The Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd Frank Act” or the “Act”) became law on July 21, 2010. Whilst the Dodd Frank Act has established a comprehensive reform of the United States (“US”) financial regulatory system, and has made changes to most of the financial industry, the focus of this article is based on the Act’s effect on swaps. In particular, this article addresses the requirement that certain swaps need to be cleared through clearing houses (“clearing requirements”).
How does the Dodd Frank Act impact Oman?
The Commodity Futures Trading Commission (“CFTC”) regulates swaps and considers that any swap entered into with a US person is subject to the Act’s rules. A ‘US person’ is defined by the CFTC to include:
- entities that are organised in the US;
- entities whose place of business is in the US; and
- swaps with affiliates of US entities.
In addition, swaps that are arranged or negotiated in the US may also be subject to requirements set by the Dodd Frank Act. Accordingly, with such a wide-ranging scope of implementation, financial institutions in Oman who engage in various types of swap transactions with counterparties in the US are subject to the regulation under the Dodd Frank Act and specifically Title VII. This is the provision that imposes clearing transactions on all non-exempt swap transactions. However, any swaps entered into before the application of the clearing requirements are not subject to clearing. The purpose of Title VII is to both minimise risk of derivatives trading to the economy and the public, and create transparency in derivatives markets.
However, it should be made clear that the CFTC and the Securities and Exchange Commission (“SEC”) as regulatory bodies have at the time of writing made only certain types of swap transactions subject to clearing requirements. It is therefore expected that further regulations governing the clearing of swap transactions will be implemented in due course. The following clearing requirements apply to financial institutions in Oman that deal in transactions with a US counterpart:
- specific interest rate swaps; and
- forward rate swaps.
These are in addition to commodity options that are already subject to clearing requirements. Therefore, specific interest rate swaps, forward rate swaps and commodity options must all be traded on a registered exchange that has been approved by the applicable regulator for trading. The applicable regulator will either be the CFTC or SEC depending on whether the swap is non-security based or security based. In addition, depending on whether the swap is non-security or security based will determine by what method it will be exchanged, for instance traded on a board of trade (which is an organised exchange or other trading facility) or national exchange.
What swap transactions are subject to the clearance requirements?
As this article has highlighted, not all swaps are subject to clearing requirements. However, the six classes of swaps that are specified by the CFTC that require clearing are:
- Fixed to Floating Swap Class;
- Basis Swap Class;
- Forward Rate Agreement Class;
- Overnight Index Swap Class;
- North American Untranched Credit Default Swap (“CDS”) Indices Class; and
- European Untranched CDS Indices Class.
Title VII provides that as of February 2014 both (1) untranched CDS indices and (2) fixed to floating interest rate swaps (US Dollars and non-US Dollars) are subject to the CFTC’s made-available-to-trade process.
Are there any exceptions to the clearing requirements?
It is worth noting that there are exceptions to the clearing requirement. One of these exceptions is the commercial end user exception (the “CEUE”). The CEUE will apply provided that:
- one counterparty to the swap is not a financial entity, or is an exempt financial entity;
- it is using the swap to hedge or mitigate a risk; and
- it notifies the CFTC as to how it generally meets its financial obligations associated with entering into uncleared swaps.
As the Dodd Frank Act was implemented a short time ago, the CFTC and SEC are still determining which swap transactions will become subject to the clearing requirements. As such, as an institution that deals with swap transactions, it is prudent to stay informed of information relating to swaps which must be cleared. In addition, financial institutions should work to identify the regulatory status of their counterparties to determine the impact of clearing requirements on them.