The Final Rules will generally be effective October 12, Background Title VII of the Dodd-Frank Act bifurcates the regulation of derivatives. Among other matters, this categorization affects whether the instrument is considered a security for purposes of the federal securities laws, whether the instrument may lawfully be traded over-the-counter or must be traded on, or subject to the rules of, an exchange, whether the instrument must be centrally cleared, which reporting and recordkeeping requirements apply to the instrument, and whether an investment manager using the instrument meets certain de minimis exemptions from registration as a commodity pool operator or a commodity trading advisor or must register as such.

Due to the wide variety of transactions within the derivatives marketplace, the continually evolving and bespoke nature of certain of these transactions and the breadth of these two definitions, there is considerable room for interpretation as to whether a given instrument constitutes a swap or a security-based swap. This Alert provides a broad overview of the Final Rules and summarizes, in turn, the following topics:.

General Interpretive Guidance B. Foreign Exchange Products C. Swaps Referencing One or More Securities or Loans and Securities Indices D. Security Based Swap Agreements E.

FDIC: Selections from the Dodd-Frank Wall Street Reform and Consumer Protection Act

Transactions That Do Not Constitute Title VII Instruments G. General Interpretive Guidance The Final Release makes clear that the determination of whether an instrument is a Title VII Instrument should be based primarily on the substantive terms and characteristics of the instrument rather than its form.

However, the Commissions stated that a relevant consideration may be whether the transaction is documented using an industry standard form agreement that is typically used for swaps and security-based swaps. Title VII Instruments referencing rates based on the volatility, variance, rate of change, spread, correlation or difference between the foregoing and other monetary rates, such as the consumer price index or the rate of change in the money supply, will also be considered swaps, as would correlation or basis swaps based on the difference between such rates.

A Title VII Instrument that references a yield that is not based upon that of a debt security, a loan or a narrow-based security index will be considered a swap or a mixed swap, depending on its terms. The Commissions also clarify that the source of certain fixed terms or conditions in a Title VII Instrument, such as the source of the interest rate payable by one party, may be informed by a term or condition of a security, rate or other commodity determined at the time of execution without changing its characterization.

It is worth contrasting here a transaction where one of the payments under the Title VII Instrument actually references a security with a floating yield.

In such a case, the payment is not merely informed by the yield of another security; it directly mimics that yield and, as such, the term would impact the characterization of the Title VII Instrument.

As discussed in greater detail below, including these foreign exchange products in the definition of swaps could entail new CFTC registration obligations for the advisers of funds that hedge foreign exchange risk associated with securities positions. Consistent with the Treasury Notice of Proposed Determination, the Final Rules call for the explicit exclusion of FX swaps and FX forwards from the definition of swap if Treasury makes such a finding. As mandated by the Dodd-Frank Act, the Final Rules state explicitly that FX swaps and FX forwards will nonetheless remain subject to the reporting requirements set forth in Section 4r of the CEA requiring the reporting of swaps to a swap data repository or to the CFTC and that swap dealers and major swap participants who are party to such transactions will nonetheless remain subject to the business conduct standards set forth in Section 4s h of the CEA.

Certain Other Foreign Exchange Products As Section 1a 47 E of the CEA only empowers Treasury to make findings with respect to FX swaps and FX forwards, the Commissions clarify in the Final Release the characterization of certain other foreign exchange products.

Such contracts are cash settled in a single currency owing to currency controls or other regulations that make physical settlement impossible or impracticable. Similarly, the Commissions include currency swaps and cross-currency swaps as swaps, each of whichcan best be described as interest rate swaps with a currency component.

A currency swap is a transaction in which one party agrees to pay a stream of payments at a fixed rate and denominated in one currency in exchange for the other party paying another stream of payments at a fixed rate and denominated in another currency.

A cross-currency swap is the same arrangement except that one party pays a fixed rate and another party pays a floating rate. The CFTC notes that the treatment of foreign exchange spot transactions will depend on the relevant facts and circumstances.

In this regard, the CFTC does not expect that an unintentional settlement failure or delay for operational reasons or due to a market disruption will prevent characterization of such a transaction as a bona fide foreign exchange spot transaction. Implications for Funds and Fund Advisers The inclusion of currency options, FX swaps and non-deliverable FX forwards as swaps could entail a significant expansion of the scope of CEA regulation of funds and their advisers that do not consider themselves to be in the business of trading swaps or commodities, but that use cash-settled FX transactions to hedge currency risk.

Similarly, an adviser to a fund that engages in a currency transaction that is excluded from the definition of swap but that rolls delivery forward through book-outs may convert the transaction into a non-deliverable FX forward, thus converting it into a swap. With respect to private funds that invest in swaps, but not in other commodity interests, the compliance date is October 12, Therefore it may be important to be sensitive to the potential impact of swap regulation on entities that do not consider that they are engaged in swaps transactions.

Swaps Referencing One or More Securities or Loans and Securities Indices Section a 6 of the Dodd-Frank Act defines security-based swaps as a sub-category of swaps without regard to the exclusion of security-based swaps under the definition of swap.

Security-based swaps are swaps that are based on either i an index that is a narrow-based security index including any interest therein or on the value thereofii a single security or loan including any interest therein or on the value thereofor iii the occurrence, nonoccurrence, or extent of the occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, provided that this event directly affects the financial statements, financial condition or financial obligations of the issuer.

Single Name Credit Default Swaps. Where a credit default swap references a single obligation of an entity, the Commissions state that it should be considered a security-based swap based on a single security or loan or any interest therein or the value thereof as per the second or third prong of the definition of security-based swap. Single Name Total Return Swaps. If a total return swap is based on a single security or loan, the Commissions will consider it to be a security-based swap under the second prong of the definition of security-based swap.

The Commissions are adopting the following rules to help delineate narrow-based security indices from broad-based security indices:. The general definition, as set forth in Sections 3 a 55 B and C of the Exchange Act and Section 1a 35 A and B of the CEA, was developed with equity securities indices in mind and, as such, would apply to determinations regarding the characterization of Title VII Instruments other than Index CDS based on indices of equity securities.

The Narrow-Based Security Index Definition with respect to Index CDS In determining whether an index underlying an Index CDS is narrow-based, the Commissions are adopting a definition of narrow-based security index that is informed by the July Debt Index Rules. An issuer of asset-backed securities is not considered to be affiliated with any other issuer included in the index. In addition to being required to meet one of the four criteria above, the security index may not be composed solely of certain exempted securities, and, if a portion of the index is composed of such securities, the remaining securities in the index would need to satisfy one of these criteria.

The Commissions in the Proposing Release requested comment on whether a securities index underlying an Index CDS should be considered broad-based if a third-party index provider makes publicly available information about the composition of the index such as the component securities, index adjustment rules, etc. The Commissions decided in the Final Release not to exclude indices from the public information availability test by virtue of being compiled by a third-party index provider.

Index Migration The Commissions state in the Final Release that the characterization of a Title VII Instrument as a swap, security-based swap or mixed swap is made prior to execution but no later than when the parties offer to enter into the Title VII Instrument and that changes in the character of the index after that time generally will not affect this initial characterization during the entire term of the Title VII Instrument unless those changes are contemplated in the index terms at the time of execution.

However, potential or actual migration of a security index could affect the characterization of the related Title VII Instrument. If the future composition of a security index is certain, or intentionally designed, to migrate from narrow-based to broad-based or vice versa during the term of the instrument owing to predetermined criteria or a predetermined self-executing formula such as trading rules providing for certain mandatory non-discretionary index adjustments upon the occurrence of certain eventsthe Commissions will view the Title VII Instrument as a mixed swap.

The Commissions clarify in the Final Release that if it is possible for future migration to nism currency derivatives pdf based on such criteria or such a formula, but future migration is neither certain nor contemplated, then the Title VII Instrument will be considered a swap or a security-based swap, as appropriate, at execution and for the term thereof, and not a mixed swap.

Conversely, if the composition of the index may change in the future at the discretion of one or both parties, then the Commissions will regard the index as a narrow-based security index and the Title VII Instrument a security-based swap.

In addition, if the material terms of a Title VII Instrument are pivot point formula forex subsequent to execution based on an exercise of discretion and not through predetermined criteria or a predetermined self-executing formulathe instrument as so amended will bull call spread collar considered a new Title VII Instrument, and the characterization of that instrument will be determined anew at the time of amendment.

Index migration may cause practical difficulties where a market participant desires to enter into a new swap that references a migrated security index or for the purposes of offsetting an existing position that references a migrated security index with a new Title VII Instrument.

The market participant may need to purchase the new Title VII Instrument on a different platform and would be subject to different, and possibly conflicting, responsibilities and obligations. To mitigate these difficulties, the Commissions established a tolerance period. With respect to broad-based security indices that migrate to being narrow-based, the tolerance period provides that the security index will continue to be treated as broad-based so long as without giving effect to the tolerance period the security index is not narrow-based for more than 45 business days over three consecutive calendar months.

The Commissions state trade option dodd frank the intention of this grace period is to provide market participants with sufficient time to satisfy any listing and clearance requirements on an alternative trading platform. In order for a swap to be eligible for the tolerance period, i the swap must not have referenced a narrow-based security index during the first 30 days of trading or ii if the security index becomes narrow-based during the first 30 days of trading, then, during every trading day of the six full calendar months preceding a date no earlier than 30 days prior to the commencement of trading of the swap on the index, the index must not have been narrow-based.

Methods of Settlement for Index CDS For Index CDS, the Commissions are adopting additional interpretive guidance relating to methods of settlement that, in certain cases, conflict with the general rule that Title VII Instruments referencing narrow-based security indices should be considered security-based swaps while Title VII Instruments stock options volume scandal broad-based security indices should be considered swaps.

In particular, if an Index CDS that references a broad-based security index provides for mandatory physical settlement of a security that is not an exempted security or loan, it will be considered a mixed swap. However, if an Index CDS that references a broad-based security index provides for mandatory cash settlement, including through an auction process, it will be treated as a swap.

Security-Based Swap Agreements Security-based swap agreements are swaps over which the CFTC has regulatory and enforcement authority, but for which the SEC also has antifraud and certain other authority. The Commissions state that they are committed to working cooperatively regarding this dual enforcement authority.

However, the Commissions emphasize that certain types of agreements do fall under the definition even though they do not fall under the definition of security-based swap.

Swaps based on exempted securities other than municipal securities will also be considered security-based swap agreements. Mixed Swaps Amixed swap is generally defined as a security-based swap that is also a swap. First, the Treasury futures trading strategies are establishing a process to provide interpretation as to the proper characterization of a Title VII Instrument.

Second, the Commissions are providing some limited regulatory relief for dually registered swap entities who are parties to certain mixed swaps. Such relief is intended to prevent such dually registered parties from being subject to conflicting or redundant regulatory requirements imposed by the parallel regulatory regimes applicable to swaps and security-based swaps.

Transactions That Do Not Constitute Title VII Instruments Because the definitions of swap and security-based swap under the Dodd-Frank Act are expansive, various commentators have pointed out that the definitions could be read to include certain types of agreements and transactions that Congress probably did not intend to be considered swaps or security-based swaps.

The Final Release states that the following instruments will be excluded from those statutory definitions. Insurance Products The Commissions generally acknowledge that traditional insurance products should not be regulated as Title VII Instruments and should be separately regulated as insurance. Instead, the safe harbor also requires that such insurance products generally satisfy four additional requirements and that the providers of such insurance meet one of four criteria.

To the extent that insurance products issued by regulated insurance companies do not satisfy these additional requirements and are regulated as swaps or security-based swaps, their regulation by the states as an insurance product would be pre-empted under the terms of the Dodd-Frank Act.

The Commissions caution that future market conditions or other developments may warrant further rulemaking to determine whether certain products meeting the Insurance Safe Harbor should nonetheless be classified as swaps or security-based swaps. Moreover, the Final Release notes the possibility of future federal regulation of insurance based on suggestions in the Dodd-Frank Act, and the Final Rules will exclude federally-regulated insurance products in er forex billig to those regulated by the states.

In particular, when a counterparty to a swap that is not a security-based swap or a mixed swap has full or partial recourse to a guarantor, including via financial guaranty insurance, then the guarantee will be considered part of the swap. The CFTC states that this interpretation does not limit or otherwise affect the Insurance Grandfather.

The CFTC intends in a future release to finalize this interpretation and its effective date and to address its practical implications, including make money blogging south africa overlap of regulatory obligations respecting guarantees of swaps with regulatory obligations respecting the related guaranteed swaps.

The Final Release generally endorses the approach that the CFTC has adopted in the past for determining intent to effectuate physical delivery of energy commodities. Commodity Options Embedded in Forward Contracts.

The CFTC is extending the forward contract exclusion to forward contracts with embedded non-financial commodity options, while reaffirming that commodity options by themselves are included in the statutory swap definition. In addition, the forward contract and its embedded option will have to trade together in order for the contract to qualify for the exclusion. Such a contract would be considered an excluded nonfinancial commodity forward contract, although its forex rates eur aed option undermines the actual delivery of the purchased commodity, so long as the contract meets additional criteria set forth in the Final Release.

These criteria are designed to ensure expedia stock options the parties intend physical delivery and are engaged in a commercial business involving the underlying nonfinancial commodity and that the transaction is commercially reasonable. Comments on the new interpretation will be due October 12, The Dodd-Frank Act excludes purchases and trade options td ameritrade of securities from the definitions of swap and security-based swap.

Accordingly, the Commissions stated that purchases and sales of securities for deferred shipment or delivery i.

The Commissions also stated that a forward sale of a security on a contingent basis may, depending upon its terms, be excluded. In addition, as the purchase or sale of a security, the SEC and the CFTC also confirmed that such forward sales of MBS in the TBA market would fall within the exclusions for the purchase or sale of one or more securities on a fixed basis or, depending on its terms, a contingent basis how to determine support and resistance in forex trading therefore would fall outside the swap and security-based swap definitions altogether.

Consumer and Commercial Agreements Acknowledging that Congress did stock market questionnaire intend common business and household agreements that have attributes of swaps and security-based swaps to fall within the parameters of the new regulations, the Commissions are excluding from the definitions — 1 agreements to acquire or lease real or personal property, 2 mortgage applications, 3 agreements for personal services, 4 sales or assignments of rights owned by a consumer, 5 purchases of products or services for personal, family or household purposes at a fixed, capped or collared price at a future date, 6 mortgage rate caps or locks on consumer mortgages, 7 employment and retirement benefits arrangements, 8 sales, servicing or distributions arrangements, 9 business combination transactions, theory of rational option pricing pdf warehouse lending transactions in connection with building an inventory of assets in advance of a securitization of the assets as with mortgages, student loans, etc.

Participations in Loans and Lending Commitments Pursuant to an interpretation contained in the Final Release, the Commissions are excluding participations in loans and lending commitments from the definition of swap and security-based swap.

In order to be within the exclusion, a participation must satisfy the following conditions: These conditions are essentially intended to distinguish a loan participation from a credit default swap or total return swap.

It has taken this step because it believes that the south african reserve bank rand exchange rate forum in which to address those issues is provided by the process set forth in Section of the Dodd-Frank Act. That statutory provision requires that the CFTC exempt regional electricity transmission transactions from the CEA if it determines that it would be in accordance with the public interest to exempt from the CEA a category of electricity transactions that are regulated by the Federal Energy Regulatory Commission or otherwise.

Recordkeeping Requirements Section d 2 B and C of the Dodd-Frank Acts requires the Commissions, in consultation with the Board of Governors of the Federal Reserve, to stock exchange jobs toronto rules governing books and records requirements forex business opportunity in india security-based swap agreements.

In the Final Release, the Commissions stated that because the CFTC already has proposed books and records requirements for swaps, those rules will apply to swaps that are security-based swap agreements. The Commissions stated that there will be no additional books and records requirements for security-based swap agreements. Anti-evasion Rules The Dodd-Frank Act empowers the Commissions to adopt changes to certain definitions including the definition of swap and security-based swap in order to assure that transactions cannot be structured to evade the requirements of Title VII of the Dodd-Frank Act.

In addition, various provisions of the Dodd-Frank Act empower the Commissions to implement anti-evasion rules in other contexts. The rule contains similar provisions regarding currency and interest rate swaps that are willfully structured as FX swaps or FX forwards in order to avoid being characterized as swaps. Similar rules will also apply to transactions of a bank that is not federally regulated, which transactions are structured to evade the requirements of the Dodd-Frank Act.

Furthermore, the CFTC will deem as unlawful any activities conducted outside the United States, including entering into agreements and structuring entities, with the purpose of willfully evading the relevant provisions of the Dodd-Frank Act. In addition, the CFTC states that, in determining whether a person is a major swap dealer or a major swap participant, it will take into account whether such person willfully designed a transaction to evade the Dodd-Frank Act.

The CFTC reasons that such a provision is necessary to prevent those who seek to evade the requirements from also enjoying the benefits of such evasion. It should be noted that all of the foregoing anti-evasion rules adopted by the CFTC will not apply to agreements, contracts and transactions structured as securities under the securities laws, because such determinations would be left to the SEC.

These anti-evasion rules also do not apply to security-based swaps. The CFTC provides assurance in the Final Release that entering into transactions that qualify for the forward exclusion from the swap definition will not be considered evasive.

However, noting that forward contracts are economically substantially similar to swaps, the CFTC states that it will attempt to identify evasive behavior by carefully scrutinizing the facts and circumstances associated with transactions structured as forward contracts that do not, in fact, qualify for the forward exclusion. The CFTC clarifies in the Final Release that a transaction that has been self-certified by a SEF or a DCMor that has received prior approval from the CFTC, will not be considered evasive, although a SEF or DCM may be found to have falsely self-certified.

Finally, the CFTC clarifies in the Final Release that a transaction willfully structured to evade will be subject to the anti-evasion rules even if the counterparty is innocent of willful evasion.

However, the CFTC notes that it will impose sanctions only on the willful evader. The CFTC further suggests that in a case of fraud or misrepresentation by a willful evader, the CFTC may seek restitution on behalf of any innocent counterparties, who additionally would retain their usual private rights of action for breach of contract and any related equitable remedies.

Conclusion The status and character of a Title VII Instrument is going to be a foundational issue for derivatives markets because of the jurisdictional consequences of the character of a transaction. The Final Rules of the Commissions regarding this characterization reach more broadly than the Proposed Rules to provide delineations of many questions, but the Final Rules might also leave many market participants troubled by the lines the Commissions have drawn, which arguably include in the definition of Title VII Instruments many types of transactions that arguably could properly not have been so characterized.

They also leave many other questions unresolved and will likely be followed by a long line of interpretive questions to be resolved by the Commissions. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.

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MeerAnthony R. NolanLawrence B. PatentSkanthan Vivekananda, Daniel A. This Alert provides a broad overview of the Final Rules and summarizes, in turn, the following topics: The Final Rules A. The Commissions are adopting the following rules to help delineate narrow-based security indices from broad-based security indices: For our Alerts discussing the commodity pool and commodity pool operator registration issues in more detail, please click here and here.

Treasury noted that, unlike most other derivatives, FX swaps and FX forwards have a risk profile that is different from other derivatives because they have fixed payment obligations, are physically settled and are predominantly short-term instruments. The CFTC notes that Section 2 e of the CEA, as added by the Dodd-Frank Act, prohibits a non-ECP to enter into an off-exchange swap and assumes that Congress did not intend to implicitly repeal the permission in Section 2 c 2 B of the CEA.

For example, on January 1, Party A and Party B agree that on February 1,a net settlement payment will be made by one party to the other based upon the understanding that i Party A will owe U. In a quanto equity swap, the underlying reference is denominated in a foreign currency, the swap itself is denominated in the domestic currency, and payments under the swap are calculated using the exchange rate prevailing at inception, thereby protecting the investor from fluctuations in the foreign currency.

The Commissions state that a quanto equity swap will be considered a swap if the underlying is a broad-based security index or a security-based swap if the underlying is a security or a narrow-based security indexbut not a mixed swap, where i the purpose of the quanto equity swap is to transfer exposure to the return of the underlying without transferring exposure to any currency or exchange rate risk and ii any exchange rate or currency risk exposure incurred by the dealer due to a difference between the domestic currency and the foreign currency is incidental to the quanto equity swap, arises from the instrument s the dealer chooses to use to hedge the quanto equity swap, and is not a direct result of any expected payment obligations by either party under the quanto equity swap.

The Commissions distinguish compo equity swaps, where the parties assume exposure to, and the total return is calculated based on, both the performance of specified foreign stocks and the change in the relevant exchange rate. Compo equity swaps are classified as mixed swaps. The CFTC believes that Congress did not intend these standards to apply to spot transactions.

As a result of the rescission of Regulations 4. If the index CDS otherwise meets the requirements in the third prong of the definition, the index CDS would be a security-based swap. Whether an instrument that is based on two or more securities will be considered a swap or security-based swap depends on the narrow-based security index analysis summarized below.

Treasury bond, would be considered a swap. Application of the Definition of Narrow-Based Security Index to Debt Securities Indexes and Securities Futures on Debt Securities, 71 Fed. It remains to be seen how this calculation will work in practice. The criteria for public availability of information that will cause an index to be considered broad-based are generally as follows: CEA section 1a 35 B iii Iand section 3 a 55 C iii I of the Exchange Act.

During the grace period, the tolerance period rules do not apply, even where there is a migration of the security index back to being a broad-based security index. If, during the period from July 1, to December 31,the related security index was broad-based, the swap would be eligible for the tolerance period under the second prong.

However, if the security index was narrow-based during any single trading day of that period, it would not qualify under the second prong. Furthermore, if the security index was continuously broad-based for the period from January 1, to November 30, but thereafter became narrow-based, because November 30, would fall more than 30 days prior to the commencement of trading of the swap, the swap would not be eligible under the second prong.

The Final Rules expand and codify the list of Enumerated Products originally proposed and eliminate the proposed requirement that an annuity be subject to Section 72 of the Internal Revenue Code in order to be excluded from the swap or security-based swap definitions. The Proposing Release had suggested adding a fifth criterion for qualification under the Product Test — that the payment on the insurance contract not be based on the price, rate or level of a financial instrument, asset or interest or any commodity — and creating an exception for variable life and variable annuity products, which deliver guarantees that vary with the performance of specified assets, such as mutual funds.

The Final Release, however, rejects any such additional criterion, so the exception is not necessary. The requirement set forth in this clause B did not appear in the Proposed Rules. As an example, it states that an emission allowance can be physically delivered and consumed by emitting the amount of pollutant specified in the allowance.

Another example would be an agreement that permits a grain elevator to sell grain to the merchant on a future date at a certain minimum price but that does not obligate the elevator to do so. Privacy Policy Legal Notices Advertisement Statement RSS Contact Us Alumni Network Home. Anchorage Austin Beijing Berlin Boston Brisbane Brussels Charleston Charlotte Chicago Dallas Doha. Dubai Fort Worth Frankfurt Harrisburg Hong Kong Houston London Los Angeles Melbourne Miami Milan Munich.

Dodd-Frank Act | Derivatives in Review

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