CFTC Staff has published a Final Report on the Swap Dealer De Minimis Exception (Final Report) addressing the level of swap dealing activity that is considered “de minimis” and therefore does not require an entity to register as a swap dealer with the CFTC. The Final Report provides updated data analysis, and summarizes public comments submitted on staff’s Preliminary Report published in late 2015 (which we discussed in a prior blog post).
The de minimis threshold
CFTC rules set an initial de minimis threshold of $8 billion in aggregate gross notional swaps entered into for “dealing purposes” over a 12-month period for an entity (and certain of its affiliates) before the entity must register as a swap dealer with the CFTC. Swap dealer registration brings with it a multitude of business conduct standards, risk management requirements, and other regulatory obligations (e.g., capital, margin, reporting, recordkeeping, etc.) imposed by the CFTC in its implementation of the Dodd-Frank Act.
However, those rules also provide that the de minimis threshold will fall to $3 billion at the end of 2017, unless the agency takes action to modify it. The CFTC directed that its Staff prepare a report on the de minimis threshold in order to assist the agency in determining whether to alter the scheduled decrease in the de minimis threshold.
The Staff’s Final Report (like its Preliminary Report) makes no recommendations. But it does indicate that its further data analysis has confirmed the key findings of the Preliminary Report (after making various assumptions necessitated by deficiencies in the available data). These findings include:
- At a $3 billion de minimis threshold, there would be up to approximately 84 additional potential swap dealers based on dealing activity relating to interest rate swaps (IRS) and credit default swaps (CDS), where the available data is most reliable (there currently are about 105 registered swap dealers);
- Only a substantial increase or decrease in the de minimis threshold would have an appreciable impact on the amount of IRS and CDS dealing activity that is subject to CFTC swap dealer regulation; and
- The substantial majority of all swaps trading already involves at least one registered swap dealer (and the gap on this metric that the Preliminary Report found between IRS and CDS on the one hand, and non-financial commodity swaps on the other hand, is narrowing).
The Final Report observes that most of the 24 comment letters received by the CFTC supported maintaining (or raising) the $8 billion de minimis threshold, although two supported reducing it to $3 billion or lower (particularly for non-financial commodity swaps due to manipulation concerns). One of these two letters was submitted by U.S. Senators Feinstein, Boxer, Wyden, Merkley, Murray, and Cantwell. The Final Report also takes note of non-binding legislative history from the Consolidated Appropriations Act of 2016 stating that the CFTC should establish a de minimis threshold of $8 billion or greater.
With respect to particular issues on which the Preliminary Report had requested comment, the staff’s Final Report concludes:
- There is little public support for setting different de minimis thresholds for different asset classes, or adopting a multi-factor de minimis threshold; and
- While the comments generally supported excluding swaps executed on an exchange or swap execution facility, and/or cleared, from an entity’s de minimis calculation, this issue should be left for another day because staff has not had sufficient time to evaluate its implications.
The road ahead
Commissioner Giancarlo issued a statement noting his understanding that the CFTC will now undertake a proposed rulemaking to determine the appropriate swap dealer registration threshold. But what that proposal will be remains to be seen.
This uncertainty regarding the de minimis threshold is highly problematic. Because the de minimis calculation is based on the preceding 12-months, a reduction of the threshold to $3 billion at the end of December 2017 requires entities wishing to avoid swap dealer registration to adjust their swap dealing activity by January 2017. This, Commissioner Giancarlo and many commenters fear, will impose unnecessary costs if the CFTC decides to keep the threshold at $8 billion; limit risk-management options for commercial end-users of derivatives; and consolidate risk in only a few large swap dealers – resulting in reduced liquidity, increased volatility, and/or higher fees or less competitive pricing.