This is the third of a multi-part series on a December 7th rule proposal by the SEC and CFTC (the "Regulators") to further define several key terms in Title VII of Dodd-Frank: swap dealer, security-based swap dealer, swap participant, major security-based swap participant, and eligible contract participant. In this posting, we ruminate regarding the Regulators’ rule proposal in respect of several miscellaneous items related to the definitions of  "swap dealer"  and "security-based swap dealer:"

1) Designation as a dealer for certain types of swaps; and

2) Interpretative Issues

a) Affiliates

b) Aggregators

c) Physical Market Participants

d) Electricity Generation and Transmission

But, as always, let’s set the theme of the posting – our prologue.

Prologue: To Be Bit to Death by Ducks

We almost skipped these miscellaneous because, well, writing about them is like being bit to death by ducks. Hopefully, we have done this in a way that makes the issues more manageable for our audience.

Designation as a Dealer for Certain Types of Swaps and SBS

Title VII provides that a person may be designated as a dealer for one or more types of swaps or SBS without being considered a dealer for other types of swaps or SBS. Never one to miss the opportunity to further complicate, Congress made this a permissive standard, rather than a mandate. 

To implement the statute, the Regulators are proposing two new rules – clause (3) of CFTC Rule 1.3(ppp) and clause (c) of SEC Rule 3a71-1. In essence, a firm will be regulated as a dealer  for any type of swap or SBS entered into by that person as a dealer, but may seek limited designation status (i.e., not be a dealer for non-dealer activity in respect of other swaps and SBS).  That all sounds logical to us.

CFTC’s Suggested Application to Physical Commodity Firms – Interesting note for readers that are physical commodity firms or other types of non-financial entities. In recognition of the fact that these firms may conduct swap dealing activity through an unincorporated business unit or division, the CFTC is proposing that the swap dealer requirements apply to swap dealing activities of the business unit but not to swap activities in other parts of the entity. That seems logical to us. But, the SEC did not sign on to this standard in respect of SBS, although that same general logic could apply to SBS – that does not seem logical to us.

Interpretative Issue #1: Affiliates

A trading desk or discrete business unit that is NOT a separately organized legal person is NOT the regulated dealer; rather, the legal person (i.e.,. corporation or, more colloquially, the firm) of which it is a part is the regulated dealer.

The indelible marks of dealing are holding oneself out as a dealer or being commonly known as a dealer. In the view of the Regulators, entering into transactions with affiliates (i.e., other legal persons under common control, such as "so-called" brother-sister companies) does not bear the imprint of these marks, unless the inter-affiliate trades are being entered into to avoid regulation as a swap or SBS dealer. (THE FOLLOWING IS NOT LEGAL ADVICE AND YOU SHOULD SEEK GUIDANCE OF LEGAL COUNSEL SHOULD YOU HAVE ANY QUESTIONS ABOUT YOUR FACTS AND CIRCUMSTANCES: As a general rule, the Regulators do not like the structural equivalent of three card monte (or Les Trois Perdants for the erudite street thieves in our readership base.)

Interpretive Issue #2: Aggregators

We LOVE the term "aggregator" at TSR. This is what it is all about::

A person, such as a co-op or a mid-market bank, enters into swaps  with other parties in order to "aggregate" the swap positions of the other parties into a larger size position for better pricing and/or more efficient execution in the derivatives markets.

The Regulators want to know what to do with aggregators and how to apply the de minimis exemption to their activities.

Interpretive Issue #3: Physical Market Participants

The Regulators want to know of any special considerations or accommodations that should be made for the markets in physical commodities such as oil, natural gas, chemicals and metals, as a result of the complexity and variation in those markets.

Interpretive Issue #4: Electricity Generation and Transmission

The Regulators want to know of any special considerations or accommodations that should be made for dealing activities of participants in the generation and transmission of electricity.  (For any non-profit, public power systems out there, the Regulators really want to hear your thoughts in respect of considerations arising from section 201(f) of the Federal Power Act).

Kicking the ducks from our ankles, we remain faithfully at your service.

Good day. Good reading. TSR