General Overview of Swap Transactions

Over the past few years the jurisdictional interplay between the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) has been significantly overhauled. One question we continue to receive from clients on this front is the potential regulatory implications under both agencies of investing or trading in swap transactions. In that regard, below is a general overview of the regulation of swaps.

The CFTC and the SEC jointly approved final rules on August 13, 2012 regarding the definition and regulation of what are generally known as “swaps.” Swaps have been categorized into four types: (1) swaps, (2) security-based swaps, (3) mixed swaps, and (4) security-based swap agreements. (Swaps and security-based swaps are the most common.) Under this framework, the CFTC regulates swaps, the SEC regulates security-based swaps, the two commissions jointly regulate mixed swaps, and the SEC has antifraud authority over the CFTC regulated security-based swap agreements.

“Swaps” are generally derivative products that reference such things as interest rates, exchange rates, commodities, or foreign exchange/currencies.

“Security-based swaps” are generally derivative products that reference single securities, single loans, or narrow-based securities indexes (indexes containing 9 or less securities).

Persons who fall within the definition of “swap dealers” must register with the CFTC, while persons who fall within the definition of “security-based swap dealers” must register with the SEC, though each commission provides registration exemptions. A dealer is generally one does one of the following four activities for swaps or security-based swaps: (1) holds itself out as a dealer; (2) makes a market; (3) regularly enters into transactions with counterparties in the regular course of business for its own account; or (4) engages in any activity causing the person to be commonly known as a dealer.

Excluded from the definition of any of the four types of swaps are “equity options” (any put, call, straddle, option, or privilege on any security, CD, or group/index of securities that is subject to the ’33 and ’34 Acts), certain consumer and commercial transactions (e.g., insurance products, loans—subject to certain requirements), physically settled nonfinancial commodity forwards (when both parities to the forward have a bona fide intent to make or take delivery), and security forwards (either the purchase or sale of securities on a fixed or contingent basis or sales of securities for deferred delivery that will be physically delivered).

Please feel free to contact us if you have any questions regarding this post.