This is the fourth 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 refinements to the definition of “eligible contract participant,” as defined in Commodity Exchange Act Section 1a(18) [as redesignated by Section 712 (a)(9) of the Dodd-Frank Act, so stop looking for Section 1a(12) – been there, done that, still do that].
Prologue: The Good Old Days
Back in the good old days, to be an ECP was something special. You walked with a little bit of a swagger, knowing that the really ugly stuff in the Federal commodities and securities laws just didn’t apply to you. Well, the good old days are gone forever. At Section 2(d) of the Commodity Exchange Act – the statutory site (we meant to use an “s” instead of a “c” – bear with us) of the key former regulatory escape valves (i.e., former Sections 2(d),(e),(g) and (h) – now stands a central clearing mandate (to some in the really geeky corners of the financial markets, this whole thing conjures up “Park51”-like imagery). Yuck…so what good is the eligible contract participant definition in the post Dodd-Frank world, anyway?
The Purpose of the ECP Definition in a Post Dodd-Frank World
Long and short – if you ain’t an ECP, you ain’t a counterparty. Let us explain in more conventional terms. Dodd-Frank makes it unlawful for a party that is NOT an ECP (a “non-ECP”) to enter into a swap or a SBS outside of a futures or securities exchange, respectively. Furthermore, if a non-ECP enters into a SBS, then Dodd-Frank requires that a registration statement for the product be in effect. Conversely, this opens the doors for a retail market in the U.S. for swaps and SBS, since it means that non-ECPs can trade swaps over futures and securities exchanges.
(EDITORIAL NOTE: We say “swaps to the people” – we are sure that this is what Messrs. Dodd and Frank had in mind when they drafted Sections 723(a)(2) and 763(e) of their joyaux de l’art Congress-ique. Who knows – maybe Billy Joel is right, “You know the good old days weren’t always good, And tomorrow ain’t as bad as it seems.” )
Rule Proposal: Amend the Definition of Swap Dealer and SBS Dealer
The Regulators are proposing to further define the term ECP to include swap dealers, major swap participants, SBS dealers, and major SBS dealers.
(EDITORIAL NOTE: Congress did not add the new regulated categories (dealers/participants) to the definition of ECP. So, it seems to us that they are “non-ECPs”…mmmm….maybe THAT is what those sneaky Senators had in mind.)
Relationship Between Retail FX and ECP Status in Context of a Commodity Pool
A small part of our readership base has a large interest in this. So, unless you care about it, gloss over it; but, if you have an interest in Retail FX, then keep on reading…
Before Dodd-Frank, a commodity pool was an ECP if it had $5 million in total assets and was operated by a CPO regulated as such under the Federal commodities laws. There WAS no requirement that each pool participant be an ECP. It mattered not whether it was a pool that traded futures contracts on retail foreign currency transactions of the type described in CEA sections 2(c)(2)(B) or (C) (this latter category of underlying, “retail forex” and any pool trading such instruments a “Retail Forex Pool”).
After Dodd-Frank, every participant in a Retail Forex Pool must qualify as an ECP, in order for the pool itself to be an ECP (see clause (A)(iv) of Section 1a(18) of the Commodity Exchange Act, which is the ECP definition).
Further, in the December 7th rule proposal, the Regulators propose a look through to the composition of any funds that, in turn, invest in a Retail Forex Pool. And, “any funds” means “any funds.” In other words, a Retail Forex Pool will not be able to qualify as an ECP under clause (A)(iv) of the ECP definition if there is a non-ECP participant at any investment level (1st tier, 2ND tier, 3rd tier, 4th tier, ad nauseum, which our spellchecker believes to be ad museum). So, if not an ECP, then a non-ECP and if a non-ECP, then no access to SEFs and no access to bi-lateral trades (i.e., a Retail Forex Pool can only access the FX derivatives markets by trading FX futures through a futures exchange).
That’s it. Next up…MAJOR SWAP PARTICIPANTS AND MAJOR SBS PARTICIPANTS. We know…the suspense is killing you.
Good day. Good reading. TSR