swaps that are not cleared by a  DCO.  

                        7.3.5.    What Reporting and Record-keeping Obligations do Swap Dealers face?  Swap dealers will be required to provide reports to the Commissions regarding the transactions and positions and financial condition of the swap dealer.  Daily trading records will need to be maintained and all related records, recorded communications (such as email, instant messaging and recorded telephone calls) for such period of time as the Commissions may require.  A swap dealer will also be required to maintain books and records of all activities related to its business as a swap dealer in such form and manner and for such period of time as the Commissions may require.  Such books and records must be available for inspection by the relevant Commission, the Department of Justice, appropriate Federal banking agencies, and other regulators.  Swap dealers will further be required to maintain a complete audit trail for conducting comprehensive and accurate trade reconstructions. [§731]

                        7.3.6.    What Business Conduct Standards Will Apply to Swap Dealers?  Each registered swap dealer will be required to satisfy business conduct standards adopted by the Commissions that will: (i) establish a duty for a swap dealer to verify that any counterparty meets the eligibility standards for an eligible contract participant; (ii) require disclosure by the swap dealer to any counterparty to a transaction of (a) information related to the material risks and characteristics of the swap transaction; (b) any material incentives or conflicts of interest that the swap dealer may have in connection with the swap transaction; (c) for cleared swaps, upon the request of the counterparty, receipt of a daily mark of the transaction from the appropriate DCO; and (d) for uncleared swaps, receipt of a daily mark of the transaction from the swap dealer; (iii) establish a duty for a swap dealer to communicate in a fair and balanced manner based on principal of fair dealing and good faith; and (iv) establish such other standards and requirements as the Commissions may determine are appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the  Act.  731]

                        7.3.7.    What Special Requirements do Swap Dealers Face when acting as Advisors to Special Entities?  A swap dealer that acts as an advisor to a governmental plan or entity, employee benefit plan or endowment, referred to as a "Special Entity," must adhere to a higher standard of conduct and act in the best interests of such Special Entity.  For example, a swap dealer that acts as an advisor to a Special Entity must make reasonable efforts to obtain such information as is necessary to make a reasonable determination that any swap recommended by the swap dealer is in the best interests of the Special Entity, including such information relating to the Special Entity's financial status, tax status, investment or financing objectives and any other information that the Commissions may prescribe.  731]

                        7.3.8.    What Special Requirements do Swap Dealers Face as Counterparties to Special Entities?  A swap dealer that acts as a counterparty to a governmental plan or entity, employee benefit plan or endowment, referred to as a "Special Entity," must adhere to any duty established by the Commission that requires the swap dealer to have a reasonable basis to believe that the special entity has an independent representative that i) has sufficient knowledge to evaluate the transaction and risks; ii) is not subject to statutory disqualification; ii) is independent of the swap dealer; iv) undertakes a duty to act in the best interests of the counterparty it represents; v) makes appropriate disclosures; vi) will provide written representations regarding fair pricing and the appropriateness of the transaction; and vii) in the case of employee benefit plans, is a fiduciary. [§731]