SEC addresses security-based swaps in rule proposals

Washington, D.C., Dec. 15, 2010 — The Securities and Exchange Commission today voted unanimously to propose requirements of end-users when they engage in a security-based swap transaction that is not subject to mandatory clearing.

The proposed rule, required under the Dodd-Frank Act, specifies the steps that end-users must follow to notify the SEC of how they generally meet their financial obligations when engaging in a security-based swap transaction exempt from the mandatory clearing requirement.

The SEC also sought comment on whether to provide an additional exemption for certain financial institutions that would permit those institutions to use the exception to mandatory clearing that is available to end-users.

"This proposal lays out the critical types of information that entities must provide in order to qualify for the end-user exception," said SEC Chairman Mary L. Schapiro. "Importantly, the proposal seeks to prevent abuse of the end-user clearing exception by requiring a non-financial entity to notify the SEC each time it elects to use the exception. Together with today's mandatory clearing rules, we are fulfilling key requirements under the Dodd-Frank Act."

Public comments on the proposed rules should be received by the Commission within 45 days after their publication in the Federal Register.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act established a comprehensive framework for regulating the over-the-counter swaps markets. Among other things, Title VII of the Dodd-Frank Act requires security-based swap transactions to be cleared through a clearing agency if those transactions are of a type that the SEC determines must be cleared.

Essentially, the clearing agency generally acts as a middleman between the parties to a transaction, and assumes the risk should there be a default. When structured and operated appropriately, such clearing agencies can provide benefits such as improving the management of counterparty risk and reducing outstanding exposures through multilateral netting of trades. In other words, by "clearing" security-based swap transactions, a clearing agency helps to reduce the risk of cascading harm throughout the financial system in the event a party to a transaction fails to meet its obligations.

Through clearing agencies, regulators are more easily able to monitor transactions, including prices and positions taken by traders.

In some cases, though, the Dodd-Frank Act exempts certain types of transactions from the mandatory clearing requirement. In particular, the Dodd-Frank Act creates an "end-user clearing exception" that exempts clearing for a security-based swap transaction if one party to the transaction:

  • Is not a financial entity.
  • Is using the swap to hedge or mitigate commercial risk.
  • Notifies the SEC (in a manner set forth by the SEC) how it generally meets its financial obligations associated with entering into non-cleared security-based swaps (the "end-user clearing exception").

In addition, the Dodd Frank Act requires the SEC to consider whether to provide an exemption for certain financial institutions — small banks, savings associations, farm credit systems institutions and credit unions — including specifically those with total assets of $10 billion or less, that would permit them to use the end-user clearing exception. The SEC is considering such an exemption as an additional proposal.

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