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An Introduction to the US Cleared Swap Infrastructure

By David. Felsenthal, Gareth Old and David Yeres
Originally posted on Harvard Law School Forum


In September 2009, the leaders of the G-20 stated that “All standardized OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.”

In the United States, legislation to give effect to this statement was a central pillar of the over-the-counter derivates provisions of the Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank requires that, following the effective date of detailed rules, standardized swaps that are accepted for clearing by clearing organizations must be submitted by the parties to the relevant clearing organization, unless one of the parties is an end-user exempt from the clearing requirement. Further, unless an end-user exemption applies, if a swap is accepted for trading by a registered execution facility, it must be traded on the exchange or by an approved off-exchange transaction like a block trade or “request-for-quote” (see “Swap Execution Facility” below).

This new regime will necessarily change the infrastructure within which swaps are transacted. Swap traders will have to become familiar with the roles of the clearing organizations, execution facilities and brokers involved in exchange trading and clearing, and in some cases, will need to execute new documentation to establish the contractual framework for trading and clearing. This briefing note briefly summarizes the roles of the key players in the new market, their regulatory status and the main contracts that bind them together.

It should be noted that Dodd-Frank distinguishes between two categories of swap transactions. “Security-based swaps” are swaps based on a single security or loan or a narrow index of securities or loan and are under the regulatory oversight of the Securities Exchange Commission (the “SEC”). “Swaps” are all other swap transactions, specifically those based on interest rates, commodities, broad-based indices and foreign exchange options, and are regulated by the Commodity Futures Trading Commission (the “CFTC”). This briefing note concentrates on the CFTC regulations, which are, at the time of writing, substantially more developed than the equivalent SEC rules.


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SEC Provides Temporary Relief: Title VII Will not go Into Full Effect on July 16

The Securities and Exchange Commission has issued guidance as to which of the Title VII requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act will apply to security-based swap transactions as of July 16, the effective date of Title VII. It also granted temporary relief to market participants from compliance with certain requirements.

The SEC’s announcement makes clear that all of Title VII’s requirements applicable to security-based swaps will not go into effect on July 16. The Commission’s action also grants temporary relief from compliance with most of the new Exchange Act requirements that would otherwise apply on July 16. 

Title VII is the portion of the Dodd-Frank Act that establishes a comprehensive framework for regulating OTC derivatives. In particular, it authorizes the Commission to regulate “security-based swaps” while also authorizing the CFTC to regulate other swaps. The portion of Title VII referred to as Subtitle B, which addresses the new regulatory regime for security-based swaps, generally will take effect on July 16 (360 days after the date of the Dodd-Frank Act’s enactment).

Although the guidance and temporary relief are now in effect, the Commission is seeking input from the public on today’s actions. Public comments should be received by July 6, 2011.

A complete list of the Commission’s work implementing the Dodd-Frank Act is available on the SEC website.

To read more on the guidance and temporary relief regarding security-based swap provisions of Dodd-Frank Act, please click here.

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SEC Announces Steps to Address One-Year Effective Date of Title VII of Dodd-Frank Act

On June 10 in Washington D.C., the SEC announced that it is taking a series of actions in the coming weeks to clarify the requirements that will apply to security-based swap transactions as of July 16 – the effective date of Title VII of Dodd-Frank – and to provide appropriate temporary relief.

The Commission will:

  1. Provide guidance regarding which provisions of Subtitle B of Title VII will become operable as of July 16, and, where appropriate, provide temporary relief from several of these provisions.
  2. Provide guidance regarding the various pre-Dodd-Frank provisions of the Exchange Act that would otherwise apply to security-based swaps on July 16. Under Dodd-Frank, security-based swaps would be included in the definition of “security” under the Exchange Act. While such swaps will be subject to provisions addressing fraud and manipulation, the Commission intends to provide temporary relief from certain other provisions of the Exchange Act so that the industry will have time to seek, and the Commission can consider what, if any, further guidance or action is required.
  3. Take other actions such as extending existing temporary rules under the Securities Act, the Exchange Act and the Trust Indenture Act, and extending existing temporary relief from exchange registration under the Exchange Act. This will help to continue facilitating the clearing of certain credit default swaps by clearing agencies functioning as central counterparties.

Title VII is the portion of the Dodd-Frank Act that establishes a comprehensive framework for regulating over-the-counter derivatives. In particular, it authorizes the SEC to regulate “security-based swaps” while also authorizing the CFTC to regulate other swaps.

To learn more about the SEC implementation of the Dodd-Frank Act and Title VII, please continue reading here.

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