CFTC and SEC May Need to Work Out Key Differences Related to Over-the-Counter Derivatives Rulemaking

In their efforts to move forward with rulemaking for over-the-counter derivatives, some are saying that the Commodities Futures Trading Commission and the Securities and Exchange Commission may find themselves grappling with differences that could pose a challenge for industry participants. For example, differences between proposed and final regulations could set up compliance issues. Also, the regulators appear to be working at separate paces to put into effect the Dodd-Frank Wall Street Reform and Consumer Protection Act’s Title VII, which issued a directive to both regulators ordering them to establish a regulatory regime to oversee swaps.

According to reform legislation, security-based swaps are swaps based on one loan or security or on a securities index that is narrowly based. In general, the CFTC’s jurisdiction includes all swaps except for security-based swaps, which the SEC oversees.

With the other types of swaps under its charge, the CFTC has to write a lot more swap regulations compared to the SEC. So far, under Title VII the CFTC has finalized 25 swap rules. The SEC has adopted three. (Just last January, the CFTC adopted rules addressing cleared swaps customer collateral segregation, registering significant swap participants and swap dealers, and business conduct for swap dealers interacting with counterparties.) However, together the regulators have jointly put forward proposals for definitions for products and key entities under Title VII. These definitions, however, have yet to be made final and some have expressed concern that the regulators are forging forward with adopting final rules without adopting the key definitions that certain requirements will be relying upon.

While the SEC has divvied up its rulemaking into the first and second halves of the year, the CFTC’s two blogs for swaps rulemaking have been separated between before March 31 and after. It doesn’t help that some of the rulemaking items that the SEC doesn’t plan to tackle until the latter part of the year will likely be dealt with by the CFTC by the end of March.

It might be tough for market participants to work with separate standards of business conduct. The SEC and CFTC have proposed rules that overall cover the same behavior, but there are key differences between their proposals when it comes to risk disclosure, counterparty verification, and safe harbors for advisors of special entities. And, in an effort to mute conflicts of interest, the CFTC has introduced requirements that Dodd-Frank is not requiring. Meantime, the SEC will continue to depend on its antifraud authority, per federal securities law.

It doesn’t help that swaps could fall into either the SEC jurisdiction or that of the SEC depending on whether a broad or narrow index of securities is their basis. This could prove especially challenging if, for example, an SEC-regulated swap also were to fall under the CFTC rules because of a broader index. Also, while SEC’s proposed registration requirements would let dual registrants undergo a simplified registration process that is expedited, the final rule of the CFTC doesn’t accommodate a process this simplified.

SEC, CFTC Divergence on Swaps Rules Could Signal Compliance Challenges Ahead, Bloomberg BNA, January 27, 2012

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