July 15, 2011
CFTC Issues Final Effective-Date Order to Avoid
Disruption to Swap Markets
If you have any questions regarding the matters discussed in this
memorandum, please contact the
following attorneys or call your
regular Skadden contact.
Mark D. Young
Washington, D.C.
202.371.7680
mark.d.young@skadden.com
Maureen A. Donley
Washington, D.C.
202.371.7570
maureen.donley@skadden.com
Brian M. Duncan
Washington, D.C.
202.371.7396
brian.duncan@skadden.com
George M. Gilbert
Washington, D.C.
202.371.7516
george.gilbert@skadden.com
Timothy S. Kearns
Washington, D.C.
202.371.7244
timothy.kearns@skadden.com
Daniel S. Konar II
Washington, D.C.
202.371.7102
daniel.konar@skadden.com
O
n July 14, the U.S. Commodity Futures Trading Commission (CFTC) issued
a final order (Order) providing clarity to the derivatives markets and market
participants on two important issues under Title VII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank): 1) What Dodd-Frank statutory provisions take effect on July 16 and 2) What exemptions or other actions will
the CFTC take to avoid disruption or legal uncertainty for the derivatives markets and
their participants caused by the Dodd-Frank provisions taking effect on July 16. The
Order took effect on July 14, and is expected to be published in the Federal Register in
a matter of days.
Dodd-Frank set an ambitious goal of 360 days after enactment (July 16, 2011) for the
CFTC to complete its work on a new regulatory framework for swaps and contemplated that the new statutory provisions would take effect when that 360 day period ended
or at a later date set by the CFTC for those rules that were not yet adopted. Despite the
CFTC’s best efforts, this 360 day period has proven to be insufficient to finalize almost
all of the new swap rules. To avoid market disruption and to allow market participants
to know what the law is, the CFTC has issued an Order that identifies which Title VII
provisions will take effect on July 16, defers the effective date of other provisions and
provides appropriate exemptive relief under its statutory authority.1 The CFTC has
also issued a no-action letter to provide further relief with respect to certain provisions.
This memorandum describes the CFTC’s actions.
In most respects, the CFTC’s Order is identical to the Proposed Order on which the
CFTC requested comment in mid-June (Proposed Order). The CFTC relies on its authority under Section 4(c) of the CEA and Sections 712(f) and 754 of the Dodd-Frank
Act to provide the relief granted by the Order. The Order adopts, virtually as proposed,
the four categories of Dodd-Frank provisions outlined in the CFTC’s Proposed Order2:
Rachel Kaplan Reicher
Washington, D.C.
202.371.7042
rachel.reicher@skadden.com
*
*
•
Category 1 provisions require rulemaking and do not take effect on July 16.
•
Category 2 provisions take effect technically on July 16, but, to the extent they rely on terms requiring further definition under Category 1,
have no legal effect.
•
Category 3 provisions are statutory exemptions in current law that
are repealed on July 16; the CFTC proposes to replace these statutory
exemptions with temporary, comparable administrative exemptions.
•
Category 4 provisions will take effect on July 16.
*
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While complicated, the bottom line is that most of the Dodd-Frank amendments have
no legal effect on July 16.
1See § 4(c) of the CEA and §§ 712(f) and 754 of Dodd-Frank.
2
The Proposed Order was accompanied by a partial list categorizing provisions. In our client alert with
respect to the Proposed Order, we included a chart reflecting our judgment as to the categorization
of Dodd-Frank provisions. Accompanying its Order, the CFTC provides market participants with a
Commission-endorsed list attached as an appendix.
2
A. Category 1 provisions require rulemaking and do not take effect on July 16.
The CFTC confirms that the provisions for which Dodd-Frank prescribes mandatory rulemaking do
not take effect on July 16, but will take effect at a future date no less than 60 days after the CFTC
finalizes its rules. In other words, the CFTC will establish the statutory effective date of Category 1
provisions in its final implementing rules for those provisions. For example, the CFTC could adopt
final rules for the registration of Swap Execution Facilities (SEFs) on October 1, 2011 and make its
rules and the related statutory provisions requiring SEF registration effective on January 1, 2012.
Category 1 provisions include most of the core Dodd-Frank reforms to regulate the swap market
comprehensively: definitions of swap, swap dealer and major swap participant; mandatory swap trading and clearing; swap reporting, including real-time public reporting; registration of swap dealers,
major swap participants, swap data repositories and SEFs; business conduct standards; capital and
margin; and the all-important commercial end-user exemption. The CFTC also lists its new antimanipulation powers as Category 1 provisions in the appendix; however, the CFTC has issued final
anti-manipulation rules that will become effective August 15, 2011.3
B. Category 2 provisions have no legal effect on July 16, but technically are
effective on that date.
Category 2 consists of those provisions that depend upon the definitions of terms that require further
definition under Category 1. They are provisions that require CFTC rulemakings to implement, but
not provisions that Congress expressly required to be implemented by CFTC rules (the Category 1
rules). For example, the requirement that a commodity pool operator register with the CFTC if its
pool trades “swaps” is a new requirement under Dodd-Frank. It is a Category 2 provision because
the amendment to add “swap” to the definition of commodity pool operator will have no legal effect
until the CFTC finalizes its rules defining what is and what is not a “swap” (a Category 1 rule). The
Order emphasizes, however, that the exemptive relief for Category 2 provisions applies “only with
respect to those requirements or portions of such provisions that specifically relate to such referenced
terms [the terms and requirements that must be defined in rules adopted under Category 1 provisions].” (Order at 8.) Thus, commodity pool operator registration and regulation under existing law
continues in effect now, but the addition of registration or regulation duties triggered by swap activity
have not gone into effect.
The Order exempts persons from having to comply with Category 2 provisions until the earlier of
December 31, 2011 or such other time specified in a rule the CFTC adopts in the future to implement
the Category 1 provision, which is a condition precedent to making the Category 2 provision work.
The CFTC emphasizes in its Order that it retains the power to extend the December 31, 2011 end
date if it appears that the CFTC will not finalize the mandated Category 1 rules by the end of the year.
The CFTC has also issued a no-action letter with respect to three Category 2 provisions. These provisions impose collateral segregation requirements for uncleared swaps and chief compliance officer
requirements on swap dealers and major swap participants; they also prohibit a derivatives clearing
organization (DCO) from performing the functions of a DCO with respect to swaps unless it has registered with the CFTC. The CFTC believes no-action relief is necessary because it may lack authority
to grant exemptive relief with respect to these three provisions. Under the no-action relief provided,
3
Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on
Price Manipulation, 76 Fed. Reg. 41,398 (July 14, 2011). It is unclear whether these new rules will be applicable to
swaps before the CFTC and the SEC finalize their product rules on swaps.
3
the Division of Clearing and Intermediary Oversight and Division of Market Oversight will not recommend any enforcement action for failure to comply with the above-referenced provisions. As with
the relief granted by the Order, the CFTC’s no-action relief expires upon the earlier of the effective
date of the applicable final rule defining the relevant term or December 31, 2011.
C. Category 3 provisions take effect on July 16, but the CFTC grants temporary
administrative relief to mitigate their impact.
Category 3 provisions, which the CFTC identifies in its Order, are Sections 2(d), 2(e), 2(g), 2(h) and
5d of the current Commodity Exchange Act (CEA). Each of these sections is a statutory exclusion
or exemption that Congress enacted in 2000 to provide legal certainty to market participants engaged
in over-the-counter (OTC) derivatives. The purpose of these exclusions and exemptions was to
make sure the CEA and CFTC regulation generally would not apply to OTC derivatives. In particular, these exclusions and exemptions made clear that no OTC swap could be held unenforceable as
an illegal off-exchange futures contract under Section 4(a) of the CEA. In Dodd-Frank, Congress
repealed each of those exclusions and exemptions. The repeal of these Category 3 provisions unambiguously takes effect on July 16.
To remove the possibility of disruption in the swap markets, the CFTC proposes to exercise its
exemptive powers to preserve temporarily the pre-Dodd-Frank legal and regulatory treatment for
swaps. Specifically, the Order temporarily exempts qualifying transactions in financial, energy and
metals commodities (and any person or entity offering or entering into such a transaction) from the
CEA’s regulatory structure. The Order clarifies that this relief applies to commodity options on excluded and exempt commodities to the extent they were permitted by the statutory exclusions and
exemptions that were in place before July 16, 2011. The Order still subjects those transactions and
persons to CEA prohibitions against fraud and manipulation. The CFTC also emphasizes that options
in enumerated agricultural commodities (for example, soybeans, wheat and corn), however, are not
encompassed by the exemption but are still eligible for exemption under the CFTC’s Part 32 rules.
The Order formulates its exemption in two complementary ways. First, any transaction that would
have qualified under existing statutory exclusions or exemptions that are repealed by Dodd-Frank is
exempt from the CEA and CFTC regulation except for the antifraud and antimanipulation provisions.
Second, any transaction that is exempt today under the CFTC’s Part 35 Swap Exemption (which is
used most often today for agricultural swaps) remains exempt even if that transaction does not satisfy
each of the four prongs for that current exemption. (Options on non-enumerated agricultural commodities (for example, coffee, sugar and cocoa) also are still eligible for exemption under Part 35.)
In addition, the Part 35 exemption is now available for private transactions where one party is not an
eligible contract participant as currently defined in the CEA (which would otherwise be a disqualifier)
if that person enters into the transactions in conjunction with its line of business.
This administrative relief for swaps will remain in place until the earlier of December 31, 2011 or the
date when the CFTC’s new regulatory framework for swaps takes effect. Again, the CFTC has indicated it will revisit its December 31 deadline in November if it appears it will be unable to complete
its new regulations by year end.
The CFTC’s intention to preserve the legal status quo for swaps is commendable and consistent with
the public interest. With no congressional action to extend the Dodd-Frank effective date by statute,
and thereby delay the repeal of the exclusions and exemptions, the Order represents a critical effort
to provide legal certainty and quell market fears.
4
D. Category 4 provisions take effect on July 16.
Category 4 provisions are “self-effectuating” on July 16 and take effect fully on that date. Among the
provisions the CFTC deems effective are the amendments to CEA Sections 2(c)(2)(B), (C) and (E),
which address certain types of foreign exchange transactions with retail counterparties. The CFTC
notes that although these amendments will be effective as Category 4 provisions, Dodd-Frank’s
amendments to the definition of “eligible contract participant” will have no effect until the CFTC
completes its rulemaking on this topic. Until then, “eligible contract participant” will have the same
meaning it had under the CEA prior to Dodd-Frank. In its final Order, the Commission has also added
a provision to its Category 4 list, authorizing private rights of action for violations of certain of the
CEA’s swap provisions. While this provision is effective, it is uncertain and even unlikely that the
private right of action would provide a meaningful remedy to any party until the Commission adopts
the required swap rules.4
With the exception of the provisions mentioned above and amendments to the bankruptcy code regarding cleared swaps, the bulk of the remaining provisions do not apply to swaps. Most substantive
Category 4 provisions impose new obligations on entities that are already subject to regulation under
the CEA, but are not directed only at swaps. For example, designated contract markets (DCMs) and
DCOs are subject to new core principles in performing their self-regulatory functions. Among these
core principles taking effect on July 16 is the requirement that a DCO have a chief compliance officer.
Also, new CFTC enforcement authorities will take effect for retail foreign exchange and commodity
transactions, whistleblowers,5 and anti-disruptive trading practices.6
E. The CFTC clarifies its grandfather order.
In its Proposed Order, the CFTC had stated that exemptive relief would not be available to an electronic trading facility that was not already operating as an exempt commercial market or exempt
board of trade as of July 15, 2011. The Order abandons this restriction and clarifies that relief under
the Order is available to an electronic trading facility that currently operates or commences operations during the period of the relief pursuant to the pre-Dodd-Frank CEA Sections 2(d)(2) and 2(e).
Further, any exempt board of trade that filed a notice of exemption prior to July 15, 2011, whether or
not it is operating or begins operating during the relief period, qualifies for both the statutory one-year
grandfather relief and relief under the Order. The Order also confirms that a DCM may list and trade
swaps under its rules for futures contracts without any exemptive relief.
4
Indeed, the CFTC acknowledges “[t]o the extent that the Final Order provides exemptive relief under CEA section 4(c)
with respect to Category 2 and 3 provisions, such exemptive relief would, in effect, preclude a person from succeeding
in a private right of action under CEA section 22(a) for violation of such provisions.” (Order at 36).
5
The whistleblower provision is only partly effective. As of July 16, some statutory sections protecting whistleblowers
from retaliation will take effect.
6
The CFTC’s authority is effective with respect to a subset of disruptive trading practices (violating bids or offers, demonstrating disregard for the orderly execution of transactions, and spoofing). The CFTC has placed the portion of its
anti-disruptive trading practice authority encompassing the prohibition on the use of swaps to defraud in Category 2.