The Impact of Dodd-Frank on Derivatives

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I. DODD-FRANK OVERVIEW

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), enacted on July 21, 2010, provides for the first time a comprehensive regulatory framework for the over-thecounter ("OTC") derivatives markets.' Fundamentally, Title VII aims to prevent future financial crises by mandating robust market level and transaction level transparency, while reducing structural leverage and systemic risk throughout the derivatives markets.2

While significant portions of Title VII remain subject to further rulemaking by the Securities and Exchange Commission ("SEC") and the Commodity Futures Trading Commission ("CFTC") (jointly, "Commissions"), Title VII codifies the global de-risking process that has been underway since the 2008-09 financial crisis, with a particular focus on:

* Reducing counterparty risk and enhancing transparency and price discovery by requiring clearing and exchange trading of eligible derivatives contracts;

* Deleveraging the OTC derivatives markets by imposing new regulatory capital and margin requirements on OTC swap dealers ("swap dealers") and certain large OTC swap participants ("major swap participants");

* Requiring swap dealers and major swap participants to register with the SEC and/or CFTC and to continuously disclose detailed information regarding their derivatives trading activities; and

* Prohibiting U.S. Federal guarantees and other Federal assistance from being provided to insured depository institutions involved in the swaps markets, subject to exceptions for certain types of swaps activities and affiliated swap dealers.

A. JURISDICTION

Dodd-Frank allocates jurisdiction over the OTC derivatives markets between the SEC for "security-based swaps" and certain participants in the security-based swaps markets, and the CFTC for all other "swaps" and certain participants in the swaps markets. The SEC, for example, will be the regulatory authority responsible for imposing new capital and margin requirements on security-based swaps, such as equity swaps, forwards, and options, while the CFTC will have analogous authority over all swaps other than security-based swaps, such as commodity swaps, forwards, and options.3

B. EFFECTIVE DATE

Significant portions of the Title VII legislation and mandated rulemaking were scheduled to take effect on July 16, 201 1 .4 The CFTC first granted temporary relief on July 14, 2011 to extend the deadline to December 31, 201 1.5 At its December 19, 2011 meeting, the CFTC further extended the effective date to July 16, 20 12.6

II. OTC DERIVATIVES SUBJECT TO DODD-FRANK

A. SWAPS

Dodd-Frank is intended to cover nearly all commonly traded OTC derivatives, including swaps and options on interest rates, currencies, commodities, securities, indices, and other tangible and intangible items and economic variables.

While a "forward" is not expressly included in the definition of a swap, a physically settled forward sale of a non-financial commodity or security is expressly excluded from the definition.7 This suggests that other forward contracts are intended to be included in the definition of a "swap."

B. SECURITY-BASED SWAPS

A security-based swap is essentially a transaction that would be categorized as a "swap" but which references a narrow-based security index or a single security or loan, or a swap that is based on the occurrence or non-occurrence of an event relating to a single issuer of a security or the issuers of the securities in a narrow-based index.8

C. FOREIGN EXCHANGE SWAPS AND FORWARDS

Foreign exchange ("FX") swaps and forwards are considered "swaps" and subject to regulation under Dodd-Frank, unless the Secretary of the Treasury determines that such transactions should not be regulated under Dodd-Frank.9 On April 29, 2011, the Secretary of the Treasury issued a Notice of Proposed Determination ("April 2011 Notice") providing that central clearing and exchange trading requirements would not apply to FX swaps and forwards. …